The United States Treasury Department has released its first-ever finance risk assessment for nonfungible tokens (NFTs) in an attempt to provide regulators with greater insight into potential risks and security concerns facing the rapidly evolving market.
Several potential risks were identified including the potential for terrorists to finance operations through NFTs, state actors using NFTs to fund nuclear proliferation, money laundering, and the potential risks to investors who may experience theft, rug-pulls, or other forms of fraud that have become well-known.
The report repeatedly reiterated that the vast majority of these illicit activities occur through fiat financing and transactions, and are not unique to the digital asset space.
"This risk assessment recognizes that most money laundering, terrorist financing, and proliferation financing by volume and value of transactions occurs in fiat currency or otherwise outside the digital asset ecosystem via more traditional methods," the report stressed.
Moreover, the Treasury found that even in cases of investor or market abuse, digital asset fraud tends to occur through age-old schemes that predate the invention of blockchain and cryptocurrencies—like Ponzi schemes or benefiting from inside information. However, the report explained that fraud has also occurred through mechanisms unique to digital assets such as smart contract manipulation.
Despite this, the Treasury's assessment pointed to a high potential for abuse and illicit activity via NFTs, though the assessment also admitted that scant examples, if any, exist of NFTs used in terrorist financing, nuclear proliferation, or drug trafficking.
Related: US Treasury strategy would tighten virtual asset regulations, increase AI use
Perhaps the most significant example of malicious activity cited in the report was the theft of digital assets by the government of North Korea (DPRK) and associated hacker groups looking to sidestep U.S. sanctions and raise revenue for military spending. Once again, the Treasury noted that NFTs made up a small percentage of the total digital asset theft and explained that other financial institutions were also hacked by the DPRK.
The report concluded with several recommendations to mitigate potential abuse through NFTs, including regulating the NFT market, working with industry insiders to prevent fraud, collaborating with foreign partners to prevent illicit geopolitical activity, and educating consumers on the potential risks surrounding nonfungible tokens and digital assets.