NFT Legal and Regulatory Compliance: Connoisseurship and Critique

36 Pages Posted: 4 Dec 2022

See all articles by Brian Sanya Mondoh

Brian Sanya Mondoh

BlockchainLex.io

Sara M. Johnson

RBC Family Office

Matthew Green

Independent

Aris Georgopoulos

University of Nottingham; University of Nottingham - School of Law

Date Written: November 12, 2022

Abstract

“An Oriental wise man always used to ask the Divinity in his prayers to be so kind as to spare him from living in an interesting era. As we are not so wise, the Divinity has not spared us and we are living in an interesting era. In any case, our era forces us to take an interest in it”. Web3 is a catch-all term for the vision of a new, better internet, focusing on investor and consumer proprietary rights. It is alleged that the term ‘Web3’ was coined by Polkadot founder and Ethereum co-founder Gavin Wood in 2014. At its core, Web3 employs blockchain and other Distributed Ledger Technology (‘DLT’), cryptocurrencies, and non-fungible tokens (‘NFTs) to give power back to consumers in the form of ownership. Web3 is broadly designed to be decentralised, and its ownership and operation is distributed across peer-to-peer networks. In Web2, centralised entities control the network and provide services to users in exchange for their personal data. Web3 is highly technical and fast-moving, and has rapidly evolved beyond its financially inspired origins, with the advent of Bitcoin (2008), and Ethereum (2015), to other blockchain and Decentralised Finance (‘DeFi’) protocols thereafter.

In this publication, we explore the use of NFTs for a variety of purposes and lay out the impact and challenges of legal and regulatory compliance on NFTs in select jurisdictions; namely; the United States (‘US’), the United Kingdom (‘UK’), Canada and the European Union (‘EU’). We also bring to the readers’ attention the case against a Latvian NFT artist whose earnings have been frozen by Latvian authorities over allegations of money laundering. Our analysis highlights that despite NFTs being an emergent technology, the lack of a uniform regulatory framework stifles innovation and investor and consumer protection, which results in disparate and sometimes contradictory regulatory outcomes. Throughout this publication, we make reference to official and expert publications, case law and statutory frameworks from the various jurisdictions, in the attempt to lay the foundation for regulatory compliance in the digital assets industry. Commentary suggests that before NFTs, the art industry was perceived to be a haven for money laundering. Arguably, this is because the traditional art industry is predominantly unregulated and resisted compliance requirements like Know Your Customer (‘KYC’) and Customer Due Diligence (‘CDD’). At its core, the principal attraction of NFTs has been the ability for creators to monetize visual art, to shape the terms of their customers’ experience through smart contracts, while bypassing traditional middlemen or gatekeepers. Because NFTs can technically represent any type of tokenized asset, both digital and physical, it may be difficult to ascertain the legality of activities employing NFTs (Mondoh and Adami-Johnson, 2022).

The potential of NFTs to be misused for fraud, money laundering , tax evasion, price manipulation, and other illicit activities is and has been a growing concern for regulators and law enforcement. Research suggests that the manipulable nature of NFT prices could theoretically help criminals to justify their illicit proceeds to tax authorities on the basis that they are legitimate earnings from NFT trading. Because of this, authorities face great difficulties in establishing genuine criminality.

Research estimates that about $USD 8 million of illicit funds has been laundered through NFT-based platforms since 2017 – representing only 0.02% of trading activity originating from known sources and $328.6 million (0.81%) originating from obfuscation services such as crypto mixers such as Tornado cash (Elliptic, 2022). That said, it is suggested that this figure still has a disproportionate impact on the industry’s reputation, undermining investor and consumer protection (Elliptic, 2022). While measures including regulation, supervision, and enforcement, amongst other things, can mitigate some of the vulnerabilities of virtual assets, several features of virtual assets can present opportunities for abuse by illicit actors. For these reasons, enforcing globally consistent and comprehensive laws will ensure that investors and consumers are protected against fraud and manipulation, and also support innovation and fair competition.

Keywords: NFTs, Blockchain, Policy, Regulations, UK, USA, Canada., Latvia, digital art, crypto assets, crypto currencies, SEC, IIROC, FINTRAC, MSB, wash trading, digital assets, compliance, governance

JEL Classification: A,E, F, G, H, K, N, Y, Z

Suggested Citation

Mondoh, Brian Sanya and Johnson, Sara M. and Green, Matthew and Georgopoulos, Aris (Aristeidis) and Georgopoulos, Aris (Aristeidis), NFT Legal and Regulatory Compliance: Connoisseurship and Critique (November 12, 2022). Available at SSRN: https://ssrn.com/abstract=4275613 or http://dx.doi.org/10.2139/ssrn.4275613

Brian Sanya Mondoh (Contact Author)

BlockchainLex.io ( email )

19 Dundonald Street
Port of Spain, Port of Spain 000000
Trinidad and Tobago

HOME PAGE: http://https://blockchainlex.io/

Sara M. Johnson

RBC Family Office ( email )

1631 Dickinson ave
1400
Kelowna, BC V1y0B5
Canada

Matthew Green

Independent ( email )

Aris (Aristeidis) Georgopoulos

University of Nottingham ( email )

University Park
Nottingham, Nottinghamshire NG7 2RD
United Kingdom
+44 (0) 115 8466307 (Phone)
+44 (0) 115 9515696 (Fax)

University of Nottingham - School of Law ( email )

Law and Social Science Building
University Park
Nottingham, Nottinghamshire NG7 2RD
United Kingdom
+44 (0) 115 8466307 (Phone)
+44 (0) 115 9515696 (Fax)

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