In a recent alert, we painted the big NFT picture, highlighting what a non-fungible token (NFT) means and the opportunities they present (see here). In this second part of the NFT series, we will take a deeper look at local regulatory control (or lack thereof) in this uncharted territory.
NFTs are being sold for record breaking prices. At the time of writing, the most expensive NFT sold is Pak’s ‘The Merge’ for US$91.8 million (but with 30,000 multiple owners). Beeple’s Everydays: the First 5000 Days follows being sold for US$69.3 million (by just one buyer). The secondary market for NFTs can prove even more fruitful, with collectors purchasing NFTs as an investment, hoping to sell them if their value increases. However, how much an NFT is worth depends on how much someone is willing to pay for it, and only a small percentage of NFTs value will actually increase.
Other Concerns with NFTs
- Whilst they transfer ownership to a buyer, they do not give the buyer copyright over the underlying asset. This means the owner cannot stop anyone from copying or distributing the underlying work;
- Buyers not being made aware what they are purchasing is not the asset itself;
- How they are treated for tax purposes;
- Consumers having to pay using cryptocurrency.
NFTs pose concerns amongst both financial regulators and consumer protection authorities, however their treatment differs across the world. An NFT transaction may also involve users across multiple jurisdictions. Therefore this guide may help those thinking of investing in NFTs or those considering selling NFTs.
The position in the United Kingdom
In the UK, there are no specific regulations on NFTs. Instead, NFTs are considered as a type of cryptoasset. The Financial Conduct Authority in its guidance distinguishes between three types of crypto-asset: a security token, an e-money token or an unregulated token. If the NFT has characteristics that make it fit the criteria of a security token, it will be considered a specified investments for the purpose of the Financial Services and Market Act 2000 (Regulated Activities) Order 2001. If the NFT is an e-money token, it will be regulated by the Electronic Money Regulations 2011.
- Security token: provide rights and obligations specified investment which includes shares, deposits, insurance
- E-money: electronically stored monetary value.
If the NFT falls into the category above, marketing them will require authorisation from the FCA. This will mean it is subject to the Money Laundering Regulations, and KYC checks and monitoring will be required on the purchaser of the NFT. However, the vast majority of NFTs will not fall under the criteria above and therefore will be unregulated.
Due to the huge sums being paid for NFTs, there is a particular concern that money launders could exploit the trade of NFTs as a way of converting the proceeds of a crime into clean money. If the NFT does not fall into the categories above, it still may be subject to the Money Laundering Regulations if it fits into the definition of “a cryptographically secured digital representation of value or contractual rights.” Moreover, NFTs that have art as their underlying asset will trigger EU and UK anti-money laundering rules if the NFT sale is €10,000 or more. If this is the case, the seller of the NFT will have to meet client due diligence requirements and maintain records of the transaction.
An NFT that is bought as an investment and then sold for a profit, any gain from the sale will be subject to Capital Gains Tax. Businesses who trade NFTs will pay corporation tax on any profits. Goods and services sold in via NFTs are likely to be subject to VAT.
The Advertising Standards Authority (ASA) has published guidance on advertisements for NFTs, after a number of decisions that resulted in adverts getting banned. To avoid this, businesses advertising NFTs should ensure that they make it clear to consumers that what they are purchasing is an NFT as well as sufficiently informing consumers the risks of purchasing NFTs including that their value could go down, as well as up, and that currently NFTs are unregulated.
Though the Australian government has recently announced proposals that would bring cryptocurrencies into the scope of regulation, NFTs, or digital assets are generally not prescriptively regulated in Australia. Though, if the NFT meets the criteria of a financial product under the Corporations Act 2001, then it will be subject to the Australian Securities & Investment Commission’s (ASIC) regulatory framework. Under the framework, an Australian Financial Services Licence is required to purchase or sell digital assets.
Cryptocurrencies are banned in Mainland China. Currently individuals in Mainland China can sell or buy NFTs. There are currently no specific laws or regulations that regulate NFTs, but on 13April 2022, National Internet Finance Association of China, Securities Association of China and China Banking Association jointly issued an initiative regarding prevention of NFT-related financial risks (the “Initiative”). Although the Initiative is not a regulation under PRC law, because the three associations are supervised by the central bank, the banking regulatory authority and the security regulatory authority respectively, this Initiative reflects the attitudes and policy orientation of regulators in Mainland China.
