Notes on NFTs, the high-art trade, and money laundering

Last month, I wrote a story for Artnet (paywalled) describing how NFTs create new opportunities for bad guys to move money without attribution. Read the full story if you can. Otherwise, here are some of the points I touch on along with additional notes.

  • The physical art world has a money-laundering problem — it is a secret world where expensive pieces are often bought and sold anonymously.  
  • Art is subjective, so it’s easy to justify spending millions of dollars on a piece. “This is a beautiful painting. I paid what I thought it was worth!”
  • The art trade is not subject to the Bank Secrecy Act. In other words, the BSA does not consider art dealers, advisers, and auction houses to be financial institutions.
  • Many collectors keep their art in freeports — ultra-secure storage facilities in tax-free zones near airports. They can sell their art to anonymous buyers, and the art itself never even needs to leave the warehouse. Thanks to middlemen and shell companies, the buyers often don’t know who the seller is either.
  • A US Senate Permanent Subcommittee on Investigations report in July 2020 highlighted the extent of the problem. The report was devastating to the art world and pointed out the need to regulate the space.
  • The art trade is already regulated in the EU, under the Anti-Money Laundering directives. 
  • I like to compare buying an NFT to buying high-art in a freeport. You become the prestigious new owner, and you don’t even have to bother hanging the piece on your wall.
  • Disclaimer: I know of no conviction yet so I can’t name anyone, but if you look through a pile of NFT transactions, you’ll see stuff that looks very odd and worthy of investigation.
  • A lot of NFTs are bought and sold for crazy amounts of money — generally in the form of crypto — and often, we have no idea who the buyers or the sellers are. It’s not clear whether the platforms facilitating these trades know either.
  • Earlier this year, two CryptoPunk NFTs sold separately for $7.5 million each in crypto — Punk #7804 and Punk #3100. In both cases, the buyers were known only by their crypto wallet addresses.
  • In February, an NFT of Nyan Cat, a cat cartoon with a Pop-tart body, sold for $600,000 — in crypto. Again, the buyer was only known by their wallet address.
  • Those are just a few examples. There are many, many others.
  • The most practical way to launder money with NFTs would be via what is called “trade-based money laundering” — deals that appear legit on the face but are meant to hide the flow of ill-gotten gains. All you need are two parties to make that happen.
  • Let’s say, I need to receive $3 million worth of dirty crypto. I mint an NFT, establish its value by wash-trading (selling back and forth to myself a few times) and then sell it to my colleague. I then cash out at a banked exchange. If anyone asks where the money came from, I simply tell them, “I sold an NFT!”
  • Because regulations haven’t caught up with NFTs, some of the NFT marketplaces are relaxed in their anti-money-laundering and know-your-customer (AML/KYC) practices.
  • Nifty Gateway, the NFT marketplace owned by Gemini, is centralized. All of its NFT trades are handled off-chain. Gemini is registered with FinCEN, and it’s widely thought of as one of the more regulated platforms.
  • Also, it makes sense that Gemini would want to minimize risk and remain in good standing with the banks. (You can link directly to your bank account via Gemini. And you can purchase NFTs on Nifty Gateway with USD via your credit card.)
  • However, other NFT marketplaces, such as OpenSea, Rarible, and Foundation, tend to be more relaxed in their AML/KYC.
  • These exchanges are decentralized, meaning the backend code runs on the blockchain. Unlike Nifty Gateway, these platforms are non-custodial, meaning you always hold the keys to your own crypto. This is sometimes used as an excuse not to have a rigorous AML program in place. 
  • “KYC is only required when you buy crypto using OpenSea,” cofounder Alex Atallah told me. In that case, KYC is handled through Moonpay, a fiat onramp that lets you buy crypto with your credit card to spend on OpenSea.
  • If you transfer your own crypto onto the platform and buy an NFT with it, OpenSea doesn’t ask who you are. Nor does the platform ask who you are if you sell your NFT for crypto and move your funds off the platform.
  • All this will likely change. 
  • Regulators have their eyes on the art market — and the NFT market.
  • On Jan. 1, 2021, Congress passed the Anti-Money Laundering Act of 2020, as part of the National Defense Authorization Act, with the biggest changes to the BSA in two decades.
  • Among the changes, the AML Act extends the BSA to antiquities dealers.
  • Antiquity dealers are now considered financial institutions with the same record-keeping and reporting requirements. It is up to FinCEN to spell out exactly how this will be implemented. FinCEN has until Jan. 1, 2022, to do so.
  • The AML Act also commissions FinCEN to study the art market. If FinCEN finds significant links between money laundering and high art, it will likely recommend Congress extend the BSA to the wider art market, too. 
  • Experts believe this is very likely to happen. (As I mentioned above, it’s already happened in the EU.)
  • The good news: There is still time for art dealers and auction houses to review and update their AML programs. (Christie’s and Sotheby’s, who have been auctioning NFTs, have likely already updated their AML programs in response to the Senate PSI report.)
  • The AML Act also formally extends the scope of the BSA to crypto exchanges, in keeping with FinCEN’s earlier guidance that virtual currency businesses are money services businesses, and therefore, subject to BSA requirements.
  • NFTs, on the other hand, aren’t mentioned in the new AML law. But they are not being overlooked either!
  • In March, the Financial Action Task Force, a Paris-based AML watchdog, issued a draft updated virtual asset guidance, which could have implications for NFTs.
  • In its draft, the FATF doesn’t specifically call out NFTs, but it replaces an earlier phrasing of “assets that are fungible” with “assets that are convertible and interchangeable” in describing the kinds of virtual assets that need regulation. (NFTs are convertible when you sell them for other forms of crypto.)
  • This subtle change in language directly targets NFTs (and DeFi as well).
  • If the US adopts the final guidance — which it most likely will — those subtle changes in wording give FinCEN the authority to regulate not only existing virtual currencies but also emerging asset classes such as NFTs.
  • Additionally, NFTs could be considered art and NFT marketplaces could be considered art auction houses and get included in new BSA laws.
  • Like high-art, NFTs hit all the right targets for money laundering.

