“Good people don’t need laws to tell their behavior responsible, but bad people will find a way around them.” — Plato
This quote has stood the test of time. People will always find a way to do good, or worse, to be wrong, in all industries, markets, communities, and ideas. Crypto and nonfungible tokens (NFTs), are not an exception to this rule. The industry is expanding rapidly — to the point of overflowing — with innumerable drops, jaw-dropping prices, and adoption from ever-expanding areas of culture.
NFTs are moving at breakneck speed and the money is there. DappRadar data shows that NFT sales soared to $10.7 billion during the third quarter 2021. This is more than 8x the quarter before. This is a lot of Penguins and Apes.
Everybody is jumping headfirst into the world of creators, brands and institutions. It is time to look around. We saw an alarming headline in the NFT space at the end of last year: After placing 57 cryptocurrency addresses (and one exchange) on the Treasury Department Office of Foreign Assets Control sanctions list, the U.S. government made illegal the purchase of a few NFTs. OFAC stated that the addresses were being used to facilitate ransomware and money laundering. According to Elliptic, the sanctioned addresses contained more crypto than $300 million according to reports.
Darknet markets and other nefarious transactions
The Treasury Department identified Chatex, a Latvian-based exchange, as the one responsible for these nefarious transactions. They said it related to “illicit and high-risk activities like darknet markets, high risk exchanges, ransomware, and high-risk exchanges.” Elliptic pointed out that this was not the first but second time the U.S. government sanctioned an exchange — and it’s the eighth time total crypto addresses have been sanctioned. Although this was the first time the government flagged a malicious address as a crypto address, it is not the first. The art industry was a haven for money laundering long before NFTs. This problem has been around for centuries because the traditional art industry has resisted compliance requirements such as Know Your Customer (KYC), and Anti-Money Laundering.
Related: Crypto must address compliance before regulators do.
The world has struggled historically to view NFTs and crypto as legitimate industries, not dark networks for illicit activity. Shyft Network is a platform that helps cryptocurrency firms comply with AML and the Travel Rule. We also help them to build compliance into blockchain data. I also wrote the first crypto regulations in order to protect the sector. Since 2010, we’ve made a lot of progress. We’ve come a long way since 2010.
The situation we witnessed earlier this month with Chatex could have been described as dirty wallets taking their crypto and going to OpenSea to buy and exchange NFTs. This would allow them to mix the process to wash their cash. This is similar to hackers stealing Ether (ETH), and sending it to smart contracts, which anonymizes its source.
Compliance that has been battle-coded
We don’t want NFT security flaws. We want to go forward. We need to move forward. Not only do we need infrastructure for compliance in crypto, but also in NFT and technology. To code transactions, we need to have battle-coded compliance protocols and regulatory actions, such as KYC rules for any customer transaction in NFT.
It is natural that NFTs development, which has been going at a rapid pace, would expand to include technology that solves regulatory problems. This has been true for crypto as a whole and all industries that have grown from something small to something large, especially when institutional investors are involved. The number of illegal and “rug pulling” that have occurred is increasing, regardless of whether it’s consumers, investors, or brands.
Related: FATF Guidance on Virtual Assets: DeFi loses, NFTs win; FATF guidance remains unchanged
NFT use cases are becoming more than just collectibles. (See: publishing, ticketing, real estate). They also offer a unique opportunity to implement compliance technology. Although it might not be as sexual as other NFT elements, it is still vital. Conforming NFTs are a powerful tool to authenticate users, act as credentials, and even allow people to build a credit history. The next generation of NFT technology will provide auditable guarantees about users’ reputations while also allowing users to keep their personally identifiable information on-chain.
What’s next for NFTs
What’s next? Regulators are currently focusing on NFTs based more on their substance than on how they comply. I’d like KYC and AML requirements to be flexible enough to accommodate the variety of NFTs, including artwork, digital tickets, smart contracts, and deeds for homes. This will protect someone from buying a house from someone who can’t verify their sources of funds or is suspected of engaging in illegal activities. You should be treated with the same care when you drop your hard-earned Ethereum on a Pudgy Penguin (guilty).
We need to create complaint NFT technology using an on-chain KYC engine that can be customized so that KYC policies from one exchange or marketplace can be made available across multiple at once or that predefined rules can be set around specific NFT platforms that users can opt-in. Our infrastructure allows digital identities to be verified with externally-linked NFT metadata. This will allow investigations to take place seamlessly. Compliant NFTs will provide buyers, markets, investors, and institutions that participate in this amazing industry with a layer of security. Facilitators of sales will be able to verify that the asset, whatever it may be, was not stolen or purchased with dirty money. You can rest assured.
NFTs have already broken records and shocked even those who doubted their legitimacy and sustainability over the past year. We need secure systems to ensure that we get to the moon safely in order to make this an industry that is not only boomed.
These views, thoughts, and opinions are solely the author’s and do not necessarily reflect the views or opinions of Cointelegraph.
Joseph Weinberg was a pioneer investor in Bitcoin in 2010, and director at Coinsetter from its acquisition by Kraken 2016. He is an expert on cryptocurrency. Weinberg is currently the co-founder and CEO of Shyft Network. This trust network based on blockchain enables users to regain their trust, credibility, and identity. He is passionate about advancing crypto and blockchain adoption and serves as an advisor to governments, regulatory bodies, and the OECD.