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NON-FUNGIBLE TOKENS (NFTs): THEIR APPEAL, REGULATION & FUTURE

The adoption of non-fungible tokens (“NFTs”) has relentlessly soared over the last two years, paving the way to enticing business opportunities but also raising concerns for many. NFTs are composed of metadata, which makes them unique and non-interchangeable, but why have they become so in demand? We explain their commercial appeal, how they're applied, how they're regulated and their future.


WHY ARE NFTs SO COMMERCIALLY APPEALING?


NFTs can be defined as certificates of ownership stored on a blockchain that are typically associated with a digital asset such as visual art, videos, music or collectibles. This means that these tokens can be used to prove the ownership of another asset (physical or digital), the title to which might otherwise be disputed.


The value of NFTs is conferred, mostly, by the fact they are issued (or “minted”) in a limited number

of pieces, at times one only. Also, the people behind the tokens are often celebrities. These factors,

considered together, contribute to increasing the demand of these tokens and, as a consequence,

their price.


HOW ARE THEY PRACTICALLY APPLIED?


To better understand how NFTs work, it is important to bear in mind that a NFT cannot make its holder the owner of the asset it represents but it only grants him ownership rights over a unique

version of that work. This means that the nature of the asset they represent can be crucial. In fact,

considering the example of a picture online (e.g., a “meme”) or of a song, it’s high likely that a number of copies of the same asset exist around the world. The simple fact of buying one NFT of a famous picture, does not suffice to giving you title on the original. You will be recognised as the owner of a digital copy of that picture, but to prove ownership of the original asset will always be required (i.e, a contract of purchase or IP rights granted by a registration with the Intellectual Property Office).


It would instead differ in the case of an individual, purchasing an original, unique Gauguin’s portrait. Storing a NFT with a digital version of the painting on the blockchain would be able prove

proprietorship rights on the asset, for the portrait would have been purchased in the normal way with no copy existing to moot the ownership over a unique piece of art.


Another good example is LeBron James’s "Cosmic" Dunk #29 NFT, the famous NFT of a 20 second videoclip featuring the American basketball champion dunking. It was purchased in February 2021 for $208,000 USD. The video will remain free to watch for everyone, but Jesse Schwarz, a 32-year-old American entrepreneur who purchased the token, now owns the proof that it belongs to him.


HOW ARE NFTs REGULATED FROM A UK PERSPECTIVE?


The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer)

Regulations 2017, as amended by the Money Laundering and Terrorist Financing (Amendment)

Regulations 2019 (the “MLRs”), impose on digital assets exchanges and custodian wallet providers

the duty to register with the UK Financial Conduct Authority (“FCA”) before undertaking any business involving digital assets.


Considering the broad definition of “cryptoassets” adopted by the MLRs (“any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”) and that the FCA has not yet managed to clearly categorise these tokens, it seems plausible that the above-mentioned registration duties will also apply to digital assets exchanges dealing with NFTs.


WHAT IS THE FUTURE FOR NFTs?


NFTs are one of the latest exciting applications of the blockchain technology and undoubtedly will

create numerous opportunities in the future. They have the power to revolutionise the art market and their dependence on a blockchain might also turn out to be of help to tackling down illegal activity in this sector. Nonetheless, the uncertainty around their categorisation and the current scarcity of guidance from the authorities suggests caution is required before making any NTF purchases or investments. We believe that governments and regulators should turn their attention to regulating NFT’s to ensure that this exciting new market can grow in stable and safe way that allows for innovation, yet protects both artists and consumers.

 

This blog was written by Joe Woodward and Nicola Scarparo.


For all questions regarding the topics raised in this blog, please contact a member of our team of digital asset legal experts.

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