In the cryptocurrency and art scene, “Non-Fungible Tokens (NFTs)” is one of the latest buzzwords that have been going around. In fact, ‘NFT’ was designated as Collins Dictionary’s word of the year for 2021. “It’s unusual for an abbreviation to undergo such a stratospheric spike in usage,” said Alex Beecroft, Managing Director of Collins Learning, “but the data we have from the Collins Corpus reflects the amazing ascendancy of the NFT in 2021.” But what exactly are NFTs?
NFTs are a one-of-a-kind digital asset that can store digital information and can represent both digital material (such as digital art and music) and real-world physical objects. NFTs are sold and bought virtually, and are valued in cryptocurrency tokens.
While the token nature of NFTs is shared amongst all blockchain developments, what makes NFTs stand out is their non-fungible nature. When it comes to Fiat currencies and even cryptocurrencies, the amount of value stored remains the same for each unit; and each unit can be traded for another similar unit without a loss in value.
Because of its non-fungible nature, one US dollar or one Bitcoin token will always be worth one dollar or one token, regardless of how many times they are traded or exchanged. An NFT is “one-of-a-kind”. Every NFT created has its unique digital signature, which cannot be replicated or replaced.
In short, an NFT allows the buyer to claim ownership over an original digital asset. These assets can be anything digital – from Fan Arts and Nyan Cat GIFs to videos and in-game items, music, and even Tweets.
Why Is There So Much Hype Surrounding NFTs?
Although the concept of an NFT has been around since 2014, most of the recent craze and excitement surrounding NFTs revolves around using this technology to sell digital art.
For NFT buyers, these NFTs allow them to ‘own’ digital assets in a digital environment for the first time. With blockchain technology, the proof of ownership of an NFT is undeniable, giving these owners both “digital bragging rights” and the ability to sell the digital assets when prices appreciate.
For the NFT creators, selling their art as an NFT can potentially provide them with a continuous stream of revenue. With the ability to code in a fixed royalty percentage, NFT creators can capitalise on the heated market to earn an income even after the initial sale.
However, there is also a darker side to the rise of NFTs. Aside from attracting artists and buyers, the NFT space is also at risk of becoming the new breeding ground for financial crimes and money laundering.
The Risks Present in the NFT Space
By nature, virtual assets created with blockchain technology are decentralised. Because of this decentralisation, cross-border transactions can often be made with ease. Combined with the anonymity blockchain transactions offer, cryptocurrencies provide a brand new channel for malicious individuals to launder their money outside the traditional financial market.
With the introduction of NFTs, money laundering has been made even easier for money launderers. For example, say that an individual would like to launder $1 million. By using a trusted third party account, the launderer can mint an NFT and purchase the NFT with cryptocurrency tokens worth $1 million. The individual can then sell the NFT, cashing in on the $1 million as it now appears to be from a legitimate source—the NFT marketplace (of course, in reality, money launderers will utilise a variety of such strategies to hide the source of their funds).
With the cover of anonymity, the NFT market is also extremely susceptible to forgery. As there is often no verification process required for most NFT sales, malicious individuals can ‘steal’, mint, and sell digital assets that they do not own. Even Giphy, a gif sharing social platform, has reported that people are turning user-created GIFs from its site into NFTs for sale.
As the craze around NFTs is pretty new, there is a severe lack of protection for digital creators. That means that apart from reporting an NFT as a stolen digital asset to the NFT marketplace hosting it, creators with stolen digital assets often cannot do anything else.
Apart from stealing digital assets, malicious individuals can also attempt to steal identities. In March 2021, someone hacked into the official Banksy website and offered to sell a limited edition Bansky NFT by posing as the artist (the piece was sold for £244,000 but the amount was returned following the sale).
How the Risks Can Be Mitigated
As with any new financial product, the recent developments surrounding NFTs open the financial market to more risks. However, by understanding how the technology works, regulators will create regulations that prevent the misuse of the technology.
As businesses and individuals, the NFT market presents a new and exciting opportunity. And while there are indeed risks in the NFT market, one can mitigate the risks by ensuring that the NFTs that one is dealing with comes from a respectable and trustworthy source. For businesses, employing rigorous KYC checks and implementing AML protocols can also prevent cases of fraud and money laundering from happening.