Regulating Non-Fungible Tokens: A Work in Progress

The rise of cryptocurrencies has left regulators and legislators alike
struggling to hone in what is largely an unregulated international market
that many believe can be a major contributor to anti-money laundering and
terrorism financing efforts around the world. Nearly equaling the historic
rise of crypto over the past year or so has been that of a new digital “asset”
that has burst onto the global scene to further complicate matters with
respect to the ongoing battle against financial crime. Non-fungible tokens
(NFTs) – cryptographic assets on blockchain that are marked by unique
identification codes and metadata that distinguish them from each other 3 –
have become a tangible means by which to digitally represent real, physical
assets (such as real estate, artwork, sports, and gaming content). Unlike
cryptocurrencies, each individual NFT “token” is one-of-a-kind, making their
worth variable. This intrinsic value comes from scarcity. Once someone
attains an NFT, they personally own that distinct image, song, or whatever
form of digital content is in their possession. No one else can use it without
the owner’s express permission, making it theirs and theirs alone.
Once “tokenized” these digital assets can be better thought of as
certificates of ownership/rights for physical pieces since they lack a tangible
form in their own right. Much like cryptocurrencies, however, these
ownership records are stored on the blockchain ledger which prevents
forgery. The lack of the fungibility component that makes cryptocurrencies
a secure and legitimate medium of transaction in a digital economy further
adds to the allure of NFTs with respect to the realms of artwork and
collectibles, respectively. While NFTs have technically existed since 2014,
they have gained a significant amount of attention over the past several
years in particular secondary to their attachment to high-valued digital
artwork and the sports world. Just recently, a piece of artwork created by
digital artist Beeple sold for over $69 million at British auction house
Christie’s, becoming the first purely digital artwork to ever be offered by
the renowned firm. Several sports moments that have been tokenized have
been accompanied by hefty price tags in their own right. Most notably, the
National Basketball Association (NBA) recently partnered with Canadian-
based Dapper Labs to create its own version of a collectible digital asset
coined NBA TopShot that allows consumers to purchase unique basketball
highlights-turned-collectibles. The novel venture has already netted over
$230 million in sales since its establishment in 2019.4 Needless to say when this amount of money is being thrown around, it
is sure to catch the attention of federal and international regulators,
begging the question as to where governing regulations fit into all of this?
While there is no specific regulatory oversight over NFTs at current, much
like the crypto-realm the debate rages on to place a true definition on these
digital assets as stores of value. NFT marketplaces, particularly those
specializing in digital art, may be subject to current suspicious activity
reporting standards based on jurisdiction. Earlier this year the United
States Congress passed the Anti-Money Laundering Act of 2020 (AMLA)
which is the most comprehensive piece of money laundering legislation
published to date. The AMLA extended BSA reporting obligations to
cryptocurrency exchanges but it did not address NFTs directly. Though it
does not specifically mention NFTs, the provisions within this law should
not be overlooked when considering delving into this realm.
Direct regulation of NFTs in the United States will require specific
legislation from Congress. It is unlikely that NFTs will hold the same
classification that cryptocurrencies will, given that NFTs fall more under
the umbrella of antiquities or artwork given secondary to the fact that they
are not a currency per se, but instead a representation of assets. While NFTs
are undoubtedly far different than traditional antiquities, the term
“antiquity” remains undefined under current AML regulations in the United
States, many believe that the NFT trade could in fact be deemed the sale of
antiquities which would subsequently fall under the ALMA/BSA. There also
remain several complicating factors with NFTs with specific respect to
classification as art should this ultimately come to fruition. Do beneficial
owners need to be identified? What will the reporting threshold be in terms
of valuations of items being sold/traded? The rules have yet to be clearly
defined. While many of these developments remain nothing more than
hearsay at this point, regulators have been preparing to handle these
unique assets nevertheless – as they should.
With respect to compliance and financial institutions seeking to avoid
potential repercussions for the activities of their clientele in regards to the
sales/purchases of NFTs, this ambiguity means applying analogous
regulatory requirements to NFTs until the proper legislation catches up.
Whether it is with the scrutiny a bank would assess a deed or a
cryptocurrency, proper due diligence should be maintained with any
transactions related to NFTs and consumers actively engaged in these
markets. In this rapidly evolving space of finance, financial institutions
should err on the side of caution when it comes to non-fungible tokens.Citations
1. Conti, Robyn. “What You Need To Know About Non-Fungible Tokens
(NFTs).” Forbes, Forbes Magazine, 27 May 2021. 
2. Sauter, Benjamin, et al. “How NFTs Could Trigger Lawsuits and Anti-Money
Laundering Regulation.” Forkast, 25 May 2021. 
3. Sharma, Rakesh. “Non-Fungible Token (NFT).” Investopedia, Investopedia, 18 Mar.
2021. 
4. Young, Jabari. “People Have Spent More than $230 Million Buying and Trading
Digital Collectibles of NBA Highlights.” CNBC, CNBC, 2 Mar. 2021