Compliance analysis of NFT projects under Chinese

By Tony Wang, Tian Yuan Law Firm
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Although China has not promulgated laws on non-fungible tokens (NFTs), the author believes that they are virtual goods or virtual properties under Chinese law; so in the absence of further clear legal provisions, legally acquired NFTs are currently protected by law.

The Civil Code has for the first time mentioned online virtual properties at the legal level. The Supreme People’s Court and the National Development and Reform Commission also issued a document, on 20 July 2020, pointing out the necessity to strengthen protection of new rights and interests such as digital currencies, online virtual properties and data.

However, the compliance of NFT-related projects under Chinese law needs specific analysis.

COMPLIANCE OF NFT PROJECTS

If the NFT corresponds to a unique digital artwork, collection or game item, which can effectively be used as a proof of authenticity of the blockchain, then the NFT already has a compliance basis. However, if NFTs are offered to the public with a promise of liquidity and the issuer provides other services that increase their value, such NFTs may be seen as wrapped in an investment contract – and thus become the securities themselves. Such arrangements carry compliance risks both in China and in the United States.

Tony Wang, Tian Yuan Law Firm, Compliance analysis of NFT projects under Chinese law
Tony Wang
Partner
Tian Yuan Law Firm

Previously, the People’s Bank of China and other departments issued: the Notice on Preventing Bitcoin Risks, on 3 December 2013; the Announcement on Preventing Risks in Token Issuance and Financing, on 4 September 2017; and the Notice on Further Preventing and Handling Speculation Risks in Virtual Currency Transactions, issued on 15 September 2021 (Yin Fa [2021] circular No. 237), imposing clear restrictions on virtual currencies, expressly prohibiting the issuance of tokens for financing, and pointing out that illegality of initial coin offerings (ICOs) and other activities was mainly due to “lack of practical application scenarios” and “the purpose of financing”.

NFTs are essentially tokens. Their ultra-high liquidity also means that all associated risks must be taken into account when designing their compliance structure. According to the regulatory logic of the above-mentioned announcement, circular No. 237 and other regulations, as well as the principle of substance over form adopted by the regulatory authorities, the operation of NFT projects must strictly comply with all relevant regulations. The author summarises the main related risks as follows:

Commercial purpose of NFT projects. There are presently many types of NFT projects, including NFT artwork trading platforms, blockchain games, metaverse and others. Legal risks corresponding to various projects are also different. Therefore, investors and entrepreneurs need to first determine the direction of the project and, based on that, analyse and avoid potential legal risks.

Commercial substance of NFT projects. Is the project a simple digital collection, similar to the Dunhuang Concept NFT, or is it a product operated by a complete decentralised governance community, similar to the BAYC (Bored Ape Yacht Club)? Different from pure digital collections, in addition to obtaining the rights and interests of an NFT itself, BAYC token holders can also rely on the NFT to participate in various activities organised by the BAYC project sponsor, and have the right to share various services and products provided by the project sponsor.

If the NFT is attached with too many rights, it must be judged one by one to prevent some attached rights from causing the NFT itself to constitute “securities” and be subject to securities laws.

Where does the NFT project go? Minting or trading? For minting, it needs to consider whether sufficient authorisation has been obtained from the original author. Minting without sufficient authorisation may infringe the original author’s copyright. If the project involves trading, specific circumstances of the trading need to be considered. Under the above-mentioned announcement, the compliance risk of providing token trading services in China is huge.

Have relevant qualifications and certificates been obtained? Depending on the specific circumstances, NFT projects may involve the filing/licensing of blockchain, value-added telecommunication services, artworks, online cultural operations, online publishing services, audio-visual programmes, and so on. Investors/entrepreneurs should pay attention to compliance issues in this regard.

NFT trading at secondary market. According to the announcement, any so-called token financing trading platform shall not: engage in the exchange business between legal tenders and tokens, and between virtual currencies; buy or sell tokens or virtual currencies directly or as a central counterparty; or provide services such as pricing and information intermediation for tokens or virtual currencies. Under this regulation, domestic trading of NFTs at the secondary market is currently subject to strict supervision.

Is the consideration for trading ETH, DCEP or RMB? Under present restrictions of the announcement, the exchange between NFTs, legal tenders and virtual currencies cannot be realised.

Where is the structure built? If the entire NFT project structure is built in China, the legal risks of NFT transaction and virtual currency exchange must be considered. If part of the structure of the NFT project is built in China, and the rest built overseas, both the laws and regulations of the country where the project is located and the long-arm jurisdiction of relevant countries must be considered. Even if the entire NFT project structure is built overseas, it does not necessarily avoid all legal risks under Chinese law.

Scope of NFT rights and corresponding assets. If the NFT corresponds to physical assets, the scope of NFT rights depends on authorisation of the corresponding asset owner. On selling the NFT, the seller must have the right to dispose of it, otherwise it may constitute an infringement.

On buying the NFT, the buyer must clearly agree with the seller on the scope of the rights it intends to acquire, otherwise the buyer may not acquire the corresponding rights. In addition, the NFT platform should try to ensure authenticity of the rights involved in the NFT sold by the seller, otherwise it may bear the tort liability jointly with the seller.

How does NFT club operate? NFT club refers to a community composed of certain types of NFT holders. Taking BAYC as an example, its official website shows a “limited NFT collection where the token itself doubles as your membership to a swamp club for apes”. Operation of the NFT club is one of the main risks in NFT projects. Issues such as how the club is governed, the role of the founding team, KOL statements and management of assets all require careful consideration of compliance risks.


Tony Wang is a partner at Tian Yuan Law Firm. He can be contacted on +86 139 1079 2757 or by email at wangwei@tylaw.com.cn

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