NFT in a legal context: investment or digital security?

From niche product to Amazon marketplace

At least in the media, the NFT hype has abated somewhat. After the artist Beeple wrote his Everydays: The First 5000 Days digital NFT collage had sold for over 69 million dollars, many investors and speculators were in non-fungible token fever.

From the high in August 2021 with just under 2.8 billion dollars in trading volume in 30 days, the NFT markets leveled off by 100 to 200 million dollars in traded assets per month at the end of 2022. However, in February 2023, the NFT trading volume increased significantly again. The data from the crypto analysis company CryptoSlam According to this, the NFT volume even broke the mark of over one billion dollars for the first time in nine months.

However, it is particularly interesting that well-known tech companies are also increasingly showing interest in NFTs. According to reports, even the Tech giant Amazon to launch its own NFT marketplace soon and offer blockchain-based games. The “Amazon Digital Marketplace” is expected to officially launch on April 24, but will initially only be accessible to US customers. The project focus is said to be on getting customers to participate in crypto games to receive free NFTs. With the NFT marketplace, Amazon is opening up a new business area, continuing to push ahead with integration into the Web3 ecosystem and thus following in the footsteps of other industry leaders such as Meta and Google, who are already active in the Web3 industry.

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Legal classification of NFTs

There are two reasons for the hype surrounding NFTs as an art or commercial vehicle: On the one hand, it makes it easy and quick to understand the provenance and authenticity, which is of fundamental importance in the art world, but also in documents or contracts. On the other hand, the digital certificates of authenticity establish a claim of exclusivity similar to ownership: The NFT is assigned to an owner who can freely dispose of it.

The increasing commercialization of NFT naturally also requires solid regulations. At the moment, however, the question in Germany is how NFTs are legally treated, especially as their design and marketing can vary greatly. It is considered a positive signal that the BaFin in a specialist article pursues a more restrictive approach: Many typical NFTs are likely to be subject to no regulation. However, it depends on a case-by-case basis.

NFTs in BaFin regulation

At the regulatory audit of NFT Does BaFin proceed in the same way as when testing fungible (exchangeable) tokens. In the case of tokens, it checks on a case-by-case basis whether they are a financial instrument within the meaning of the Securities Trading Act or the Markets for Financial Instruments Directive (MiFID II), a security within the meaning of the Securities Prospectus Act (WpPG) or investments under the Asset Investment Act (VermanLG). There are several possible sub-categories of financial instruments:

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• Classification as a security

NFTs are classified as securities if they embody securities-like rights, are transferable and tradable on the financial market. Securities-like rights include membership rights or debt claims asset content, similar to stocks and debt securities. To date, BaFin is not aware of any NFTs that can be classified as securities in the regulatory sense. On the one hand, the tokens have so far lacked embodied securities-like rights. And on the other hand, NFTs are usually provided with individual rights and content, meaning that standardization and thus tradability in the sense of the regulatory securities concept are ruled out. However, in the case of classification as a security, the issuer of the NFT may be required to comply with German securities laws and regulations, such as prospectus requirements.

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• Classification as an investment

NFTs can also be qualified as an investment in accordance with the VermAnlG on a subsidiary basis for classification as securities. For example, it is entirely possible that an NFT that serves as proof of ownership of an object of art is to be classified as another investment in accordance with Section 1 paragraph 2 number 7 Alternative 1 VermAnlG if it represents the issuer's obligation to sell the object of art profitably and grants the token holder a claim for repayment and interest. However, there is no obligation to prepare a prospectus or an investment information sheet if less than 20 shares, in this case NFT, are issued as part of an issue (§ 2 paragraph 1 number 3 letter a VermanLG). It is also decisive which “advertising statements” are made by or on behalf of the issuers, such as the “particular suitability of the NFT offered for investment.” NFTs, which become (short-term) speculative objects by chance, are therefore unlikely to be regulated.

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• Classification as crypto values

Crypto assets are digital representations of a value that are accepted as a means of payment by third parties or for investment purposes. Using non-fragmented NFTs with individual content as a means of exchange or payment hardly appears realistic simply because of the lack of interchangeability of content. On the other hand, the situation is different when it comes to use for investment purposes, which is not excluded from the outset with NFT. The mere fact that users speculate with an NFT, i.e. can make a profit through the purchase and subsequent sale, is not sufficient to objectively assume an investment purpose in the affected NFT category. As part of the audit, both the rights associated with the tokens and the advertising statements made by the issuer or third parties responsible for distribution will therefore be important. If, for example, the NFT offered is particularly suitable for investment, there could be a crypto value.

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If an NFT qualifies as a financial instrument, the mere sale or issue by the issuer generally remains permission-free. However, further trading activities may require authorisation in accordance with KWG or WPIG. The issuance or sale of NFT may also already be subject to prospectus requirements.

Insofar as NFTs are the subject of regulated financial or investment services, this also triggers the applicability of the Money Laundering Act (GwG) and, if applicable, the Crypto Value Transfer Ordinance. However, according to the current legal situation, the currently particularly relevant art NFTs and collectibles are generally not subject to BaFin's money laundering supervision.

NFTs could have a lot of potential due to their technical design and diverse uses in art, culture, the metaverse or in business. It is therefore important that regulatory and supervisory authorities around the world create reliable legal frameworks in a timely manner. A regulated, transparent market would improve the growth and reputation of the NFT industry while encouraging groundbreaking innovations.

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