Are non-fungible tokens covered by regulation?

This article is first on the Fin Law Blog appeared.

Cryptocurrencies such as Bitcoin, Ethereum or Ripple are characterized by the fact that there are a large number of their types. They are designed identically in the sense that one bitcoin corresponds exactly to the other in value, which is why they are suitable as units of account.

This is different with non-fungible tokens (NFT). They are created using smart contracts on suitable blockchain infrastructures and have an individual character. NFTs are therefore not suitable as a unit of account, but instead for the digital reflection of individual objects or rights.

The Regulation on Markets in Crypto Assets (Markets in Crypto Assets Regulation – MiCAR), which was recently finally adopted after the conclusion of the trilogue negotiations between the EU Commission, the EU Parliament and the European Council, originally wanted to create a reliable legal framework for the entire crypto market in Europe – also for NFTs.

However, the final text of the MiCAR does not provide for any regulation of NFTs, as crypto assets that are not fungible are to be excluded from the scope of the new regulation.

Confusion surrounding the application of MiCAR to NFTs

The text of the final MiCAR does not provide for the regulation of NFTs. At the end of the trilogue negotiations, however, the EU Commission gave its approval to the text with the proviso that NFTs should generally not, but in individual cases should come under the MiCAR if they are part of collections. However, what exactly is to be understood by collections is not defined or specified in the text of the MiCAR.

The EU Commission probably meant cases in which an issuer issues several NFTs that differ in details but clearly belong to an overall issue. Examples would be NFT-based trading cards for the players of a football team or a series of NFT-based images that all show basically the same motif, but differ in a small detail or the color representation. Unfortunately, there is no official explanation of the concept of collection from the EU Commission or any other institution that can ensure a uniform interpretation throughout Europe.

It is therefore currently unclear which specific NFTs may benefit from the advantages and disadvantages of MiCAR in the future. Once the MiCAR comes into force, the competent national supervisory authorities will have to specify their administrative practice on this issue and position themselves. What then threatens is the international patchwork quilt in the NFT regulation, which MiCAR was actually supposed to abolish.

ESMA must develop a definition of the collection

Now that the final text of the MiCAR has been finalized, the European Securities and Markets Authority (ESMA) is responsible for developing draft technical regulatory standards and interpretative guidance. In particular, these should enable a uniform European interpretation of the new provisions by the national supervisory authorities.

In the technical standards to be developed, ESMA should also clarify the question of the applicability of the MiCAR to NFTs and clearly define what it understands by a collection in this context. Before publishing regulatory technical standards for new EU regulations, ESMA always conducts a public consultation in which it gives market participants and experts the opportunity to comment on all relevant aspects.

The NFT industry should use this opportunity to work towards an appropriate and workable administrative practice for NFTs in the MiCAR regulatory regime and to avoid a new European patchwork quilt.