C8 The BulleTin • Sunday, april 25, 2021
NON-FUNGIBLE TOKENS
Solve these puzzles on C4
Digital art frenzy raises questions
about taxes and law enforcement
transactions of non-fungible
tokens are definitely traceable,”
she said in an interview, calling
it a “tight paper trail.”
The IRS is “keenly aware” of
the use of blockchain to move
wealth and is investing in the
skills needed to trace those
trades, she said.
BY CAITLIN REILLY
CQ-Roll Call
The sale last month of a dig-
ital piece of art for a near-re-
cord price raises new questions
about a technology the financial
sector sees as offering great op-
portunity.
Christie’s auctioned the
artwork for $69 million and
recorded the transaction
on a public blockchain as a
“non-fungible token,” or NFT.
The digital collage incorpo-
rating 5,000 separate digital
images was created by Beeple,
whose real name is Mike Win-
kelmann, and can be seen on
the auction house website.
The price exemplifies the
frenzy involving non-fungi-
ble tokens, which rely on the
same technology that powers
cryptocurrencies, including bit-
coin and ether. The tokens are
unique records that represent
another asset. Unlike cash or
cryptocurrency, a non-fungi-
ble token isn’t completely inter-
changeable with another.
The flurry in activity and
soaring prices of non-fungible
tokens are raising questions for
federal officials about whether
the assets are susceptible to
money laundering, manipu-
lation or tax evasion. The art
world’s experience may also
give federal regulators a hint of
challenges in the future — as
well as a tool to address those
challenges. One area of vulnera-
bility is blockchains where both
cryptocurrencies and non-fun-
gible tokens are bought and
sold.
Tim Carpenter, who oversees
the FBI’s art crime team, said
the scope of the money laun-
dering problem in the art in-
dustry is “enormous.”
“Criminal enterprises have
long looked at the art market
as a useful place to hide their il-
licit proceeds,” he said. “It stems
largely from the fact that the
art market is almost completely
unregulated.”
Carpenter spoke with CQ
Roll Call about using art to
launder money in general and
wasn’t authorized to speak
about NFTs specifically.
The frenzy in NFTs has seen
Twitter CEO Jack Dorsey sell-
ing his first tweet as an NFT
for $2.9 million and football
player Rob Gronkowski selling
more than 300 collectible cards
for about $1.6 million total. In
February, an animated GIF of
the cartoon “Nyan Cat” fetched
more than $500,000 as a token.
Marketplaces where the to-
kens are created, bought and
sold saw a combined trading
volume of $342 million in Feb-
ruary, up from $12 million in
December, according to the
blockchain application tracker
DappRadar.
Money laundering
Auction houses selling art
don’t face the same know-your-
customer and anti-money laun-
dering regulations that banks
and financial institutions do.
That makes them an attractive
Nancy Kaszerman/ZUMA Wire
The Christie’s Auction House sale of a digital artwork for $69 million
last month illustrated the frenzied interest in non-fungible tokens.
vehicle for obscuring the illicit
origins of funds.
Skyrocketing prices and easy
movement across borders also
make non-fungible tokens at-
tractive commodities through
which to launder wealth, Car-
penter said.
Josh White, an assistant pro-
fessor of finance at Vanderbilt
University, said the anonymity
offered by non-fungible tokens
may raise some of the same
money laundering issues as the
physical art world. White was
an economist for the Securities
and Exchange Commission
from 2012 to 2014 and had later
stints as visiting scholar and
consultant to the agency.
“Blockchain is by nature both
visible and anonymous,” he
said. “If I were moving money
from the drug trades or any
kind of illegal activity, the cryp-
tocurrency space and the NFT
space by relation is definitely a
way that you can move assets in
a large way, in an anonymous
way, to try to circumvent some
of the banking rules that we’ve
put in place to identify this type
of stuff.”
The potential use of non-fun-
gible tokens for illicit activity
likely drives some of the de-
mand for and, by extension, the
value of non-fungible tokens, he
said. non-fungible tokens that
trade on blockchains, such as
Ethereum, that also support a
cryptocurrency provide an ad-
ditional layer of anonymity be-
cause users can buy tokens with
cryptocurrencies they also own
anonymously, White said.
Even for a crook, the
non-fungible token isn’t risk-
free, as its value could drop.
If a criminal buys a van Gogh
painting to launder money or
trade illegally, the artwork will
still be valuable years from now,
White said.
“But the token, you don’t re-
ally know,” he said. “What if the
speculative market comes to a
halt? What if there’s no more
demand for NFTs? The value
could go to zero really quickly,
whereas the value for the van
Gogh is still there.”
Manipulative trading
Whether non-fungible to-
kens have a long-term role in
illegal transactions depends on
how easy they are to trade and
how stable their prices are.
In the meantime, they’re
more likely to attract people
trying to manipulate prices than
money launderers, White said.
He cited similarities between
the emerging non-fungible to-
ken market and the penny stock
pump-and-dump schemes he
investigated at the SEC.
“No matter what new tech-
nology comes along, a lot of the
fraud is the same,” he said.
Manipulators would draw
in other investors by creating
the appearance of liquidity or
demand for a penny stock by
passing the assets among ac-
counts controlled by the same
group of people through “wash
trades.”
“For the NFTs, you could see
the exact same thing,” White
said. An individual could trade
an NFT among different cryp-
tocurrency accounts he or she
controls to attract buyers.
The emerging cryptocur-
rency sector has largely kept its
eye on the SEC and the Com-
modity Futures Trading Com-
mission in its fledgling years,
but investigation of this type
of manipulative trading would
likely fall to the Justice Depart-
ment, White said, noting that,
unlike penny stocks, non-fungi-
ble tokens aren’t securities. The
department may partner with
Treasury’s Financial Crimes En-
forcement Network if a scheme
involves banks, or with the
CFTC if it incorporates deriv-
atives.
White said investigators
looking for manipulation in
non-fungible token markets
have an advantage: the block-
chain itself, which should reveal
whether the same accounts pass
a token back and forth even
if account owners are anony-
mous.
Tracking tax evasion
Michelle Hutchens, assistant
professor of accountancy at
the Gies College of Business in
Champaign, Ill., said the public
digital record of a blockchain
would also help the IRS track
the movement of wealth and
uncover tax evasion.
“There are certain areas of
the economy where potentially
tax evasion or avoidance is eas-
ier because the wealth is less
trackable,” she said, adding that
there’s no equivalent public re-
cord of transactions in the cash
economy or for tangible art.
“With the appropriate tools,
Custody and customs
Wasim Ahmad, chief cryp-
tocurrency officer at the digital
asset storage and security firm
Vault12 Inc., said non-fungible
tokens raise questions about
the nature of custody when it
comes to digital assets and the
corresponding tax implications.
The issue is a familiar one in the
securities markets.
Ahmad corrected what he
called a misconception about
non-fungible tokens, saying in
an interview that the tokens and
the digital art they represent are
often conflated.
“They’re talking about the
NFT, which is the record of the
art, and they’re talking about
the art itself as if it’s all one
thing, and it’s not one thing,” he
said. “The NFT is much more
like a receipt.”
The tax question is whether
owners of non-fungible tokens
should have access to the same
tax havens that collectors of
physical art have. They can de-
lay or avoid some taxes by stor-
ing the art in warehouses called
freeports that exist outside na-
tional jurisdictions.
“If you purchase something
and it goes straight to a free-
port and you don’t receive it,
you don’t pay certain duties and
taxes,” he said. “There isn’t a
digital equivalent of that.”
Ahmad said he’s exploring
whether a digital freeport is
needed and how that would
work legally.
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