News: Coinbase set to go public, Tether releases meaningless attestation, are NFT sales slipping? 

Happy Easter! NFTs of this disturbing Easter bunny series are available on OpenSea. I was looking for more NFT bunnies but couldn’t find too many. Maybe I wasn’t looking hard enough.

In any case, Bitcoin is now at $58,000 and Tether has more than 42 billion tethers in circulation. Here’s the news:

Coinbase set to go public

Coinbase, the largest crypto exchange in the U.S., will start selling shares on Nasdaq on April 14. The company will trade under the ticker symbol “COIN” and offer 114.9 million shares as part of its direct listing. Share price will be determined by orders coming into the stock exchange. 

Currently valued at $100 billion, Coinbase is going public during the biggest Bitcoin bubble yet. The event will make Coinbase CEO Brian Armstrong—who owns 39.6 million of the company’s shares—a very wealthy man indeed. And the VCs backing the company will realize huge profits, as they all dump their shares on retailers.

On April 6, the exchange is expected to reveal its first quarter financial results and full year outlook. (CNBC) (Coinbase statement)

Tether’s meaningless attestation

In its latest PR move, Tether published an attestation verifying that it had $35 billion in assets backing a similar amount of tether for a blink in time on Feb. 28. The attestation was produced by accounting firm Moore Cayman, based in the Cayman Islands.

Bitcoiners are head over heels about this, but the report is meaningless. The document explicitly states that this does not mean tethers were fully backed at any other time—or are now. And the report doesn’t fit what the NYAG required Tether to publish by mid-May, because it doesn’t break out each category of backing asset by percentage. What’s backing tethers could be mainly bitcoin and toxic assets, for all we know. (David Gerard)

Days after Tether produced the attestation, it printed 1.2 billion tethers—one of its largest issuances ever. What’s a few billion more when bitcoiners think you are legit?

The wonderful world of NFTs

Are NFT sales slipping? Average prices for NFTs have fallen almost 70% from a peak in February to about $1,400, according to Nonfungilble.com, which tracks NFT marketplaces.

