19 Apr NFTs: Beyond Cryptocurrency and Regulation
You may have seen the term ‘NFT’ in the headlines lately, mostly in relation to the astronomical sums being spent on them. Just last month, a piece of digital artwork sold for a record breaking US69.3 million. What exactly are NFTs? In this Article, we break down what they are and how they work.
Advancements in technology have evolved at such a rapid pace that often it fits into everyday life without even noticing it. A little over 10 years have elapsed since blockchain technology was conceptualised and introduced into the world but the strides taken by the technology have nonetheless casted a shadow over traditional financial markets.
Blockchain technology has introduced a system in which transactions across a network of systems can be independently validated and the transaction history tracked on a ledger, without relying on a central authority. The increasing curiosity in and limitless opportunities created by the technology have instigated the creation of various innovative uses. One of the uses of blockchain technology that has recently gained momentum and piqued interest are digital assets called non-fungible tokens or ‘NFTs’.
What are NFTs?
An NFT is a unique cryptographic or digital asset or content, ranging from art, songs, videos, photographs, and even memes – essentially almost any digital item that is capable of having proprietary or ownership rights attached to it. Each NFT has a unique digital identification (‘ID’) which is exclusive to that particular item and is intended to be the sole and single item of its kind. Its value is therefore inherently derived and is not directly fungible (i.e. interchangeable) with any other NFT. An NFT can most easily be likened to a painting such as the Mona Lisa by Leonardo da Vinci – the original painting by the painter derives its value inherently. This can be distinguished from Bitcoins for example, whose value is not intrinsic to any one Bitcoin, but rather each Bitcoin is of equal value and thus interchangeable.
As an asset, albeit digital, the potential commercial use of NFTs may be limitless. Some practical uses may be to generate rental income by leasing the digital asset to other users, as security to access loan financing, or it can be added to a digital portfolio that can be advertised at digital marketplaces to facilitate convenient sale of an artist’s work.
In fact, the increasing popularity and attraction to NFTs are grounded in various reasons which include the following:
- The owner of the NFT has distinct ownership of the asset by virtue of the unique ID which cannot be copied or reproduced.
- The concept is intended for the intellectual property rights to remain vested in the owner of the rights.
- The blockchain technology that underpins an NFT allows any person to validate the originality of the NFT and to examine its transaction history.
- It represents an ingenious alternative for artists to sell their work digitally, and to even facilitate the payment of royalties through the retention of their intellectual property rights.
Are NFTs regulated?
From a regulatory perspective, like cryptocurrencies, NFTs represent a grey area in the law due to their digital nature. In considering whether NFTs fall within an existing regulatory scheme, you will need to consider the legislative framework of entities such as the Central Bank of Trinidad and Tobago, the Trinidad and Tobago Securities and Exchange Commission (‘TTSEC’), and the Financial Intelligence Unit of Trinidad and Tobago).
In January 2019, these entities issued a joint statement in which they informed the public that they were not of the view that virtual currency providers were supervised by them nor were there legislative provisions which provided protection to consumers. This was followed up by the TTSEC in November 2020 stating that the assessment of whether cryptocurrencies were securities would be entertained on a case by case basis. To the date of publication however, no cryptocurrencies have been registered with the TTSEC.
While NFTs can be distinguished from cryptocurrencies such as Bitcoin, the statements of the regulatory authorities, which suggest that cryptocurrencies remain unregulated for the most part, illustrate that NFTs would also remain unregulated, at least in the immediate short term.
On an examination of the current legislative framework, it is difficult to envision where NFTs can be classified They are less likely than cryptocurrencies to be considered electronic money or currency, due to their nature being more akin to an asset. On that front, local real estate laws have not yet extended past physical property into the realm of digital property.
From a tax perspective, countries such as France have to sought to counteract the challenge arising from digital assets (regulated as crypto-assets) by making legislative changes to provide clarity and certainty to persons involved in the trade of digital assets, which are deemed to create to taxable benefit as long as the digital assets are not converted into legal tender currency or to acquire goods and services. Reasonably, conversion or acquisition may lead to income tax and taxable capital gains. While it remains to be seen whether other countries including Trinidad and Tobago will adopt similar approaches, the InvestucateTT database of the TTSEC recognises NFTs and virtual currencies as examples of crypto-assets. Although the database is only an educational tool, it represents a window into how the TTSEC may potentially treat with NFTs in the future.
More recently, on 7th April 2021 the TTSEC published a notice indicating that a joint steering committee had been established to collaborate on matters relating to financial technology. The collaboration entails establishing a Joint Regulatory Innovation Hub and Regulatory Sandbox. The Innovation Hub is intended to provide support to individuals and entities on regulatory and registration requirements for proposed financial technology products and services, while the Regulatory Sandbox is envisioned to operate as a live testing tool which will allow entities to test financial products services, business models and delivery mechanisms prior to offering to the public.
While there are many advantages to dealing in digital assets such as NFTs, the technology and its issues have not yet been developed to a stage where it is without significant risk. Notably:
- Counterfeiting appears to be a prevalent issue wherein many artists have had their works converted into NFTs without their permission.
- The absence of express agreements between the parties may result in undue hardship.
- The counterparty to an NFT arrangement could be anywhere in the world, which may be subject to unknown regulatory requirements, or may complicate or frustrate attempts to enforce a legal right.
Recent reports have even suggested that the NFT bubble might already be close to bursting. Only time will tell whether they are here to stay or a mere flash in the pan.
NFTs, Bitcoins and other digital assets represent a continuing movement towards the digitalization of financial markets and are a testament to the creativity and innovation that has been synonymous with the 21st century. However, we should nonetheless remain cautious of speculative investments which are largely unregulated. While NFTs can turn any item into a one-of-a-kind digital collectible item, there are vast risks in investing in this asset. There must be an alignment between the advancements made in technology and the progression of the law to regulate these activities. As such, dealing in NFTs should be approached with significant caution and legal advice should be sought before entering into an arrangement.
Disclaimer: This Document Provides General Guidance Only And Nothing In This Document Constitutes Legal Advice. Should You Require Specific Assistance, Please Contact Your Attorney-At-Law.
This blog post was authored by Miguel Vasquez and Nikkishia Maraj, associates, in the Firm’s Dispute and Risk Management and Transactional groups, respectively. For more information, contact firstname.lastname@example.org.