When NFTs are traded via global platforms, issuers and buyers need to be aware of the legal and regulatory treatment in different jurisdictions. However, as NFTs are a relatively new asset class, much of the NFT legal and regulatory framework is still evolving, both in the UK and globally. Despite rumours that NFTs are explicitly covered by the Crypto-Asset Markets Regulation (MiCAR), they are currently not specifically regulated. Nevertheless, existing laws and regulations apply, and there are several business and legal issues that any company that issues, trades or exchanges NFTs must consider. Definition of the scope of the NFT It is essential that issuers clearly indicate which rights are “sold” with the NFT. This could include certification of ownership of an asset, a license to use intellectual property rights, or even contractual rights, such as the right to receive or use a particular asset (digital or virtual) or access benefits. Clarity in advance will prevent the issuer from waiving unintentional rights and possible claims from buyers who claim a false statement of the rights offered. Similarly, the buyer of an NFT must understand what they are buying. For example, if the NFT contains smart contract functions, this is coded there and may not be apparent at first glance. The buyer`s due diligence is required to determine what rights and obligations are acquired, particularly whether they could affect the current or future value of the NFT and the underlying asset.
What an NFT represents, how much is to be generated by the sale, and whether it is even able to acquire fractional ownership is largely determined by the commercial rationale for the DTV issuance. For example, if the value is due to the scarcity of an NFt or the underlying asset, an issuer may want to restrict the split (and must ensure that it can enforce these restrictions), and buyers may seek assurances in this regard. However, if the NFT or underlying asset is of high value, splitting the NFT (without sharing the underlying asset) can open up investment opportunities for those who otherwise cannot afford it. These factors also determine (for example) the content of terms of sale or smart contracts and the applicable legal framework. Issuers of intellectual property rights will want to closely control the use of intellectual property rights related to an NFT by buyers. The sale of a claim to unique content may, prima facie, amount to a transfer of copyright. Typically, however, copyright and other intellectual property rights remain with the issuer and the buyer is granted the right to display the underlying asset. Attention should be paid to how intellectual property rights are licensed through the sale and onward transfer of the NFt, in particular to ensure the protection of the issuer`s valuable brand (including effective remedies in case of abuse of its intellectual property rights). What the buyer of an NFT will own depends on coding or smart contract built into the NFT (or terms of sale in a traditional contract format). For example, NFT creators can set up an NFT to create an automated ongoing payment of royalties or commissions for reselling tokens. Payment could be automated via a smart contract within the NFT, with the issuer able to track resales as it is recorded on the blockchain where the NFT is held. Financial regulation Companies must assess whether their NFT is a regulated investment, security or payment instrument and/or whether the offer for sale or provision of related services such as a depositary or exchange platform constitutes a regulated activity within the meaning of financial regulation.
NFTs are not (yet) specifically regulated, but if they have the characteristics of other regulated investment units, they can trigger national and supranational legal obligations. In particular, issuers must demonstrate the non-fungibility of an NFT they offer to avoid it being considered a security token or cryptocurrency that could be covered by financial regulation (including the upcoming MiCAR). These regulatory obligations range from the identification and verification of know-your-client and related record-keeping, monitoring and other compliance obligations under anti-money laundering regulations, to sanctions regimes, to much more stringent requirements when securities regimes or other investment laws are triggered. Transmitters and service providers are generally subject to regulation in the jurisdiction in which the DTVs or related services are sold, particularly when they are offered in the retail market. Given the inherent global nature of these digital assets, cross-border analysis is usually required. The responsibility for compliance rests with the supervised entity and is difficult to transfer. In addition to possible fines, the risk of non-compliance to reputation is serious. Aside from financial regulation, companies must also ensure that all marketing activities comply with their NFTs, keeping in mind that several regulators have taken enforcement action in the crypto space, including with regard to unregulated crypto advertising that has not sufficiently highlighted financial risks. Data security and ESG The sale of NFTs is unlikely to involve the disclosure or exchange of material personal data, so compliance with data protection laws will not be an important consideration.
However, the security of data and NFT transactions more broadly will be paramount. Technical teams need to determine which security and data exchange standards and which blockchain protocol (most commonly Ethereum) will be used. In addition, appropriate technical provisions must be put in place to ensure the sustainability of DTVs and, in particular, of all the digital assets they represent. We have already discussed the environmental impact of some blockchain systems. With environmental, social and corporate governance issues high on the corporate agenda, companies issuing NFTs, especially those on Ethereum (a proof-of-work system), need to check whether they align with a broader corporate environmental strategy.