This blog is authored by Aashray Raina, 1st Year Student, RGNUL, Patiala and Associate Editor at Law and Tech Times, RGNUL
Keywords: Tokenization, Copyrights, Regulations, Cryptocurrency, Blockchain, Smart Contracts.
In the annual budget presented on 1st February 2022, the Finance Minister of India, Nirmala Sitharaman, delivered plans to impose 30% tax on income earned from trading virtual digital assets, ranging from cryptocurrencies to Non-Fungible Tokens (NFTs). A consensus among experts has been reached that the imposition of tax on cryptocurrency assets is a significant step towards the legitimization of digital assets in India. Since the market generated $250.846 million in sales in 2020, NFTs have gained enormous popularity. About $40.9 billion were made in the year 2021, solely through investments. It has become clear that NFTs are on the verge of exploding. Big brands have also been discovered to be spending millions of dollars on NFTs for the purpose of marketing and capitalizing on the trend.
NFTs are one-of-a-kind tokens that serve as proof of ownership of digital assets that are involved in utilizing the data storage on blockchain technology. With tokenization and metadata, one can create a non-fungible token that is difficult to duplicate or replicate. NFTs consist of creative works of art such as pictures, music, video clips, GIFs, games, sports clips, tweets, etc., whatever may interest afficionados who are willing to spend millions. These crypto assets, in contrast to other cryptocurrencies, cannot be traded one for another. The demand and value of NFTs keeps on increasing due to its scarce nature. Buyers and investors see this as a quick grab opportunity due to the ability to mint non-replicable data. However, despite the enormous popularity and imposition of taxes, legal conformities are still up in the air.
After personalities such as Amitabh Bachchan, Parthiv Patel, and Kamal Hasan to news agencies like Hindustan Times started their respective NFT marketplaces, India received a smack of NFT awareness and produced a lot of buzz. WazirX, India’s most popular cryptocurrency exchange was the first to enter the market. The NFT marketplace on WazirX reported that it has sold NFTs for $400,000 between July and October. Since the Supreme Court in 2020 struck down the 2018 RBI circular, which interdicted banks from providing any services regarding virtual currencies, the concerned parties found some solace with the extension in its legal scope. During the winter session of Parliament, the government proposed a bill to regulate digital currencies, the specifics of which were not made public. Such discretion and prior threats of a ban, along with the application of the highest possible tax rate, has caused the digital asset space to go into a tizzy ride.
“Can I copy your homework?”
Consider the following scenario: You receive an art print signed by Van Gogh, which is a limited edition. Although the original work piece still belongs to Van Gogh, you received a copy of the art which was authenticated by Van Gogh himself.
NFTs work in a similar way. When an NFT is minted, tokenization takes place depending upon the number of copies and auction. What you buy is not the actual art but a copy of the digital asset, which is a metadata of the work. When you buy an NFT, you receive ownership of the particular digital asset, but what you don’t initially receive are copyrights. NFT owners can produce the owned work through sales in limited editions, whereas even after selling, the actual owner has the rights to mint more copies unless he grants a license to transfer rights. The rights transferred depend upon the ‘smart contracts’ which are made through the NFT platforms. The issues of infringement arise when minting takes place by someone who is not the authentic owner of the work or when an owner utilizes the NFTs without the transfer of rights. Due to the lack of legislation surrounding NFTs, most such infringement cases are solved by actions taken by auction platforms.
The Quentin Tarantino v Miramax, ‘Pulp Fiction’ NFT case has raised questions such as ‘who owns the copyrights?’ and ‘who can rightfully mint NFTs?’ Miramax, the production house for Pulp Fiction, argues that Tarantino breached copyrights. The fact remains that the scenes created in Pulp Fiction were original screenplays, and the intellectual property of Tarantino. Whereas this notion of breach of contract relating to the NFT begs the question that since the contract was not a smart contract and contains nothing of the sort of an NFT, can the dispute still be considered?
Safety around this cyberspace
Concerns like the impact and safety of one’s work with NFTs were also raised from Banksy’s artwork, which was sold as an NFT by a viewer after the original was destroyed during a live stream.
The lack of regulations and provisions for NFTs has made them an ideal scene for money laundering and infringement of intellectual property. Although some countries like Switzerland monitor crypto assets under Anti-Money Laundering (AML) regulations and some others are taking the same into consideration, the lack of description of NFTs has given them an escape from under the radar. Just like someone can steal your print version of Van Gogh, one can also steal your NFT too. Vice recently reported the case of “ILOVEPONZI” who lost his Ape NFTs to hackers. The challenge with NFT platforms is that a person can mint a file of work, without even having ownership rights. Open Sea, which is one of the largest NFT servers, has a policy that states that no plagiarized content will be uploaded to its servers. Yet recently it was found that around 80% of the NFTs on Open Sea were fake or fraudulently acquired. Dutch artist Lois van Baarle found more than 100 pieces of her art for sale. She was surprised when she found out that it wasn’t put up in her name. NFTs have become an exhibition for the art of stealing art. Concerns around real or fake art and the security of assets have raised alarms across the market. This whole new aspect of digital crime is the reason why regulations around the authenticity of tokens are necessary.
Here comes the money
In January 2022, Coinbase and Mastercard finalized their agreement, which allows Coinbase users to buy upcoming NFTs with Mastercard credit and debit cards. NFTs are generally bought using cryptocurrencies through DLT, and since the NFT market is booming with big brands who are launching their own NFTs, financial firms are looking at the option of payment for buying NFTs. The present methods require blockchain regulations as the data transactions are stored there. Corporations dealing with NFTs will encounter international jurisdiction cover as NFTs contain no territorial restrictions and are part of an open network. The responsibility for compliance will be borne by the regulated organization among the parties, and it will be difficult to transfer due to particular jurisdictions. Non-compliance will result in severe penalty consequences once regulations are determined.
