What Legal Issues NFTs Entail?
Almost every day we witness a new innovation that confirming that non-fungible tokens (NFTs) can be used in a multitude of areas in addition to the art work, as traditionally known. The artwork and its circulation in the market entail enough legal complexity/uncertainty and those new use cases of NFTs only add to this phenomenon. But what do we have on the regulatory side of the equation? It does not seem as innovative and passionate as the NFT world.
The lack of regulations in the Crypto world
The crypto currencies were once limited to a narrow and relatively isolated environment of crypto innovators and enthusiasts, but within a decade the adoption was so great and led to so many real legal issues that regulators finally stepped in. Be it slowly, the regulatory framework is forming around the globe and various aspects are being addressed at least in the form of guidelines, principles, draft regulations and amendments to the existing ones. The NFTs, on the other hand, seemed to be left out of the regulatory works, due, in part, to their recent emergence as a sub-segment of the crypto world.
Need for NFT regulations
First of all, let’s remember that currently, the increasingly expanding NFT space is one of the least regulated segments of the crypto world. The existing and emerging regulations are addressing the conventional financial-market-like aspects of crypto currencies. There are a number of factors/features that contribute to the NFTs being subject to regulation (mostly as far as property/intellectual property, ownership and other rights concerned). Hence, it becomes clear that the more the NFTs touch the real world, the higher the potential and complexity of legal repercussions they would cause and would trigger legal remedy/need for regulation. This seems to be the natural result of the tremendous variety and creativity involved in NFTs.
The existing standards/regulations
To be clear, the use of decentralized finance (DeFi) and anonymity brought by the crypto assets and blockchain technology have been important items on the agenda of the financial standard setters and regulators for quite a while. And this for legitimate reasons, such as anti-money laundering and customer protection.
The Financial Action Task Force (FATF), for example modified Recommendation 16, what has been called the Travel Rule guideline, to guard against money laundering and other illegal actions. The Travel Rule for Crypto Assets mandates crypto companies to send, receive, and sanction screen customer personal information alongside a crypto transaction over a particular threshold. Crypto and DeFi businesses should comprehend and prepare to abide by these regulations or risk losing their operational licenses.
Recent legal developments regarding the NFTs
The recent legal developments involving NFTs point to some initial steps in dealing with the NFTs. The UK court acknowledged the NFTs to be private property that need to be protected against theft. Furthermore, although aimed at majorly crypto currencies and not directly the NFTs, the coming Proposal for a Regulation of the European Parliament and of the Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 (MiCA) also treats some of the NFTs as financial instruments if they meet certain conditions, regardless of their non-fungibility or uniqueness.[1]
Below is a table displaying some features of NFTs and relevant/potential areas of law.
* MiCA tends to treat some crypto-assets “that are otherwise considered to be unique and not fungible with other crypto-assets” and “the fractional parts of a unique and non-fungible crypto-asset” not unique and not non-fungible, and thus, as financial instruments. This, however, constitutes an exception to the rule and is subject to the analysis.
** “The issuance of crypto-assets as non-fungible tokens in a large series or collection should be considered as an indicator of their fungibility. The sole attribution of a unique identifier to a crypto-asset is not sufficient to classify it as a unique or not fungible.”
To be fair, the draft text of MiCA Regulation clearly states that it will not apply to crypto-assets that are unique and not fungible with other crypto-assets (a.k.a. NFTs), including digital art and collectibles, whose value is attributable to each crypto-asset’s unique characteristics and the utility it gives to the token holder. Similarly, it also will not apply to crypto-assets representing services or physical assets that are unique and not fungible, such as product guarantees or real estate. While these crypto-assets might be traded in market places and be accumulated speculatively, they are not readily interchangeable and the relative value of one crypto-asset in relation to another, each being unique, cannot be ascertained by means of comparison to an existing market or equivalent asset. Such features limit the extent to which these crypto-assets can have a financial use, thus limiting risks to users and the system, and justifying the exemption.
However, the Regulation, when put into force, would be the most extensive regulation globally for crypto assets and will also potentially generate more analyses on the NFT products through guidelines and analyses.
In Germany, crypto assets are regulated as financial instruments. NFTs that qualify as crypto assets or serve investment purposes are subject to anti-money laundering requirements. Theoretically, the NFTs that meet the definition of a financial instrument will be subject to additional licensing requirements.
Similar to MiCA, some countries (including Australia and Singapore) would treat some NFTs as securities if the NFT meets the criteria of a financial product and a license is required to purchase or sell such digital assets.
A cryptocurrency prohibiting China tolerates the NFTs on the condition that they are not like cryptocurrencies.[2]
Conclusion
Looking at the NFTs and their ever-creative use cases, their touch points to the traditional and evolving legal ecosystem appear to be far greater than crypto currencies. Not to mention the traditional artwork, digital artwork, audio, still and video imagery; the NFT usage also spans from sports, fashion, gaming, luxury goods, metaverse, supply chain, ticket sales, event participation, membership tokens, fund raising, donation, branding, political causes to real estate. While these areas not new, their application in the world of cyber-creations pose interesting and potentially difficult regulatory challenges.
[1] See the MiCA draft, accessible at https://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:52020PC0593
[2] See a number of the features the NFTs must have in China at https://www.natlawreview.com/article/nft-collection-brave-nft-world-regulatory-review-nfts-part-2
