BaFin provides information on their qualification

This article is first on the Fin Law Blog appeared.

In a specialist article dated March 8, 2023, BaFin comments on how it classifies NFTs (Non Fungible Tokens) under supervisory law. BaFin therefore understands NFTs to be cryptographic tokens that are based on the distributedledgers-Technology (DLT), with the main manifestation of DLT being blockchain. As the name already implies, NFTs are not fungible with each other due to their technical properties and are therefore not interchangeable. The potential fields of application are numerous. Collectibles and digital art are likely to be the most popular classes of NFTs.

With regard to the regulatory qualification, BaFin plans to proceed in the same way as with fungible tokens after its publication. The decisive factor for the regulatory classification of the token should therefore not be its technical characteristic of individuality, but the rights and content assigned to the NFT in the individual case. BaFin therefore always wants to decide on a case-by-case basis whether an NFT is a crypto asset, an investment or a security.

NFT can be an investment – ​​classification as a security not yet known

NFTs may qualify as securities if they embody security-like rights, are transferable and are tradable in the financial market. BaFin understands rights similar to securities to be membership rights or financial claims, for example to payment of returns, as in the case of shares or debt instruments. In principle, BaFin considers the transferability of tokens to be a given as long as it is not artificially restricted. With regard to tradability, the authority expects a certain degree of standardization to the effect that the NFTs in a tranche must convey the same rights. However, since the rights and content associated with NFTs are fundamentally individual, most of them lack the tradability required for classification as a security within the meaning of the legal definition of securities. According to BaFin, it has not yet become aware of any NFTs that qualify as securities.

Even if the regulatory classification as a security usually fails, in individual cases they can still be investments and thus regulated financial instruments. What is decisive in the individual case is the rights with which the token is equipped. If, for example, an NFT serving as proof of ownership for an object of art embodies the obligation of the issuer to sell the object of art at a profit and to grant the token holder a claim for repayment and interest, the token holder should qualify as an investment. In the case of a public offering of an NFT qualifying as an investment, there is an obligation to create a capital market prospectus, unless an exception to this obligation applies.

NFT can be crypto value – service providers may need a BaFin license

In certain cases, NFTs can be crypto assets within the meaning of the German Banking Act (KWG) or the German Securities Institutes Act (WpIG). Crypto assets are digital representations of value that are accepted by third parties for payment or for investment purposes. A use as a means of exchange or payment can usually be ruled out from the outset due to the lack of interchangeability of NFTs. The situation is different with the second alternative of use for investment purposes, which can definitely be the case with NFTs. In this regard, however, BaFin clarifies that the mere fact that, for example, users are speculating on price gains with an NFT is not sufficient for the assumption of an investment purpose.

When examining the legal classification of an NFT as a crypto asset, BaFin wants to take into account which rights are associated with the token and which marketing activities are carried out when it is sold. If, for example, the expectation of price gains is fueled as part of the offer of NFTs to the market, this can be an indicator for regulatory classification as a crypto value. If an NFT has to be classified as a crypto value, this can lead to the service providers involved, especially in the secondary market, requiring a BaFin license for their business dealings with the tokens, for example for proprietary trading, investment brokerage or financial commission business.