The NFT bubble hit its all-time high around the time Metakovan bought Beeple’s “Everydays—The first 5000 days” for $63.9 million on Christie’s. (Bloomberg) 

Cointelegraph also reports that the NFT market is experiencing a silent crash. While we can always see what the price of bitcoin is up to, tracking the movements of illiquid markets is trickier. When it comes to NFTs, buyers simply evaporate and sellers fail to move their wares. 

What is causing the drop in prices? “I suspect it is because the secondary sales have evaporated, so the dream of ‘greater sucker’ has gone away in about the same timeframe as the Crypto Kitties NFT bubble,” Nicholas Weaver said.

Meanwhile, Shares of Funko, a toymaker in Washington, are rising after the company acquired a majority stake in TokenWave, a developer of TokenHead, a mobile app for showing NFT holdings. Funko plans to launch its own NFT offerings this summer. (CNBC)

Other companies are jumping into the space. NFT platform Recur announced a $5 million seed round led by the DeFi Alliance, Delphi Digital, Ethereum co-founder Joe Lubin, and Gemini, among others. (Cointelegraph)

Justin Sun, the CEO of Tron, is now buying serious high art. He bought a Picasso for $20 million at Christie’s in London on March 23, where he also picked up an Andy Warhol for $2 million.

Sun, if you recall, was the second highest bidder for the Beeple “Everydays—the first 5,000 days” piece, driving up the price for Metakovan. Apparently, the Christie’s team in Asia reached out to Sun after the NFT sale to talk him into buying real physical art with all his spare change. (ArtNews)

How does OpenSea, an online market for NFTs, deal with copyright violations? They pocket the buyer’s money and tell them they should have done their own research. Buyer beware! (Vice)

John Cleese’s auction for an NFT of a speedily drawn Brooklyn Bridge ended on April fools’ day. The proud owner is now JeffBezosForeskin who paid $35,000 in ETH for it on Mintable.  

SNL is selling an NFT to their NFT skit an OpenSea. The top bidder gets two tickets to a live taping of the show. This gimmick just does more to promote NFTs, imho. (Decrypt)

Other newsy bits

A DOJ investigation into Representative Matt Gaetz and Joel Greenberg—the former tax collector in Seminole County, Florida—is focused on the pair recruiting women for sex. Greenberg is a bitcoiner. At one time, he wanted to start his own blockchain company, but was accused of dipping into public funds to do so. (The Daily Beast)

Greenberg has made a lot of headlines in recent years.

Terror-linked groups in Syria’s war-torn Idlib are changing their crypto tactics to avoid detection by Western law enforcement. (Wired)

Me, quoted in the news

After I wrote my story revealing the mystery Beeple art buyer, I got a lot of calls from the media asking me for comments about NFTs. 

I am featured in Voice of America: “Cryptocurrency Fuels Digital Art-Buying Frenzy”

Ben Munster quoted me in an article for The Art Newspaper: “NFT art bubble? 2017 crypto bust could spell out the future of current boom”

Kenny Schachter quoted me in an opinion piece for Artnet: “Professor Kenny Schachter Is Here to Teach You More About NFTs (and Put the Crypto Critics in Detention).” David Gerard is quoted in the same story. Kenny refers to us as “curmudgeons.” 

I was also interviewed by the Verge: “NFT mania is here, and so are the scammers.”

(Updated April 4 to add info about Recur.)

Feature image: Scary bunny on OpenSea

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WTF is an NFT? Here’s a rundown of the basics

NFTs are all over the news lately.

Recently, I was having drinks with a friend, who knows zip about crypto, and out of the blue, she started asking me about “non-fungible tokens.” 

The next day, a musician friend posted an amateurish drawing of a guitar on Facebook, proudly announcing, “This will soon be available as an NFT.”

If initial coin offerings were the crypto grift of 2017 and decentralized finance (aka “DeFi”) was the grift of 2020, then “nifties” are the grift of 2021, and they do just what crypto grifters need them to do: lure more dumb money into crypto.

