A Regulatory Review on The NFT’S – A Comparative Study

NFTs, or non-fungible tokens, are the digital ownership certificates for specific, typically digital assets that are stored on a blockchain. NFTs are most frequently sold in connection with digital artwork, but they can also be a video, music file, in-game item, tweet, physical item like a trainer, or even real estate. Each NFT uses blockchain technology to store transactional data that is accessible to everyone and enables the owner to confirm the ownership of the NFT. Since NFTs are tied to certain underlying items, they are all distinct and cannot be exchanged for one another. The fact that customers are not purchasing the digital piece itself is crucial to keep in mind. What you are actually purchasing is essentially a set of metadata a group of pieces of code that points to the original, unaltered version of the work. This means that even if you own it, someone else might still download, view, or sell the digital art. Some of the most valuable brands are now investigating the potential of NFTs. The largest of the numerous online marketplaces where people can buy or trade NFTs at the moment is Open Sea. NFTs are bought with cryptocurrencies like ether (ETH), which serves as the Ethereum blockchain's base currency. Cryptocurrencies, as opposed to NFTs, are fungible, or interchangeable (but only in respect of that cryptocurrency, so, one bitcoin could be swapped for another bitcoin, but that bitcoin could then not be swapped for an ether). The non-fungibility of an NFT, on the other hand, is what makes it valuable because each NFT is distinct and cannot simply be substituted by another NFT. It serves as a means of certifying the artwork and your ownership and is effectively the equivalent of an artist's digital signature. 

 

Why Do We Regulate?

Currently, there are no laws or regulations that apply to NFTs in the majority of jurisdictions. However, depending on the token's features, its intended use, the range of jurisdictions and regulatory frameworks where the NFT in question is minted or marketed, and where key players in a transaction are based, existing regulations governing digital assets and tokens may apply in some circumstances. In the UK, for instance, trading an NFT for cash or other crypto assets necessitates registration in accordance with the 2017 Money Laundering Regulations. Financial institutions must make sure they are consistently in compliance with changing regulatory requirements if they intend to or already enable any type of transaction involving crypto assets. Other NFT-related issues

• Even while they offer the buyer ownership, they do not grant the buyer copyright to the underlying item. This implies that the underlying work's owner cannot prevent anyone from copying or disseminating it;
• Buyers are not informed that the asset they are purchasing is not the actual asset;
• How they are handled in terms of taxes;
• Customers who must pay using cryptocurrencies.

Both financial regulators and consumer protection agencies are concerned about NFTs, although there are regional variations in how they are handled. A NFT transaction could also involve users from different countries. Therefore, anyone considering buying NFTs or selling NFTs may find this information useful.

 

In The United Kingdom, The Situation

 

1. Financial Control

There are no explicit NFT legislation in the UK. NFTs are viewed as a sort of crypto asset instead. Security tokens, e-money tokens, and unregulated tokens are the three categories of crypto-assets that the Financial Conduct Authority separates in its guidelines. For the purposes of the Financial Services and Market Act of 2000 (Regulated Activities) Order of 2001, the NFT will be regarded as a designated investment if it meets the requirements of a security token. The Electronic Money Regulations of 2011 will apply to the NFT if it is an electronic money token.

2. Criteria

• Security tokens: give investors the rights and duties associated with a certain investment, such as shares, deposits, and insurance.
• E-money: monetary value that is electronically stored.

If the NFT fits under the aforementioned categories, the FCA will need to approve their marketing. As a result, the money laundering regulations will apply, and the NFT buyer will need to submit to KYC checks and surveillance. The great majority of NFTs, on the other hand, will not meet the aforementioned requirements and will thus be unregulated.

3. Money Laundering

There is a specific worry that money launderers could use the trade of NFTs to turn the proceeds of a crime into clean money because of the enormous sums that are being paid for NFTs. The Money Laundering Regulations may nevertheless apply to the NFT even if it does not fit into the aforementioned categories if it qualifies as a cryptographically secured digital representation of value or contractual rights. In addition, if the sale of an NFT is worth €10,000 or more, EU and UK anti-money laundering regulations will be triggered. If so, the NFT seller will need to fulfil client due diligence requirements and keep track of the transaction.

Tax: Any gain from the sale of an NFT that was purchased as an investment and sold for a profit will be liable to capital gains tax. Profits from the trading of NFTs by businesses are subject to corporate tax. The sale of goods and services through NFTs will probably be subject to VAT.

Advertising: After a number of judgements that resulted in the banning of commercials, the Advertising Standards Authority (ASA) has produced recommendations on advertisements for NFTs. To prevent this, businesses marketing NFTs should make sure they are transparent about the fact that what customers are buying is an NFT and that they have received adequate information about the risks of doing so, such as the fact that NFTs' value could go down as well as up.

