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The Guardian - UK
The Guardian - UK
Technology
Chris Stokel-Walker

TechScape: the taxman is starting to take notice of the NFT gold rush

A file illustration taken in London on December 30, 2021, shows gold plated souvenir cryptocurrency coins arranged by a screen displaying a NFT marketplace
A file illustration taken in London on December 30, 2021, shows gold plated souvenir cryptocurrency coins arranged by a screen displaying a NFT marketplace Photograph: Justin Tallis/AFP/Getty Images

When world war three comes, the nuclear bombs drop out of the sky and humanity is wiped from the Earth, two things will remain: cockroaches and NFTs.

NFTs have become one of those unavoidable things that you really, really, shouldn’t have to think about, yet here we are. I’m writing about them, and you, inexplicably, are reading it.

Most people still don’t really understand what non-fungible tokens (NFTs) are, to go by the constantly upward trajectory of Google search trends, and even those that do sometimes struggle to come up with meaningful use cases for them. NFTs are unique digital items stored on the Ethereum blockchain. They’re most commonly associated with and connected to pieces of individual “artwork” (your mileage may vary, depending on how strongly you wrap inverted commas around that word), which are exchanged for eye-wateringly large sums of money.

It’s that last bit that makes them so interesting. Paris Hilton, Jimmy Fallon and Gwyneth Paltrow all own NFTs, which they bought using a middleman company called MoonPay, and have begun talking about them on national TV. (If you want to know what the people who previously owned those specific NFTs thought of their new owners, then I have a story for you).

Generally, if the penpushers at Her Majesty’s Revenue and Customs (HMRC) begin sniffing around something, you can assume that it is hurtling into the mainstream. And those eye-wateringly large sums of money have also made NFTs interesting to the taxman. We learned this week that HMRC has made its first NFT seizures as part of an investigation into a suspected attempt to defraud the taxman of more than £1m.

“Our first seizure of a Non-Fungible Token serves as a warning to anyone who thinks they can use cryptoassets to hide money from HMRC,” said Nick Sharp, the deputy director for economic crime at HMRC.

Monkey business

I have done my fair share of reporting on NFTs, and a depressingly large proportion of stories have been about how someone has been conned – whether that be having money stolen directly, or investing in a project that wasn’t what it claimed to be. While not every NFT project is a scam – far from it – the sector is experiencing a wild west gold rush that is attracting plenty of people willing to sacrifice the long-term reputation of an entire technology in order to make a quick buck for themselves.

And it is a gold rush. In 2020, blockchain market research company Chainalysis recorded $106m of NFT trades in 2020. A year later, that was $44.2bn.

Individuals like Damian Augustyniak, a 30-year-old Polish artist who makes more than £40,000 a month designing the artwork for NFT projects – and who told me he was able to tell me exactly how many people he employed because he’d just meticulously filled out his tax return – are few and far between.

It makes sense that people don’t always declare their income from NFTs. The whole premise of Web3, of which NFTs are one part, is that it’s free from the shackles of The Man. The decentralised future of the internet is designed to be a kind of ‘make your own rules’ space, where as a group you decide what to do. It’s a bit like Lord of the Flies – with all the potential issues that could ensue. The fact that all the transactions take place outside the realm of fiat currency, with NFTs bought and traded using cryptocurrencies, compounds that.

Yet it’s also one of the biggest things that is likely to be a stumbling block to more widespread adoption of NFTs. It’s also why tax authorities like HMRC are likely to spend more time scrutinising the flow of cash in exchange for jpg images.

Money for nothing?

Chainalysis believes a significant proportion of the NFT market is wash trading – people selling NFTs to themselves in order to hike up the price. The company has pinpointed 262 users who have sold an NFT to another user account they also own more than 25 times. “While we can’t be 100% sure that all instances of NFT sales to self-financed wallets are intended for wash trading, the 25-transaction threshold gives us a higher degree of confidence that these users are habitual wash traders,” they write.

Hilariously, most of them have lost money. But those who won, won big – counteracting the bumbling traders’ losses. More than $8.5m in profit was made by wash traders in 2021: a lot of cash that tax authorities would probably want to take their share of. Same for the money laundering, nearly $1.5m of which Chainalysis alleges was used in the last three months of 2021 to buy NFTs.

It makes for sobering reading for both sides: tax authorities are missing out on huge amounts of questionable money flowing through massive marketplaces. And those trying to launder ill-gotten gains are starting to see the enemy coming over the hill, keeping an eye out on what they’re doing. HMRC’s seizures are just the tip of the iceberg: earlier this month the US Department of the Treasury also gave a warning to the NFT world that it was watching them – and expected them to add the value of their art to their annual tax returns.

So, feel free to “ape in” (crypto speak for getting very excited and rushing into buy in) to NFTs, if you want. But let’s be honest: filling out your tax return is difficult enough without trying to quantify the value of a pixelated monkey.

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