How do they do this? By convincing artists that by “tokenizing” their digital art, they can prove ownership and make oodles of money for their work. They just need to buy crypto first, and then sway their friends into believing that crypto and NFTs are the wave of the future. Also, by convincing investors that NFTs are the hottest new thing.

If you are trying to get up to speed on this nonsense, you’ll find answers to your most basic questions below.

What’s an NFT?

NFT stands for non-fungible token. Fungible means interchangeable. It’s the idea that one asset can be swapped out for another and nothing is lost.

Bitcoin and ether, the two most popular cryptocurrencies, are examples of fungible tokens. One bitcoin works like every other bitcoin; likewise with ether.

A non-fungible token is different because only one ever exists. Each NFT contains unique data, so NFTs are not interchangeable with each other. They are not divisible either, whereas fungible tokens are.

This is a wonderful play on bitcoiners’ idea of scarcity. There will only ever be 21 million bitcoin—and there will only be one NFT! Scarcity clearly means something is valuable. Grab it while you can.

Most of the ICO tokens in the 2017 crypto bubble ran on Ethereum and were based on the ERC-20 token standard, so exchanges and wallets would know how to integrate them. NFTs on Ethereum also have their own standard: ERC-721. 

Other blockchains, like Tron, Binance Chain, EOS, and Polkadot, support NFTs but Ethereum is by far the most popular and widely used.

Because NFTs are unique, they are hyped as “collectibles,” rare one-of-a-kinds that will only go up in value over time. 

What are you actually buying?

An NFT is only a pointer to something else on the web. It could be an image, a music or video file, or even a tweet. The object itself does not live on the blockchain.

In fact, the server holding the object could go away or it could change what is displayed at that location—and then your NFT would point to nothing or something totally different, like a rug.

Really, an NFT is simply proof that an object exists.

It doesn’t convey copyright, or for that matter, any legal rights at all. If anything, it is akin to a “certificate of authenticity,” which says this is where this thing is located. Unless you have a contract that specifically spells out you own the rights to this object, you literally just bought the pointer.

In addition to a slew of hitherto unknown auction houses where NFTs are sold, big-name auction houses are getting in on the game. Sotheby’s recently announced it will be selling its first-ever NFT on behalf of digital artist Pak in April.

And last week, Christie’s auctioned an NFT of Beeple’s “Everyday: The First 5000 days” for $69.3 million in ETH. Christie’s even made the unusual decision of accepting its premium in magic beans.

In its conditions of sale, Christie’s carefully points out that NFTs carry no rights:

“You acknowledge that ownership of an NFT carries no rights, express or implied, other than property rights for the lot (specifically, digital artwork tokenized by the NFT). You understand and accept that NFTs are issued by third parties, and not by Christie’s itself.”

Even if you own an NFT, that doesn’t mean you can restrict other people from seeing the object it points to. 

Jack Dorsey, Twitter’s billionaire CEO, is selling an NFT to his first tweet. The bidding is now up to $2.5 million. But you don’t need an NFT to see the tweet. (It’s worth mentioning that Dorsey is a big fan of crypto. His company Square invested $50 million into bitcoin last year, so it’s no wonder that he is shilling NFTs.)

When you buy an NFT, what you are buying is the private key to a crypto-token. The value is mainly speculative. You will only get for it what someone else is willing to pay—if you can find a buyer, and there is no guarantee that you will, when the time comes to cash out.

The problem is that people’s perceptions of what they are buying when it comes to NFTs don’t always mesh with the legal realities. And marketplaces involved in these sales are not always transparent about what they are selling. In fact, the more questions you ask about the real underlying value of an NFT, the vaguer the responses become.

How to create an NFT

If you are an artist who wants to create an NFT to auction, first you want to download a digital wallet that supports the ERC-721 token standard, such as MetaMask, Trust Wallet, or Coinbase Wallet, and put a little ETH in it to pay for “gas.” Plan on spending $50 to $100 worth of ETH to cover the costs of creating your token. 