Worldwide: Around the Globe Regulations
Although the NFT space is still in its initial and nascent stage, light has been shed in some corners of the globe to increase awareness about this rapidly rising market phenomenon.
The Chinese government has been strictly regulating the crypto asset space. The notice issued by the Initial Coin Offering with government agencies to The Central Bank of China was the first official regulatory notice towards crypto-related services. The National Internet Finance Association of China in May 2021, directed that banks and payment firms shall not provide any digital/crypto services through them. The Chinese government further provided restrictions based around the potential trouble related to crypto investments, with which the scope of NFTs in China looks narrow for now.
The European Commission proposed Regulation Of The European Parliament And Of The Council on Markets in Crypto-assets, and amending Directive (EU) 2019/1937 on 24th September 2020, which is also referred to as Markets in Crypto-Assets (MiCA). The package included a list of reasons and objectives, mainly to monitor the regulations and fill the gaps by categorizing digital assets. As the MiCA package consisted of regulations for digital tokens and Distributed Ledger Technology (DLT), the question remains whether NFTs fall under the legislation or not, as they were not explicitly termed in the proposal.
The Financial Conduct Authority (FCA) in U.K. has provided a distinction between regulated and unregulated tokens. Given the nature of NFTs and cabinet pushing ministers to adhere to a clear policy stand on crypto, NFTs are likely to fall under the category of unregulated tokens as per the FCA. In accordance with the Money Laundering Regulations of 2017 in the UK, which define DLT and crypto assets, NFTs will have a platform ready with anti-money laundering and cyber-security provisions.
The Financial Crimes Enforcement Network (FinCEN) of the U.S Treasury Department has not specified NFTs but has issued guidelines for virtual currencies, which could determine the ambit of NFTs. However, the definition and ambit of NFTs as ‘securities’ as per the SEC is still unclear. If NFTs are regarded to be analogues for currencies, FinCEN may consider NFTs to be subject to the 1970 Bank Secrecy Act (BSA) and FinCEN rules. This provision shall mainly promote the prevention of money laundering through crypto assets.
Dubai Financial Services Authority (DFSA) in March, through its Consultation Paper 138, released frameworks for regulations of digital assets. The DFSA provision induces investment in tokens as derivatives in crypto coded form. The frameworks are a step closer to identifying NFTs as security or derivatives as the DFSA is also looking to propose the induction of investment tokens not covered under the 138 paper.
Japan specifies the use of NFTs in gambling as illegal and has entertained particular cryptocurrencies as legitimate payment methods. With the booming NFT market around anime, Japan could be looking at the potential surrounding it. Although there are no regulations around NFTs, as per legal experts, they will either be considered ‘securities’ under the Financial Instruments and Exchange Act or as crypto assets under the Payment Services Act.
Legal spectrum in India
To incorporate the challenges and problems that come with NFTs, Indian regulatory bodies need to upgrade their systems in order to be able to serve a population of a billion-strong. The broad spectrum of legalities and NFTs themselves leave grounds for inclusion under quite a few ambits. Given the nature of NFTs and digital currencies, Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), and Foreign Exchange Management Act (FEMA) will be the essential bodies. Legal experts observed that Budget 2022 contains the clause for virtual digital assets under which NFTs can fall. However, if NFTs are specified as securities or derivative tokens, it is to be seen how SEBI will treat NFTs, especially after the regulation of crypto-assets. The scope of NFTs as financial payment methods can be seen since the RBI introduced Central Bank Digital Currency (CBDC), which are digital currencies. but unlike crypto currencies, these are centralized. It remains to be seen how these currencies will be utilized, as well as whether there will be an opportunity to purchase NFTs with CBDC after the digital art market is approved.
NFTs will strike the four necks of the regulation, which are mainly – IPR, IT Rules, The Copyright Act and Laws of Contract. The IPR arena includes patents and trademarks which can be referred to as tokenization and use of metadata when talking in terms of NFTs. The inclusion of the NFT model under the IPR arena seems feasible with the latest developments in technology laws. However, it is yet to be seen how the transfer of rights through license will take place, since The Copyright Act of 1957 states that copyrights need to be in the form of writing. The second issue here is that The Copyright Act, 1957 only provides space for literature, dramatic, musical, and artistic works, films and sound recording while NFTs include tweets, real estate, games etc. as well, meaning they cannot be included under the ambit of this Act. Since the transfer of ownership during trading of NFTs takes place through smart contracts, it will be important for the legal experts in India to incorporate those and determine whether they can be treated under the Indian Contract Act, 1872, not only for the progress of NFTs as a currency but also the digitization of the Indian marketplace.
Conclusion
NFTs are exploding in popularity and hold immense potential, but the hazards and laws around them are still unclear. Although the new announcement provides reason for optimism among stakeholders and investors, it also has elicited a range of sentiments, including feelings of uncertainty and conformity. The involvement of celebrities and company boards in the launch of NFTs, as well as the public’s awareness of them requires various legal aspects and agencies to be addressed in order to prevent illicit activities through them. NFTs are dynamic in nature and can be regarded as securities, assets, art work or intellectual property. As a result, classification and categorization of NFTs are required in order to develop some legal provisions. The increasing number of violations in the NFT area, along with the uncertainty surrounding authenticity, begs the question of what the central government will do.
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