Are NFTs an animal to regulate? A European approach to decentralization, part 1
Non-fungible tokens (NFTs) are constantly in the news. NFT platforms are springing up and champions are emerging, like OpenSea. It is a real platform economy that is taking shape, like those in which YouTube or Booking.com have established themselves. But it is a very young economy, which has trouble understanding the legal issues that apply to it.
Regulators are beginning to take an interest in the subject, and there is a risk of a backlash if the industry does not regulate itself quickly. And, as always, the first blows are expected east of the Atlantic.
In this first article devoted to the legal framework of NFTs, we will focus on the application of the regime of digital assets and financial law to NFTs in France. In a second article, we will come back to the issues of liability and copyright.
Related: Legally non-fungible tokens
A digital asset?
In France, the definition of digital assets includes two types of tokens. On the one hand, utility tokens, i.e. all representative intangible assets, in digital form, of one or more rights, which can be issued, recorded, stored or transferred by means of a device of ‘shared electronic record allowing the owner of the property in question to be identified, directly or indirectly.
NFTs are intangible assets that can be issued, recorded, stored or transferred via shared electronic records.
On the other hand, payment tokens, i.e. any digital representation of value that is not issued or guaranteed by a central bank or public authority, is not necessarily linked to a legal currency and does not have the legal status of money, but is accepted by natural and legal persons as a transferable, storable or electronically exchangeable medium of exchange.
Is an NFT a digital asset under French law?
An NFT is acquired to obtain a right of ownership, but it can also be acquired to claim the provision of one or more services related to this NFT.
Further, an NFT can be considered a digital representation of value that is not issued or guaranteed by a central bank or public authority, is not necessarily tied to legal tender, and does not have the legal status of currency, and which can be stored or exchanged electronically. It follows that NFTs could be classified as digital assets, either as a usage token or a payment token, or both.
The consequence of classifying NFTs as digital assets would be twofold.
Register as a virtual asset service provider
If the NFT-issuing platform sets up, in addition to its primary market, a secondary market on which users would benefit from: 1) a digital asset storage service or access to digital assets for the benefit of a third party in order to hold, store or transfer these digital assets, and/or 2) a service of buying or selling legal tender digital assets, and/or 3) a service of exchanging digital assets for other digital assets, and/or 4) operation of a digital asset trading platform, followed by mandatory registration as a digital asset service provider with the French financial regulator, the Autorité des marchés financiers (AMF), is required.
In addition, customers must be identified through a Know Your Customer. Our analysis is supported by the fact that NFTs are qualified as “crypto-assets” by the draft European regulation “Markets in Crypto-assets” (MiCA).
Related: How should DeFi be regulated? A European approach to decentralization
The Financial Action Task Force (FATF) also issued an opinion on the assimilation of NFTs to “digital assets” in its famous recommendation of October 2021. It specifies that NFTs are “generally not considered [virtual assets].”
However, similar to its approach to DeFi, the FATF stresses that regulators should “consider the nature of NFT and its function in practice, not the terminology or marketing terms used.” In particular, the FATF argues that NFTs that “are used for payment or investment purposes” may be virtual assets.
Related: FATF Guidance on Virtual Assets: NFTs win, DeFi loses, the rest stays the same
Although the directive does not define “for investment purposes”, the FATF likely intends to capture those who buy NFTs with the intention of later reselling them for profit. While many buyers buy NFTs because of their connection to the artist or work, much of the industry buys them because of their potential to increase in value. In other words, many NFTs could qualify as digital assets to follow this interpretation.
Application of the ICO scheme?
As soon as there is a public offering of digital assets (to more than 150 potential buyers) in France, the French ICO regime applies. The issuer is then subject to the following rules: The “simple” advertisement of the token offer is authorized, corn any canvassing would be prohibited as well as any “quasi canvassing”, except if the issuer has obtained the AMF visa.
This is a delicate point because the NFT issuer could not “invite” French residents to register on its site without breaking the law. It would then be required never to target “French” groups or communities.
However, we do not believe that the ICO regime is applicable to NFTs, because this regime is designed to regulate a fundraising operation and protect the investor. Certain provisions of the law are incompatible with an NFT offer (i.e. offer limited to 6 months, sequestration of funds during the ICO, etc.).
This is the spirit of the proposed MiCA regulation, which considers NFTs as digital assets by default, but excludes them from certain obligations specific to ICOs (publication and notification of a white paper).
Anti-money laundering and KYC obligations?
We have already noted the risk of qualifying as a virtual asset service provider (VASP), which would entail a KYC obligation (from 1 euro of transaction). In addition, persons acting as intermediaries in the art trade, including when it is carried out by art galleries, when the amount of the transaction is equal to or greater than 10,000 euros, are subject to an obligation to apply vigilance measures based on the assessment of the risks presented by their activities in terms of money laundering and terrorist financing.
Related: NFT and Compliance: Why We Need to Have This Conversation
In short, all NFT platforms, which are related to digital works of art, should implement KYC procedures even if they are not qualified as digital assets, which is far from being the case today.
In the USA?
We know that the approach in the United States is different from that in Europe because the American Securities and Exchange Commission (by applying the famous “Howey Test”) qualifies tokens which would be seen as digital assets in Europe, as transferable securities .
The risk that the SEC classifies tokens as “securities” is therefore significant. The SEC has not yet come to a firm conclusion on the matter, but it has been suggested in the past that some NFTs could qualify as securities, particularly when sold fractionally.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Thibault Verbiest, a lawyer in Paris and Brussels since 1993, is a partner at Metalaw, where he heads the department dedicated to fintech, digital banking and crypto finance. He is the co-author of several books, including the first book on blockchain in French. He acts as an expert with the European Blockchain Observatory and Forum and the World Bank. Thibault is also an entrepreneur, having co-founded CopyrightCoins and Parabolic Digital. In 2020, he became president of the IOUR Foundation, a public utility foundation aimed at promoting the adoption of a new internet, merging TCP/IP and blockchain.