After that, there are plenty of sites, including OpenSea, Mintbase, and Rarible, that will take your money and step you through the process of “minting” your NFT.

Connect your wallet to one of those sites. Write up a description of your artwork, upload your image, and voila, you’ve created your first NFT.  

Unfortunately, many struggling artists find their NFTs simply languish on these auction sites, and they’ve sunk $100 into nothing when they could have gone out and bought groceries instead.

A short history of NFTs

Where did NFTs spring from? Although the technology for NFTs has been around almost as long as bitcoin, NFTs hit the mainstream in 2017 with CryptoKitties, a game that allowed people to buy and “breed” limited-edition virtual cats with crypto. CryptoKitties was the first NFT to use the ERC-721 standard.

Last summer, game developers got into NFTs in a big way. NFTs enabled gamers to win in-game items (e.g., a digital shield, a digital sword, or digital skins), transfer their assets from one game to another, and then sell their in-game NFTs in blockchain marketplaces—sometimes for impressive sums.

Soon after, NFTs found their way into the art world, hyped by celebrities who weren’t always up to speed on crypto. Lindsay Lohan minted her own token on Rarible, based on an image of her face.

Hours after she put her NFT up for sale, she tweeted, “Bitcoin is the future, happening now,” even though her NFT lived on Ethereum. Lohan sold the image for over $17,000. It was quickly resold for $57,000.

Here are some NFTs making the news in the last two months:

Keep in mind, most of these NFTs don’t sell for real money, they sell for ETH, and the trick is then converting your ETH into fiat, so you can spend it in the real world.  

What are the risks?

NFTs open the door to fraud and general funny business. This is because 1) money is involved, usually in the form of crypto; and 2) regulators haven’t caught up with grift. 

Crypto bros promote NFTs as the ultimate stamp of authenticity, yet for many artists, the NFT market has done the opposite: it’s opened the door for swindlers. Here’s what can happen:

You can create an NFT of someone else’s work. There are no protections in place to ensure that an NFT you are buying was created by the actual artist. Digital artists, ranging from 3D renderers to pixel painters, have all discovered their art on online marketplaces. 

There are literally dozens of bots on Twitter that will allow you to create an NFT of a tweet simply by tagging it, and Twitter has thus far made no moves to block these accounts.

The problem got so bad that Corbin Rainolt, who designs detailed paleo art, had take down all of his dinosaurs and repost them with watermarks. 

“I tried to block all NFT accounts but it seems I can’t block everyone of these accs,” he said on Twitter.

Illustrator Chris Moschler doesn’t get the buzz around NFTs.

“Art theft has never been this aggressive and rampant ever before,” he tweeted, after blocking dozens of Twitter accounts trying to mint NFTs based on his tweets. “I cannot understand how this is still being called a revolutionary movement in the art world.”

It is also possible to create an NFT of a piece of work on one auction site, and then create NFTs on the same piece of work on a plethora of other auction sites. What’s to stop you?

Some NFT marketplaces do better due diligence than others, but they take a cut of anything sold and can easily wash their hands of it afterward.  

Your NFTs can also be stolen. Not your keys, not your crypto, as the saying goes, and when you leave your NFT on an auction site, they have control of the keys.

Recently, several Nifty Gateway customers reported a hacker breaking into their accounts and stealing their NFTs. Some of the victims also said their credit cards on file were used to purchase additional NFTs, which were then transferred to a hacker’s account. (Nifty said those users did not have 2FA turned on.)

Also, NFTs open up big-time opportunities for money laundering. Art is an attractive vehicle to launder money, to begin with. Transactions are often private, and valuations of art can vary widely for unexplained reasons. Art prices can also be extremely high, so there is no reason not to expect that NFTs will be used for the same purpose.

Right now, the NFT bubble is a big one. Crypto grifters promote NFTs because it’s a new avenue to bring fiat money into the world of crypto and to pump up their bags. The problem is, all bubbles eventually pop, and when this one does, retailers will be left holding the bag. 

Feature image: Beeple’s artwork from “Everydays: The First 5000 days.” Courtesy, Christie’s

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