What regulations for NFTs

NFT platforms are springing up like mushrooms as champions emerge, such as OpenSea . It is a real platform economy, like YouTube or Booking.com, which is emerging. But a very young economy, which is struggling to take stock of the legal issues that apply to it. 

What regulations for NFTs

Regulators are beginning to take notice, and there is fear of a backlash if the industry does not discipline itself quickly. And as always, the first shots are to be expected on the other side of the Atlantic.   

In this first article devoted to the legal framework of NFTs, we will focus on the application of the digital asset regime and financial law to the supply of NFTs in France. We will return in a second article to the issues of liability and copyright. 

A digital asset?

The definition of digital assets within the meaning of the Monetary and Financial Code (CMF) includes two types of tokens.

On the one hand, usage tokens, i.e. all intangible assets representing, in digital form, one or more rights, which can be issued, recorded, stored or transferred by means of a device of shared electronic record (DEEP) to identify, directly or indirectly, the owner of the property in question. 

NFTs _ assets that can be issued, registered, stored or transferred through shared electronic records. 

Second, the definition of digital assets includes payment tokens, i.e. any digital representation of a value that is not issued or guaranteed by a central bank or public authority, that is not not necessarily linked to a legal currency and which does not enjoy the legal status of money, but which is accepted by natural and legal persons as a medium of exchange that can be transferred, stored or exchanged electronically. 

Is an NFT a digital asset within the meaning of the law? 

An NFT is acquired to obtain a property right, but it can also be acquired to claim the performance of one or more services related to this NFT.

Furthermore, an NFT can be seen as a digital representation of a security that is not issued or guaranteed by a central bank or public authority, that is not necessarily linked to legal tender and that does not benefit from the legal status of money, and which can be stored or exchanged by electronic means.

It follows that NFTs could be classified as digital assets, either as usage tokens or payment tokens, or both. 

The consequence of classifying NFTs as digital assets would be twofold: 

Registering as a PSAN

If the NFT-issuing platform implements, alongside 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, or/and

2 – a service for the purchase or sale of digital assets in legal tender, or/and

3- a service for the exchange of digital assets against other digital assets, or/and

4 – the operation of a digital asset trading platform, then mandatory registration as a digital asset service provider with the AMF is required.  

In addition, customers must be identified by means of a KYC.

Our analysis is supported by the fact that NFTs are targeted by the draft European MICA regulation as “crypto-assets”. 

The FATF (“  Financial Action Task Force  ”) also issued an opinion on the assimilation of NFTs to “digital assets” in its famous recommendation of October 2021. It indicates that NFTs are “generally not considered as [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 and not the terminology or marketing terms used. In particular, the FATF argues that NFTs that "are used for payment or investment purposes" can be virtual assets.

Although the directive does not define the term “for investment purposes”, the FATF likely intends to encompass persons who purchase NFTs with the intention of later reselling them for a profit. While many buyers source NFTs because of their connection to the artist or work, much of the industry does so 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 regime?

As soon as there is a public offer (to more than 150 potential buyers) of digital assets in France, the French ICO regime applies.

The issuer is then subject to the following rules: 

The "simple" advertising of the token offer authorized, BUT any canvassing would be prohibited as well as any "quasi canvassing", UNLESS the issuer has obtained the visa of the AMF.

This is a delicate point here because the issuer of NFT could not "invite" French residents to register on its site without violating the law. It would then be required never to target “Francophone” 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 offer of NFTs (offer limited to 6 months, sequestration of funds during the ICO, etc.). 

This is also the spirit of the draft MiCA regulation, which by default considers NFTs as digital assets, but excludes them from certain obligations specific to ICOs (publication and notification of a white paper).

The risk of qualification as intermediation in miscellaneous goods

According to Articles L. 551-1 et seq. of the Monetary and Financial Code, an intermediary in miscellaneous goods is any person who:

– directly or indirectly, by way of promotional or canvassing communication, offers, as usual, to third parties to take out life annuities or to acquire rights to movable or immovable property when the purchasers do not provide them the management themselves, or when the contract offers the option of redemption or exchange and the revaluation of the capital invested;

– collects funds for this purpose;

– is responsible for the management of said assets (this first category of intermediaries in miscellaneous assets will be called “intermediaries in miscellaneous assets of category 1”).

The Monetary and Financial Code provides that an intermediary in miscellaneous goods is also any person who offers one or more customers or potential customers to acquire rights to one or more goods by highlighting the possibility of a direct financial return. or indirect, or having a similar economic effect (this second category of miscellaneous goods intermediaries will be called "category 2 miscellaneous goods intermediaries").

The AMF exercises a priori control of investment proposals corresponding to the two types of activity described above (whereas previously this a priori control only concerned the activity of intermediaries in miscellaneous category 1 assets). Thus, any transaction on miscellaneous assets cannot be the subject of communications of a promotional nature or canvassing without prior allocation by the AMF of a registration number on the information document intended for investors, under penalty of sanctions. criminal (up to 5 years' imprisonment and a fine of €18,000) and administrative (in particular disqualification from practicing). It is therefore necessary to draw up an information document in accordance with the requirements of the AMF and submit it to it in order to obtain registration with the AMF of this document. 

It is worth asking whether the issuance of tokens can constitute an intermediation activity in miscellaneous goods. If no direct or indirect financial return is put forward, the issue of tokens cannot constitute an intermediation activity in miscellaneous goods of category 2. As for the activity of intermediaries in miscellaneous goods of category 2, it It is not impossible that it corresponds to the project if we consider that the acquirers of the tokens do not manage them themselves. On the other hand, on the second condition, there is no possibility of recovery, exchange or revaluation of the capital (the tokens are exchanged on a secondary market, which is different from a commitment of recovery, exchange or revaluation by the issuer).  

Anti-money laundering obligations (KYC)? 

We have already noted the risk of qualification of PSAN, which would lead to a KYC obligation (from 1 euro of transaction).

In addition, persons who act as intermediaries in the trade of works of art, including when this is carried out by art galleries, when the value of the transaction is of an amount equal to or greater than to 10,000 euros, are subject to an obligation to apply vigilance measures, according to the assessment of the risks presented by their activities in terms of money laundering and terrorist financing.

In short, all NFT platforms, which are linked to digital works of art, should implement KYC procedures, even if they do not qualify as digital assets, which today is far from be the case...

In the USA ? 

We know that the approach is different in the United States than in Europe because the Securities Exchange Commission (by applying the famous “  Howey Test  ”) qualifies securities tokens that would be seen as digital assets here. 

The risk of qualification as “  security  ” by the SEC is therefore significant. It is not yet pronounced on the question, but a Commissioner, Hester Peirce, has already hinted that certain NFTs could be qualified as securities , especially when they were sold in a fractional way.

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