NFTs are not treated as cryptocurrencies or virtual currencies in the Initiative. According to the Initiative, however, the following code of conduct should be followed:
- Not to include securities, insurance, credit, precious metals and other financial assets as underlying items of NFTs, to prevent an issuance or trading of financial products in substance;
- Not to weaken the non-fungible characteristics of NFTs by dividing ownership or through batch creations etc., to prevent an initial coin offering (ICO) in substance;
- Not to provide centralized transactions (such as centralised bidding, electronic matching, anonymous transactions, market makers etc.), continuous listing transactions, standardized contract transactions and other similar trading services for NFTs, to prevent setting up trading venues in substance;
- Not to use virtual currencies such as Bitcoin, Etheruem and Tether as pricing and settlement tools for issuance and trading of NFTs;
- To conduct real name authentication of the issuing, selling and purchasing parties, and to properly preserve customer identity information and records of issuance and trading of NFTs, and to actively cooperate with anti-money laundering work; and
- Not to invest in NFTs directly or indirectly, and not to provide financing support for NFTs investments.
Due to their increasing popularity, and strict regulation of cryptocurrencies and assets, there is scope for regulation and investors and sellers alike should be wary that regulation may be soon to come.
Like the UK, there is no specific regulation or legal definition of NFTs in the EU and no harmonised regulatory regime across the member states. The European Commission has published a Markets in Crypto-assets Regulation (MiCA) which specifically excludes NFTs from its scope. However, like in the UK, the proposed Regulation should explicitly apply if the NFT gives the holder or specific rights such as those of financial instruments, such as profit rights or other entitlements. In these cases, the NFT may be treated as a “security token”. NFTs will also be subject to any national legislation that applies to them.
In France, there is no current regulatory framework for NFT, though digital assets do fall under the scope of the 5th Directive. If an NFT qualifies as a token or digital asset under French law, then this may trigger requirements as to the NFTs marketing and advertising and impose the requirement for the trader to be registered as a digital asset service provider. An NFT that has identical rights to those of a financial instrument, for example a transferable security, may then fall into the scope of financial regulation.
Last year the Germany Government announced that no change to the regulatory framework was planned in relation to the emergence of NFT. However, NFTs may fall under the scope of some legislation in Germany.
NFTs that qualify as crypto assets or serve investment purposes will be subject to anti-money laundering requirements, whilst those that meet the definition of a financial instrument will be subject to additional licensing requirements.
Those wishing to sell NFTs that constitute as a financial instrument will need a licence from the Federal Financial Supervisory Authority (BaFin) and the issuer of the NFT may need to publish a prospectus if NFTs qualify as securities within the meaning of the Prospectus Regulation or qualify as an asset investment under national regulations.
Whilst there are no specific laws regulating NFTs in Italy, NFTs might qualify as “investment products” as per Article 1, paragraph 1, letter u) of the Italian Consolidated Financial Act, this implies additional requirements on the seller such as being licensed.
As a matter of fact, “investment products” is a broad category of instruments which includes “any other form of investment of financial nature The Italian Supreme Court in a case related to certain transactions promoted by financial promoters on works of art, ruled that the:
“other forms of investment of a financial nature” [therefore] include, according to the case law and specialized doctrine, all those forms of employment of a capital in the expectation of a return whose achievement is not decisively influential for the investor and which involve the assumption of a risk of a financial nature; this definition must therefore include any instrument, however denominated, that is representative of the employment of capital”.
The Italian Authority’s—namely Consob—clarified that “investment of a financial nature” include all of the following elements:
(i) the use of capital;
(ii) the expectation of a return; and
(iii) the risk involved.
Therefore, if, on a case by case assessment, an NFT meets the above requirements then, the related regulation of “investment products” might apply.
If an NFT qualifies as virtual currency, then it will trigger anti-money laundering requirements, even though a case-by-case assessment is, once again, necessary. Finally, under a fiscal point of view, as for the income tax, in the event that the NFT falls within the scope of the transfer of intellectual property rights it has to be considered whether the transferor is acting in a professional capacity as an author or whether the considered activity is occasional. As for the applicability of VAT, it has to be assessed whether the author is subject to VAT as well as whether the transfer falls within the scope of copyright law.
