A group of tax enforcement leaders from five countries, including the U.S., are collaborating on ways to investigate the use of nonfungible tokens and decentralized finance exchanges by tax criminals.
The Joint Chiefs of Global Tax Enforcement (J5) brought together a group of investigators, cryptocurrency experts and data scientists this week in London so they could coordinate on tracking down individuals and organizations committing tax crimes around the world. The event, known as “The Challenge,” includes experts from the U.S., the U.K., Canada, Australia and the Netherlands with the goal of optimizing the use of data acquired from different open and investigative sources available to each country, including offshore account information.
This year’s iteration of the Challenge focused on nonfungible tokens (NFTs) and decentralized exchanges (DEX), the cryptocurrency exchanges often used for decentralized finance, or DeFi, transactions.
The J5 recently released a red flag indicator document warning various industries of potential areas of concern when dealing with NFTs. The Challenge was first hosted in 2018 by the Dutch Fiscal Intelligence and Investigation Service (FIOD) in Utrecht with the aim of tracking down those who make a living facilitating and enabling international tax crime. The following year, the U.S. hosted a second “Challenge” in Los Angeles focused on cryptocurrency.
Last year, the COVID-19 pandemic caused the challenge to be held virtually where the event focused on fintech companies (see story). Using various analytical tools, members of each country worked as teams to generate leads and find cryptocurrency-related tax offenders, based on the data available to them through the challenge. This year’s J5 Challenge is hosted by Her Majesty’s Revenue & Customs (HMRC) in London from May 9-13. The main goal is to establish new ways to combat tax fraud and money laundering in the wake of new emerging threats inherent in the blockchain technology related to NFTs and DEX.
The J5 includes the Australian Taxation Office, the Canadian Revenue Agency, the Dutch Fiscal Information and Investigation Service, Her Majesty’s Revenue and Customs from the U.K. and the IRS’s Criminal Investigation division in the U.S.
Working within existing treaties, real data sets from each country are brought to the challenge to make connections where current individual efforts would take years to make those same connections. The challenges have proven to be helpful for the J5 as they generated plenty of leads for criminal investigators to probe. For example, one case involved BitClub Network, a multimillion-dollar Ponzi scheme where thousands of people were scammed into buying into a bogus mining pool, one of the first J5 successes stemming from the J5 Challenges.
NFTs can be used in both tax evasion and money laundering schemes, or a combination of the two. “While we’re very interested in tax crimes, we’re interested in all financial crimes,” said Jim Lee, chief of the IRS’s Criminal Investigation division, during a conference call Tuesday with reporters. “Money laundering is tax evasion in progress, and that’s true regardless of the medium. Often it comes down to a changing strategy because every money laundering case is tax evasion in progress.”
In some cases, that means not reporting the gains when selling a group of digital assets that have increased in value. But in other cases, the value of an NFT has mysteriously declined, with a similar set of traders buying an NFT for an inflated value and then selling it for less, perhaps even back to themselves.
“We’re looking from a tax evasion perspective and a money laundering perspective,” said IRS Special Agent and J5 Crypto Group Lead Oleg Pobereyko, a U.S. team member. “We’ve noticed that there are a lot of NFTs in use as a means of laundering funds. When you look at consistency, it’s the same group of individuals buying NFTs for $8,000, and within a short period of time they’re selling them for $6,000 and it’s consistently the same pattern. We just try to look at how they’re utilizing the NFTs for money-laundering purposes.”
The J5 tax authorities have been partnering with companies in the private sector like Blocktrace and Chainalysis to help identify suspicious activity.
“All the schemes we’ve seen in the past with traditional tax evasion and money laundering, they just are using a new method to do it with NFTs, with ERC20 tokens, with the cryptocurrency itself,” said Jim Daniels, director of investigations at Blocktrace.
In 2020, according to Chainalysis, $106 million was spent on NFT smart contracts, but the amount jumped to $44 billion last year. The number reached $30 billion as of the end of April.
“In the last quarter of 2021, at Chainalysis we saw evidence of fraudsters and scam activity taking place on the blockchain, where funds were transferred into NFTs and smart contracts where individuals were obviously using NFTs to launder the proceeds of a crime,” said Phil Larratt, a public sector operations specialist at Chainalysis. “We also saw some evidence that sanctioned entities had put funds into NFT platforms.”
The company has also seen evidence of wash trading strategies over the past 12 to 18 months where sellers would sell NFTs to themselves to falsely manipulate the market price. In one case, an individual sold over 800 NFTs to themselves to manipulate the price.
The J5 officials noted that NFT exchanges and decentralized exchanges lack the kinds of robust Know Your Customer (KYC) features used by traditional banks to deter illicit actors from using them as a haven for tax fraud and money laundering. During the course of this week’s five-day event, J5 organizations are looking for leads that meet the criteria based on the investigation blueprints they have established. At the end of the fifth day, the various groups will present their findings and a plan for how they will continue their investigations over the next six months.
“NFTs are the modern, digital way of trade-based money laundering,” said Niels Obbink, chief and general director of the Netherlands’ Fiscal Information and Investigation Service,, in a statement. “A rising issue is that the platforms involved in the trade in NFTs are not yet obliged to execute KYC-measures. Since there is little to no control, criminals have — as we say in the Netherlands — free play. These technological developments in the field of decentralized finance underline the need for international cooperation. The J5 fosters this cooperation.”
The Challenge is one of several J5 events being held in London this week. The J5 is also hosting a Global Financial Institutions Summit to bring together leaders in financial and tax crime compliance from the public and private sectors.