Are NFTs crypto assets, and why does it matter?

Talk to most of the big legal and accountancy firms in Amsterdam, London, New York, Paris and Singapore (considered to be the financial centres of the world), and you will find that one of the fee-paying activities keeping them busy is giving advice on non-fungible tokens (NFTs).

NFTs have become almost mainstream, with almost any organisation or individual owning intellectual property looking to cash in on the NFT craze and issue their own NFT.

As to be expected, where there is money you will often find nefarious actors lurking around and hoping to snaffle and abscond with unsuspecting investors cash – or defraud the tax man. Indeed, the BBC has recently reported just this in the UK: HM Revenue and Customs (HMRC) said three people had been arrested on suspicion of attempting to defraud it of 1.4m, adding that HMRC said the suspects in its fraud case were alleged to have used sophisticated methods to try to hide their identities including false and stolen identities, false addresses, pre-paid unregistered mobile phones, Virtual Private Networks (VPNs), false invoices and pretending to engage in legitimate business activities”.

It may actually come as a surprise to some that the calibre of organisations selling NFTs include:

• Selfridges – …bringing digital goods to real-life shopping and broadening its accessibility in fashion. featuring artwork by Victor Vasarel and new physical pieces from designer brand Paco Rabanne inspired by Vasarelys work. (Vogue magazine)
• Gucci – selling virtual handbags at a higher price than the physical ones.
• All 20 of the Premier Football League clubs.
• The British Museum is to sell its second set of NFTs.
• The Hermitage Museum in St Petersburg to sell NFTs of Michelangelo paintings.
• Hollywood actors and celebrities are selling NFTs.

As the below chart shows, the attraction of NFTs is global.

Countries with the highest NFT adoption rates:

Source: Finder.com

However, are the lawyers, accountants and consulting firms who are helping their clients to issue NFTs? If so, this could be treading on thin ice. If NFTs were to be classed as a form of cryptocurrency, then potentially should they only be issued by those organisations (in the UK) on the Financial Conduct Authority (FCA) crypto register?

The reason this is potentially is because the FCA definition of cryptocurrencies quotes: Cryptoassets are cryptographically secured digital representations of value or contractual rights that usesome type of distributed ledger technology (DLT) and can be transferred, stored or traded electronically.

The FCA has further stated that, if a firm is engaged with the trading of crypto assets it needs to apply to be on the FCA crypto register, which is not an insurmountable problem especially for those firms already regulated. However, although required to have existing AML/KYC processes in place, the challenge for these firms is the time it can take to be entered onto the FCA crypto register since applications to date have involved a slow process.

In addition, the FCA has already announced that in the summer of 2022 it will be announcing new rules: The FCAs draft rules include proposed restrictions on the marketing of crypto assets, in preparation for the government bringing the promotion of these high-risk investments under the FCAs remit.

Meanwhile in the US, whilst no formal definition for crypto assets exists the Investment News publication has reported: The SEC has the authority to regulate cryptocurrenciesbecause they’re often part of an investment contract, which meets the definition of a security under current law.

So, given that an NFT is a unique digital representation (typically of intellectual property – an asset, for example), will American regulators endeavour to argue that NFTs are securities?

Therefore, if in the future we see record labels, museums, sports clubs, tech start-ups being sanctioned by regulators in different jurisdictions for selling crypto assets without the appropriate regulatory licenses, will these issuers of NFTs sue their advisors?

Furthermore, if this were to happen, are the legal, accounting and consulting firms actually insured? Ben Davis at Superscript (a specialist digital asset insurance brokerage in the UK) told us: Companies need to ensure that they have kept their underwriters/ providers of insurance up to date with any changes in their business activities. Most insurers specifically ask whether their clients engage or work with digital assets as it changes their exposure and the risk theyre insuring. If the client does not keep them apprised of material changes to their business activities it could potentially invalidate their insurance or have a claim denied. This is true for all insurance but specifically for Professional Indemnity, Directors and Officers liability and Media/IP insurance cover.

If nothing else, maybe those giving advice on NFTs ought to double check their terms of engagement with their customers or, in any event, keep their insurers up-to-date with which activities they are engaged – just in case they need to make a claim on their PI or DOL insurance.

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