Money laundering in the metaverse: NFTs, DeFi

by James · October 11, 2022

According to a recent analysis, 17 million Ethereum transactions between Q4 2017 and Q1 2022 were associated with both criminal and legitimate operations. The general cyber money laundering activities increased by 30% in 2021 compared to 2020, with hackers laundering a total of USD 8.6 billion in cryptocurrency.

During this time, thieves have increasingly relied on DeFi protocols to launder money: DeFi protocols received 17% of all cryptocurrency transferred from illegitimate addresses in 2021up from 2% in 2020.

NFT sales also reached over $25 billion in 2021, with individual units selling for as much as $90 million. However, high-profile scams in 2022, including a $600 million theft of NFT gaming business Axie Infinity in March and NFTs worth $2.8 million taken from Bored Ape Yacht Club’s Instagram account in April, has caused concern in the market.

Money laundering has become a major problem in web3.0 platforms due to the absence of KYC verifications and AML screening methods deployed in the loop. With these growing numbers, we address the most important causes and solutions for anti-money laundering compliance in the metaverse.

First, let’s learn what the web3.0 platform consists of and why it’s easier to launder money in Metaverse.

Table of Contents

What is web3.0? How is it more vulnerable to money laundering?

Web3.0 is essentially a blockchain-based decentralized, trustless and permissionless token economy. Of course, cryptocurrencies and NFTs use the same technology. As a result, the use of digital currencies is expected to become more popular.

Some even advocate Web3.0 because it enables the recovery of client content and data, which has long been consolidated in Big Tech.

In many aspects, web3.0 will return to the original World Wide Web (known as web1.0), when anyone could upload anything without requiring intermediaries or approval from a central organization.

Concerns have been raised in recent months regarding the ties between cryptocurrencies, NFTs and fraud. It is now obvious that the rise of the metaverse and web3.0 can potentially facilitate money laundering.

This is because if all you need to join the metaverse is a Facebook account, many complications can develop. As an example:

How can people defend themselves against identity fraud and theft?
How will the age restriction for users be enforced?
How can vulnerable users be protected from cunning criminals?

While the blockchain is accessible and everyone has access to copies of transactions, the identity of those carrying out the transactions remains hidden. This means that there is no way of knowing whether the currency’s source is authentic. In many ways, this makes the metaverse an ideal place for illegal behavior.

Furthermore, the metaverse will enable criminals to convert their money into untraceable and easily hidden currencies. Rather than requiring a labor-intensive procedure, money laundering would only need a criminal to repeatedly click a button to buy and sell products in the metaverse, resulting in a long record of transactions that humans would not be able to to trace.

After all, the lack of traditional intermediaries in web3.0 means that users do not need to go through any KYC or anti-money laundering (AML) procedures.

What is the compliance risk in Metaverse?

Identity theft, hacking, breaching and other financial fraud are all possible in the metaverse as they all aim to steal someone’s personal information and gain access to their digital wallets for illegal purposes. Due to the decentralized blockchain-based framework that links each job to digital wallets, large sums of money can be transferred using the metaverse.

There is currently no clear understanding of economic crime legislation as it relates to the metaverse. The lack of Know Your Customer (KYC) authentication, on the other hand, means that consumers are generally less secure in the digital realm. Inadequacy of metaverse consensus and unified rules can become a motivator for criminals to engage in illegal activities.

Because the Internet is not typically constrained by a single central authority or regulatory organization, it is widely expected that the metaverse will follow a similar pattern. In terms of digital security, Web3.0 seems to transport businesses back to the days of the World Wide Web, allowing users to perform activities freely without the need for intermediaries or third-party software.

Why are NFTs attractive for money laundering?

NFTs are essentially digital works of art with the same characteristics as traditional art. Furthermore, NFTs have the advantage of being completely digital, making them much easier to replace than moving actual paintings. An NFT, like a cryptocurrency, can be moved from one wallet or owner to another in seconds.

However, the unpredictable values of NFTs make them particularly appealing for money laundering purposes. While the Bitcoin to EUR exchange rate follows the market principles of supply and demand, the pricing of NFTs is highly speculative. In reality, an NFT bought for one euro can be sold for one million euros the next day. As a result, NFTs appeal to the laundering of black money through legitimate transactions.

While blockchains make it possible to track these transactions across wallets, it is now easier than ever to move wealth anonymously. For these reasons, and in accordance with the US Financial Crimes Enforcement Network (FinCEN), the “Emerging Digital Art Market” poses a significant risk of money laundering and financial crime.

To summarize, NFTs can be used for money laundering due to unpredictable pricing (which is very attractive to fraudsters) and the ability to transfer values anonymously. As a result, criminals can use NFTs to avoid detection.

How can money laundering in Metaverse be countered?

Money laundering procedures in the metaverse are extremely complicated, extremely fast and cross several countries. All this means that the process is difficult to identify using current methods.

As a result, it is imperative that current AML regulations change and sophisticated technology is used. In Metaverse, for example, both artificial intelligence and machine learning can be used for transaction monitoring and identity verification.

Furthermore, it becomes clear that information exchange and cooperation between agencies and between countries will be necessary. Furthermore, a more metaverse-friendly version of KYC will be required.

While it may still be legal to allow someone to establish an avatar and access the metaverse with a Facebook account, a metaverse-friendly version of KYC needs to be developed to guarantee that AML requirements are as strict as they are offline. After all, whether individuals want to buy or sell in the metaverse, KYC and customer due diligence are still important in the fight against fraud.

How IDcentral can ensure compliance in Metaverse

ID center offers an API-based eKYC and KYX solution that verifies identity, age and documents through a fully digital process. Completed within 8 seconds, our AI-based solution ensures the best customer experience while streamlining verification quickly and accurately.

IDcentral’s AML screening solution also ensures that both new and existing customers comply with anti-money laundering regulations, while also performing background checks for sanctions screening, terrorist financing and other regulations.