 

Australia

Although the Australian government recently declared plans to regulate cryptocurrencies, NFTs, or digital assets, they are not typically subject to prescriptive regulation there. The Australian Securities & Investment Commission (ASIC) will be in charge of regulating the NFT if it qualifies as a financial product under the Corporations Act 2001. To buy or sell digital assets, one must have an Australian Financial Services Licence, in accordance with the framework.

 

China

China's mainland forbids the use of cryptocurrencies. NFTs can currently be purchased or sold by individuals in Mainland China. NFTs are not currently subject to any specific laws or regulations, but on April 13, 2022, the National Internet Finance Association of China, the Securities Association of China, and the China Banking Association jointly released an initiative regarding the prevention of financial risks associated with NFTs. Because the three associations are under the supervision of the central bank, the banking regulatory authority, and the security regulatory authority, respectively, and because the Initiative is not a regulation under PRC law, it reflects the attitudes and policy orientation of regulators in Mainland China.

NFTs are not regarded by the Initiative as cryptocurrencies or virtual currencies. However, the Initiative recommends that the following code of behaviour be followed:

• To prevent the issuance or trading of actual financial goods, not to include securities, insurance, credit, precious metals, and other financial assets as underlying items of NFTs;
• To prevent a genuine initial coin offering (ICO), avoid weakening the non-fungible properties of NFTs by batch creations, ownership division, etc.;
• Not to provide continuous listing transactions, standardized contract transactions, centralized transactions (such as centralised bidding, electronic matching, anonymous transactions, market makers, etc.), and other similar trading services for NFTs, to prevent the establishment of trading venues in substance;
• Refrain from using virtual currencies like Bitcoin, Ether, and Tether as tools for pricing and settlement while issuing and selling NFTs;
• Real name identification of the issuing, selling, and purchasing parties; effective preservation of client identity information; records of the issuing and trading of NFTs; and active participation in anti-money laundering efforts; and
• Avoid making direct or indirect investments in NFTs and refrain from any financial support to NFTs investments.

Due to the stringent regulation of cryptocurrencies and other assets and their growing popularity, there is room for regulation; therefore, buyers and sellers should be on the lookout for it.

 

Germany

The German government stated that no changes to the legal system were anticipated as a result of the development of NFT last year. NFTs might, nevertheless, come under the purview of some German laws. NFTs that fit the definition of a cryptocurrency asset or are used for investments will be subject to anti-money laundering regulations, while those that fit the definition of a financial instrument will need to obtain extra licenses. The Federal Financial Supervisory Authority (BaFin) will require a license from anyone wishing to sell NFTs that are considered financial instruments, and the issuer of the NFT may need to publish a prospectus if the NFT qualifies as a security under the Prospectus Regulation or as an asset investment under local laws.

 

United Arab Emirates

A consultation document titled, Proposals for Enhancements to Capital Markets and Virtual Assets in ADGM was just released by the Abu Dhabi Global Market (ADGM). According to the ADGM's proposals, businesses wishing to assist NFT trading will need to obtain a license from the financial authority of the free zone. It also takes into account the possibility that NFTs could make ADGM's anti-money laundering and Sanction Rules applicable. Sellers and investors should be aware of these duties even though they are still just at the consultation stage.

NFTs may, under very certain conditions, be governed by the crypto asset regulations. These rules apply to cryptocurrency assets that are traded on exchanges or classified as securities. Anti-money duties may be triggered depending on the underlying asset's characteristics.

The Securities and Commodities Authority, with the assistance of Clifford Chance, has introduced the Crypto Asset Regulations in the UAE, which are intended to cover crypto assets that are securities or otherwise traded on an exchange (a regulated commodity token). A DLT record acting as a representation of ownership is specifically referred to as a crypto asset. These rules will therefore only be applicable if and to the extent that NFTs are advertised, offered, or connected to other financial activities carried out within the UAE and are tradable through a digital assets exchange. Given their unique and non-fungible character, NFTs listing on digital asset exchanges is unlikely to be practicable in the near future. This is unlikely to be an exchange to which the present UAE rules are meant to apply whether an NFT is the subject of a brokerage arrangement or peer-to-peer transfer (whether organized through an internet platform or not). Despite the foregoing, it is still feasible that NFT-related operations in the UAE (such as brokerage, for instance), will be subject to AML compliance obligations. This possibility would need to be evaluated based on the type of underlying asset and the magnitude of the transaction. The Abu Dhabi Global Market (ADGM), a developing financial free zone in the United Arab Emirates, has emerged as a key regional hub for the trade of virtual assets. In contrast to other regions of the UAE, the ADGM has created its own legislation regarding a virtual assets and issues licenses to businesses to carry out authorized operations in this regard. Again, though, it's unlikely that NFTs will fall under these regulations. A virtual asset is defined as a digital representation of value that can be traded digitally and serves as a (1) medium of exchange, (2) unit of account, (3) store of value, or any combination of these three. This does not specifically contain a representation of ownership, unlike the UAE regulations. NFTs are arguably not collected as a result. However, the ADGM's Financial Services Regulatory Authority only enables enterprises to conduct operations in respect of Accepted Virtual Assets, which are required to meet a number of requirements to the extent that a specific NFT is determined to be a virtual asset (including maturity and market cap). NFTs are not likely to meet these requirements.

