Driven by concerns over potential fraud, intellectual property theft, tax evasion, and money laundering, governments all around the world are looking at ways to regulate digital currencies and non-fungible tokens (NFTs). Nations have taken vastly different approaches depending on who’s in charge, how they characterize NFTs, and how bullish their outlook is on digital currencies. While some countries such as China have taken a more conservative approach, El Salvador, for example, made cryptocurrency legal tender in their country last fall, in defiance of criticism from the International Monetary Fund (IMF). US President Joe Biden is now marshaling federal regulatory agencies in preparation for an executive order that will discuss crypto in terms of national security and law enforcement
US Regulation of NFTs
In the US, NFTs have drawn significant regulatory scrutiny from multiple state and federal agencies since their popularity spiked in 2021. This is because the existing regulatory and legal environment is not designed to manage the creation, licensing, and trade in NFTs and other digital assets. While entrepreneurs have found novel ways to incorporate NFTs into esports, sports betting, film, and other industries, digital assets such as NFTs pose significant regulatory hurdles.
The White House’s initial government-wide strategy to assess the risks and opportunities posed by cryptocurrencies and digital assets is seen as a sweeping first step toward defining regulatory approaches to NFTs. Research used to inform this strategy includes a Department of the Treasury report that details the impact of NFTs on money-laundering activities in the global art trade. According to the report, in certain circumstances, an NFT may be deemed a virtual asset service provider (VASP) under the Department of Treasury’s Financial Crimes Enforcement Network’s regulation (FinCEN). However, to date, FinCEN has not issued guidance specific to NFTs.
Given the complexities, gaps, and redundancies in the current regulations, it appears inevitable that Washington will issue additional guidance on how NFTs should be treated – as securities, currencies, collective investments, financial instruments, or something else. This is especially important since there is no single federal law that regulates digital assets. State regulation provides no consistent precedent.
Washington, D.C. and 49 states have at least one proposed or enacted regulation pertaining to digital assets and cryptocurrencies. At least 13 states have proposed or enacted legislation on licensing requirements, 25 have proposed or enacted a money transmitter law, and 23 have proposed or enacted bills to create a regulatory sandbox or committee to study the implementation and use of digital assets and cryptocurrencies. States typically focus on generating state revenue from NFTs and other digital assets, with 34 proposing or enacting tax regulations. These regulations vary widely from jurisdiction to jurisdiction and change frequently.
Scattershot enforcement of inconsistent law raises additional challenges:
- Litigation occurs one court at a time and leads to delayed and inconsistent decisions
- Enforcement matters that are settled do not carry any precedential effect
- Inconsistencies in the way in which enforcement matters are resolved can lead to conflicts between state and federal authorities.
Regulators in Europe have taken an interest in digital assets though they have not yet expressly issued any regulations specific to NFTs. In 2020, the European Commission proposed a new regulation known as Markets-in-Crypto Assets (MiCA) to regulate virtual assets, streamline distributed ledger technology and provide legal certainty to digital assets such as cryptocurrencies, security tokens, and stable coins. Certain provisions of the MiCA would apply to NFTs, due to the act’s broad definition of the term “crypto-asset” which includes asset-referenced tokens, e-money tokens, and other digital assets. Under Title II of the MiCA Proposal, NFTs would likely fall into the “catch-all” category of “other crypto assets.”
In addition to MiCA, some EU member states have issued regulations that specifically address NFTs. For example, Luxembourg recently grouped NFTs into three specific categories of collective investment instruments, electronic money, and financial instruments, each of which has its own respective qualities and regulations. Similarly, in 2019 France published the Law on Business Growth and Transformation (known as “PACTE Law”) to comprehensively regulate crypto assets service providers (“CASPs”).
There has been an increased drive by countries around the world to regulate digital assets. El Salvador recently doubled down on its commitment to Bitcoin, buying another $15 million worth during a recent plunge in the cryptocurrency’s price. Still, the Central American nation has not yet promulgated guidelines to regulate digital assets, including NFTs. In February 2022, India announced a 30 percent tax on income derived from the transfer of any virtual assets. To capture details of applicable crypto transactions, India also will assess a 1 percent tax at the source on all such transactions. Similarly, Ukraine, Japan, Russia, Switzerland, and others have either devised rules to regulate digital assets or are in the process of regulating them. Conversely, China, for example, has taken a notoriously strict stance on cryptocurrencies, banning them outright. However, Chinese regulators are currently developing regulations governing and describing the legal minting, use, and trading of NFTs.
NFTs’ arrival in the mainstream awareness and rapid proliferation has prodded nations around the world to increase their scrutiny to protect their citizens and collect their share of related revenue. With so much money at stake, we can expect even more regulation at the national and state levels. Government regulation is inevitable in most countries, as without a robust regulatory framework, there remains the growing risk of illegal activities such as tax evasion, money laundering, terrorist financing, fraud, and theft. NFTs have the potential to disrupt both existing and emerging technology sectors and drive commensurate opportunity and risk. Hence, businesses already using or considering taking advantage of this still-new technology must keep an eye on applicable regulatory developments.
Consultation with an experienced NFT attorney can help platforms, creators, and others in the NFT space comply with applicable law and navigate the complex and constantly evolving legal and regulatory landscape.
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