One of the major challenges in crypto regulation has been to link new categories of assets and services and the legal definitions of what qualifies as regulated assets and services. Non-fungible tokens (NFTs), stablecoins, and decentralized finance (DeFi) remain gray areas subject to evolving regulatory perspectives.
This article, taken from our 2023 State of Crypto Travel Rule Compliance Report, provides a side-by-side comparison of the Financial Action Task Force's (FATF) and the European Union's (EU) regulatory stances on NFTs.
What are NFTs?
NFTs are unique digital assets tokenized on a blockchain and have distinct identification codes, and metadata. Users can trade NFTs for fiat money, cryptocurrencies, or other NFTs based on their value determined by the market and owners. NFTs are challenging to classify and regulate due to their various possible configurations. The entire crypto market took a hit in 2022, and NFTs were no exception, as noted in the chart below.
NFTs were the subject of several regulatory and legal interventions and initiatives in 2022, ranging from insider trading cases to intellectual property qualifications and advertisem*nt restrictions. By way of example, we provide highlights below. N.B. The dates accompanied by a clipboard icon indicate a document a regulator produced.
NFT Legal & Regulatory Spotlight in 2022
- June 1, 2022 - A former employee of OpenSea (an NFT marketplace) was charged in the first digital asset insider trading scheme with accusations of wire fraud and money laundering.
- June 23, 2022 📋 - The European Union Intellectual Property Office (EQUIPO) clarifies how they classify NFTs, incorporating the term “downloadable digital files” authenticated by non-fungible tokens in Class 9.
- November 29, 2022 - The European Parliament hosted a meeting with NFT and metaverse experts. Industry representatives suggested policymakers regulate use cases rather than technology.
- December 21, 2022 - The UK's Advertising Standards Authority ruled against Crypto.com and Turtle United's NFT advertisem*nts for not disclosing investment risks.
Crypto Travel Rule and NFTs
The FATF and EU have divergent, nuanced perspectives on NFT regulation, including varying. classifications and approaches. The primary distinction revolves around whether an NFT is considered a Virtual Asset (VA), which depends on usage and characteristics. The disparities mainly arise from differences in evaluation criteria and the circ*mstances determining VA status. The following sections provide an overview of the FATF's and EU's general positions on NFTs as VAs and if they consider NFT-related activities as covered by the regulation. Additionally, we discuss notable developments and essential considerations from the FATF and EU.
FATF vs. EU: General Stance on NFTs
FATF: FATF generally does not consider NFTs as VAs; however, the classification can depend on the nature and purpose of the NFT. It suggests governments evaluate each NFT case-by-case based on its intrinsic characteristics rather than the terminology used in its marketing.
According to the FATF, an NFT would be classified as a VA if it's used primarily for payment or investment and has features that make it either fungible or not unique, such as the fractional parts of a unique crypto-asset, or if it's issued as part of a large series or collection. [1]
EU: On the other hand, the EU’s stance, particularly reflected in the MiCA (Markets in Crypto-assets Regulation), maintains that unique crypto-assets like NFTs, digital art, and collectibles are excluded from its scope.[2]
In the EU, the uniqueness of the crypto-asset and the value it brings to the holder, and its non-fungibility determine whether or not it falls within the regulation. Like FATF, the EU encourages authorities to adopt a substance-over-form approach, emphasizing the asset's features over the issuer's designation.
FATF vs EU: Is an NFT a Virtual Asset?
FATF: An NFT is not a VA if used as a collectible rather than for payment or investment. However, it is considered a VA if used for payment or investment or if its unique features become fungible.
EU: In contrast, the EU excludes unique and non-fungible crypto assets, like NFTs, from the VA classification. However, if an NFT's de facto features or uses make it either fungible or not unique, it may be considered a VA.
FATF vs. EU: Are NFT-Related Activities Regulated?
FATF: In its Money Laundering and Terrorist Financing in the Art and Antiquities Market report, the FATF recognizes that “markets for digital art, non-fungible tokens (NFTs), and art finance service providers all have intrinsic characteristics that expose them to different money laundering and terrorist financing vulnerabilities.” [3]FATF also clarified that NFT platforms that offer NFTs functioning as VAs may be considered VASPs, which the FATF Standards cover.
Factors to consider when assessing the application of AML/ CFT obligations:
- The nature of the business dealing in NFTs;
- Their function in practice; and
- The facts and circ*mstances of the platform or other person doing business. [4]
EU: Although MiCA generally excludes NFTs, the forthcoming Anti-Money Laundering Directive 6 (AMLD 6) will likely cover companies that provide services related to NFTs.
FATF vs. EU: Noteworthy NFT Developments
FATF: In its Targeted Update 2022, the FATF acknowledges the “rapid development of NFT markets and their functions/forms,” and promises to “continue to monitor this issue and discuss any new implementation issues and country approaches.” [5]
EU: Similarly, The European Securities and Markets Authority (ESMA) is mandated to publish guidelines on criteria and conditions for the qualification of crypto-assets as financial instruments. The guidelines should also help better understand cases in which crypto-assets that are otherwise considered unique and not fungible with other crypto-assets might be qualified as financial instruments.NFT offerors or persons seeking admission to trading are primarily responsible for the correct classification of the crypto-assets, which the competent authorities might challenge.
Conclusion
As the debate around the regulatory status of NFTs continues, it is clear that the technology is advancing at a pace that challenges existing legal and regulatory frameworks. FATF and the EU have recognized the complex nature of NFTs and their potential risks. Their nuanced approach reflects a careful and ongoing analysis of how these unique digital assets fit within the broader financial system.
While these organizations may differ in their current views on whether NFTs qualify as Virtual Assets, there is an alignment in the principle of evaluating NFTs on a case-by-case basis, considering their intrinsic characteristics and practical uses. This approach signifies a move towards a substance-over-form philosophy in regulatory practices.
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