Chris Bourne, compliance expert in AML, CTF, KYC and KYB, Northrow.
The UK has long prided itself on its robust Anti-Money Laundering (AML) legislation and its commitment to combatting financial crime. However, as criminals continually evolve their tactics, it is crucial to assess the effectiveness of AML controls in the UK and their future suitability as technology and crime develop.
This article reviews the steps the UK is taking to enhance its AML and Counter Terrorist Financing (CTF) controls, as well as the challenges it faces in ensuring financial integrity, with particular attention paid to Non-Fungible Tokens (NFTs) and their use in the proliferation of financial crime.
Gaps in AML laws and the rise of NFTs
The emergence of NFTs, essentially unique digital assets that can be bought, sold, and traded on various online platforms, has introduced new challenges to AML controls. Currently, the most expensive NFT ever sold was created by Mike ‘Beeple’ Winkelmann. Entitled ‘The First 5000 Days’, the NFT fetched a staggering $69.3 million in March 2021, becoming the fourth most expensive piece ever sold by Christie’s by a living artist. With such vast amounts of money being paid for digital tokens, it is no wonder the risk of money laundering and financial crime within the sector has skyrocketed.
The rapid adoption of NFTs has revealed gaps in AML laws, creating legal loopholes that criminals can exploit to launder illicit funds. These gaps have arisen primarily due to the anonymity and complexity surrounding NFT transactions.
While traditional financial products and services are subject to stringent AML regulations, the same level of oversight is not always applied to NFTs. Criminals have capitalised on this disparity, using NFTs to disguise the origins of illicit funds and launder money through digital art sales or complex token transfers.
There are several ways in which criminals can use NFTs to proliferate financial crime:
Layering: Money launderers may use NFTs as stepping stones in the creation of complex layers of transactions, making it difficult to trace the origin of funds. They can purchase NFTs using illicit funds, sell them to another party, who then resells them to another, creating a chain of transactions that masks the original source of the money.
Blending clean and dirty money: Criminals can also mix illicit funds with legitimate funds by purchasing NFTs using a combination of both. They may use dirty money to purchase the NFT and then sell it to another individual for clean funds, effectively laundering the illicit money.
Anonymity: NFT transactions can provide a certain level of anonymity and pseudonymity, making it challenging to identify the real individuals involved in the transactions. Money launderers can exploit this by creating multiple anonymous or pseudonymous accounts to conduct transactions, making it difficult for authorities to trace the flow of funds.
Quantifying the exact amount of money being laundered through NFTs is a complex task. The anonymity and decentralised nature of blockchain technology, which underpins NFT transactions, makes it difficult to obtain precise figures.
However, there have been reports and investigations suggesting that substantial amounts of illicit funds have already been laundered through NFTs, highlighting the urgency to address this issue effectively. Research from Statistia estimates that money laundering on NFT marketplaces totalled in excess of US$1.3 million in Q4 2021 alone.
What is the UK doing to improve AML controls?
Recognising the evolving landscape of financial crime, the UK has taken significant steps to enhance its AML controls. The government has introduced several legislative measures in recent years, including the 2017 Money Laundering Regulations and the 2019 Fifth Money Laundering Directive, which require financial institutions to implement stronger due diligence practices, customer identification measures, and risk assessment frameworks.
Despite the efforts made in regulating the AML compliance of traditional financial institutions and firms, challenges persist in effectively countering money laundering, particularly concerning NFTs. The speed at which technology advances often outpaces the development of regulatory frameworks, creating a window of opportunity for criminals to exploit emerging platforms and technologies.
As recently as February 2023, the government set out plans to regulate crypto assets such as NFTs, despite the FCA having oversight to monitor crypto asset firms for AML and terrorist financing protocols since early 2020.
Firms in the UK involved in exchanging or providing custody for NFTs, or indeed any other crypto asset, must be registered with the FCA and comply with AML requirements. However, this doesn’t prevent crypto asset businesses based outside of the UK from targeting UK consumers, nor from UK firms that have failed registration (nearly 90% of all applications fail) from relocating to alternative jurisdictions with lesser regulation and AML controls.
Safeguarding against the risks of NFT transactions
It is crucial for businesses and individuals involved in NFT transactions to remain vigilant of the risks associated with NFT and crypto asset transactions, as well as how to mitigate these.
Implementing comprehensive AML and KYC/B checks is essential, whether it involves conducting automated background checks on new clients or monitoring existing clients to ensure they are not involved in any suspicious or fraudulent activities. By verifying customer identities, firms can identify any red flags, such as previous involvement in illicit financial activities or associations with high-risk entities. This initial screening helps establish trust, protect against potential risks, and mitigate the chances of being unwittingly involved in money laundering schemes.
Further, monitoring services are crucial for NFT firms’ ongoing vigilance. These tools continuously track the activities of existing clients, ensuring that any sudden changes or suspicious patterns are detected promptly. By actively monitoring client behaviour, firms can identify potential indicators of money laundering, such as frequent large transactions or inconsistent buying and selling patterns. Such proactive measures allow for a swift response, reporting of suspicious activities, and the prevention of illicit transactions within the NFT ecosystem.
Research suggests that the problem of money laundering through NFTs may escalate in the near to mid-term, given the increasing popularity of digital assets and the evolving sophistication of criminal networks. Therefore, it is imperative for the UK to remain vigilant, adapt swiftly, and continuously enhance its AML controls to address emerging challenges effectively.
Tackling the issue of using NFTs for money laundering requires collaboration between governments, financial institutions, technology providers, and regulatory bodies. By fostering partnerships and sharing information, all involved in the NFT ecosystem can stay ahead of money laundering trends and implement proactive measures to combat fraud and financial crime.
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