 

NFTS And Intellectual Property Issues and The Related Risks

Who holds the copyright to the asset and has the authority to construct an NFT is one of the major issues that NFTs bring up? In addition, is the act of tokenizing (or minting) a violation of copyright if the NFT is merely a record of the link to the artwork? The relationship between copyright and NFTs is a growing concern, and there have been a number of occasions where conflicts have raised difficult copyright issues. For instance, Miramax sued Quentin Tarantino for copyright infringement in California when he declared his intention to sell seven unique scenes from his original hand-written script as NFTs. The Art Wars program, which has been in operation since 2013, commissions artists to produce various renditions of the Star Wars Stormtrooper helmet. In a reverse scenario, the original artist would sue the third-party distributor. Photographer David Bailey, artist Damien Hirst, and sculpturer Anish Kapoor are among others who have contributed to the project.

The attorney for David Bailey asserted that the artist had not granted permission for the NFTs and had not been compensated in any way, and that the curator neither owned the original works of art nor had permission to produce derivative works. Any artists who remained in the project will get royalties in a regular way; the curator has now announced. It's interesting to note that the UK Supreme Court previously specified the copyright for the Stormtrooper helmet in Lucas film Ltd & Ors v. Ainsworth & Anor, although subsistence is unlikely to be a concern in this instance.

By sternly instructing independent artists not to sell NFTs that feature their IP, Marvel and DC have both taken the NFT problem head-on. According to some creators, this is contrary to the custom of selling their own unique comic artwork. Additionally, a lot of independent artists, who perhaps ought to be celebrating the invention of NFTs, are lamenting the theft of their work and the subsequent conversion of it into NFTs without their permission and the little choices they have to stop it from happening again.

An NFT platform is accountable for copyright infringement for infringing NFTs sold on its platform, according to a recent decision by the Hangzhou Internet Court in China, which will take effect on April 20, 2022. The Fat Tiger drawing served as the central focus of the case. It's significant that the court determined the copyright owner has the right to buy and sell NFT digital works. The platform was told to pay damages and deliver the NFT to an unreachable address in order to burn it (it is impossible to permanently delete an NFT). It will be fascinating to watch if other nations adopt a similar policy.

There are significant cybersecurity and fraud threats as a result of the development of the digital world and the astounding increase in the popularity of NFTs. NFT risks of counterfeit stores that resemble genuine NFT stores and use their logo and original content. Fake NFT stores are a significant issue connected to the dangers and difficulties of NFTs in cybersecurity. The bogus NFT stores might offer for sale NFTs that aren't actually there. Buyers should be aware of the risks associated with artist impersonation and fake NFTs so it will be a great idea to consult with a legal expert before taking a step. Some nefarious individuals are able to pass themselves off as well-known NFT artists and sell fraudulent NFTs under their identities. Copyright theft, imitation of well-known NFTs or false airdrops, and NFT giveaways are some of the other significant non-fungible token dangers and issues connected to cybersecurity and fraud. You should be aware of the risks posed by social media frauds that might advertise NFTs.

 

Conclusion

The demand for non-fungible tokens (NFTs), or digital assets that prove ownership of a distinct form of an underlying asset, has skyrocketed. Recent NFT issuances in the sports and digital arts industries have sold out in a matter of seconds, earning their creators millions of dollars. NFTs have the potential to create new revenue streams by creating new types of digital property, serve as new channels for companies and digital creators to connect with clients, followers, and audiences, and allow for the monetization of physical assets, subject to restrictions in any applicable jurisdiction. Although the issuing of NFTs is expanding quickly on a global scale, their legal and regulatory status is still changing. The regulatory environment for NFTs is currently a haven of novel prospects, which frequently accompany breakthrough technologies. The risks associated with these prospects, including concerns about intellectual property, consumer welfare, and money laundering, are, however, becoming more and more apparent to policymakers. Businesses planning to venture into this new market should be wary of the mounting pressure on governments to impose regulations on their operations there.