Crypto exchanges have become increasingly susceptible to hacking. Data from the Chainalysis Crypto Crime Report 2021 highlighted attacks totaling US$531 million in 2020, and evidence suggests that the figures are higher for 2021. There have also been reports of hackers stealing from crypto wallets.
Many of these issues are driven by the nascency of the crypto ecosystem. Crypto exchanges responded to past security breaches with substantial improvements to security systems and customer information safeguards, driving high demand for specialists in these areas. Responsible innovators will need to consider appropriate controls and the necessary education to inform buyers of potential cyber risks.
3. Illicit activities
Although illicit activities are less common in the NFT world than the traditional financial sector, one can expect to see old crimes occur in this new world, such as “rug pulls” in NFT sales, where instead of delivering NFTs after payment, an NFT issuer disappears with the funds, and “man-in-the-middle” attacks where funds are diverted to the bad actor instead of the NFT issuer. Illicit funds can even be used to purchase NFTs that are then resold in exchange for clean funds.
Regulators are also beginning to consider the link between NFTs and sanctions evasion. In the US, although regulators have yet to produce clear guidance on NFTs, the Office of Foreign Assets Control (OFAC) has made it clear that US persons and entities dealing with virtual assets remain subject to OFAC controls.
4. Securities and taxation
NFTs can be purchased as a whole piece or as a fractionalized part. One could take a whole item, such as a Leonardo da Vinci painting, and sell it in smaller parts. However, fractionalization may fall under existing securities legislation and NFT issuers and promoters may also come under scrutiny.
In addition, the NFT ecosystem has several potential implications for tax policy, including income tax from NFT creators, capital gains on a buyer’s profits, and corporation tax on NFT platforms.
5. Cyber literacy and financial inclusion
Purchasing NFTs requires a certain level of technological knowledge, and buyers often have to purchase primary crypto tokens, such as Ethereum, before they can make their NFT purchases. They might also have to “whitelist” crypto addresses to receive early access to benefits or discounted pricing. Policy makers will need to look at how to make crypto and NFTs as accessible as possible, whilst encouraging NFT innovators to build knowledge platforms and streamline processes for buying, owning and selling NFTs.
6. Energy usage
Ethereum, the most commonly used cryptocurrency for NFTs, uses anywhere from 48 kWH per transaction – roughly the same energy expenditure of the average US household for 1.5 days, or 2-3 days for an Australian household – to 238.22 kWH, which equates to 100,000 Visa transactions. Policymakers might have to consider how best to balance the environmental impact of NFTs with sustainability initiatives.
The NFT sector will continue to accelerate and mature. Jurisdictions, particularly hubs such as Hong Kong that bring together financial acumen, technology, a strong legal and regulatory ecosystem, and a thriving arts-and-culture sector, can succeed by considering how crypto could offer access to the transformational ecosystem of NFTs, how the skills and employment opportunities for the next generation will be born from this emerging world, and how society can benefit.