In Japan, there are currently no specific laws that regulate NFTs, but in January 2022, the government announced it was launching an NFT task force, which hints that regulation is on the horizon. Currently, if a NFT holder is given money or assets that constitute a sharing of profits then the NFT may fall within the definition of securities under the Financial Instruments and Exchange Act. In Japan, special consideration should be given to whether NFTs violate any gambling laws, which are particularly relevant to NFTs used in games.
Like the other member states, there is no legal definition or specific regulation of NFTs in Portugal, but, if an NFT meets the definition of a virtual asset, then it will trigger anti-money laundering obligations. Portugal also follows Spain, in that companies or individuals that exchange, transfer or provide custody services of NFTs that constitute as investments will need to be registered as a Virtual Asset Service Provider.
There is no specific regulation of NFTs in Spain, but NFTs may be subject to anti-money laundering regulations if they fit the definition of a virtual currency. Companies or individuals that exchange, transfer or provide custody services of NFTs that constitute as investments will need to be registered as a Virtual Asset Service Provider. In Spain, NFTs will also be regulated by the laws of its underlying asset. Earlier this year, the Spanish Ministry of Consumer Affairs announced it is considering regulation of crypto-games. It has also imposed regulation in relation to advertising of crypto-assets, to ensure that investors are aware of the risks.
Singapore’s central bank has recently announced that it will not regulate the NFT market. It considers the emerging market to be in its infancy, and at present does not wish to regulate something which people are investing their money in.
However, under Singapore law, should an NFT have the characteristics o of a capital markets product under the Securities and Futures Act (SFA), it will be subject to MAS’ regulatory requirements. For example, should an NFT be structured to represent rights to a portfolio of listed shares, it will like other collective investment schemes be subject to prospectus requirements, licensing and business conduct requirements.
Similarly, should an NFT have the characteristics of a digital payment token under the Payment Services Act (PSA), this may impose specific restrictions and obligations on the seller of such NFT.
United Arab Emirates
The Abu Dhabi Gobal Market (ADGM) has recently published a consultation paper called “Proposals for enhancements to capital markets and virtual assets in ADGM”. In its proposals, the ADGM considers that companies will need a licence from the free zone’s financial regulator to be allowed to facilitate NFT trading. It also considers that NFTs may trigger compliance with ADGM’s anti-money laundering and Sanction Rules. Whilst still only in consultation form, sellers and investors should keep these obligations in mind.
NFTs may in very certain circumstances be subject to Crypto Asset Regulations. These regulations cover crypto assets that are securities or are traded on an exchange. Depending on the nature of the underlying asset, anti-money obligations may be triggered.
NFTs are currently not specifically regulated in the U.S. Whether and how regulation applies turns on how a particular NFT is classified, and such classification usually depends on the particular rights and attributes associated with an NFT. For example, the Securities and Exchange Commission has recently announced that it is investigating potential illegal token offerings. Currently NFTs may classify as a security under the Securities Act 1933 and Securities Exchange Act 1934 if a particular NFT has the characteristics of those of a security, for example like an investment contract, than it could be deemed to constitute and be treated as a security.
Although not frequently the case, if an NFT has some sort of monetary value attached to it, it could implicate regulatory obligations from the Financial Crimes Enforcement Network (FinCEN), such as requirements to comply with comprehensive anti-money rules. An NFT with those characteristics may also risk trigger state-by-state licensing requirements under state money transmitter laws.
More frequently we see NFTs with some monetary value attached to them used in loyalty or reward programs. Such NFTs may well avoid FinCEN and state money transmitter rules, but there are strict rules about how such a program must be structured. s. The IRS is now also focused on NFTs and has sent 10,000 letters looking to collect taxes from cryptoassets, including NFTs.
For NFT creators, selling an NFT on a marketplace will result in tax being paid on the profits as income tax. For investors, purchasing an NFT may result in capital gains tax being incurred if the NFT is then sold for a profit.
The NFT regulatory landscape is a currently an oasis of fresh opportunities that often come with new technology. However, legislators are becoming increasingly aware of the risks that come alongside these opportunities, including issues around intellectual property, consumer welfare, and money laundering. Any businesses which intend to explore this new world should be aware of the increasing pressure on jurisdictions to regulate their actions within it.
In our next alert, we will be considering the copyright issues with NFTs.