Non-Fungible Tokens (NFTs)

Are they the new distributor in the Art Market? 

What are NFTs?

Non-fungible tokens, or NFTs, are digital collectibles that exist in a number of forms, including PDFs, tweets etc. NFTs have hit the headlines recently, and slowly but surely, we are seeing a growing trend in their use and popularity, not least influenced by stories such as:

• The creator of Twitter, Jack Dorsey, sold his first tweet as an Non-Fungible Token'>NFT for around $2.9 million in March. 
• The recent release of the new Kings of Leon album as an NFT.
• Digital artist Mike Winkelmann (aka Beeple)’s piece, “Everydays: The First 5000 Days”, sold at a Christie’s Auction for $69 million (making it the third-most expensive artwork by a living artist)

NFTs are about proprietorship and ownership. The effect of an NFT is that it provides evidence of the record of ownership, which is stored on the blockchain, to the holder of the asset. It acts as a sort of cryptographically secured certificate of title, showing that the purchaser is the owner of that underlying asset, similar to a digital certificate of title or stamp of authenticity. 

It is becoming clear that, eccentricity aside, NFTs are capable at least in offering innovative and flexible scope 

Each asset is assigned a lengthy string of alphanumerics which provides an absolute and unchangeable record of who owns it.  

Are they regulated? 

From the UK regulatory perspective, NFTs at the moment fall squarely into a regulatory black hole, with no express published guidance considering their UK regulatory treatment. 

As with other types of cryptoassets, the legal and regulatory framework applicable to NFTs is still (we suspect) in development, and the extent to which existing regulations cover NFTs is not clear cut.

That being said, if you look more closely at the functionally and/or concept of an NFT, it could be reasoned that a particular NFT would need to be regulated with at least HMRC, but why? 

Art Market Participants 

NFTs can, as we have seen, be digital piece of art. This means they, or those that trade in them, could therefore be subject to the regulatory sector as an “Art Market Participant”. 

From January 2020, “Art Market Participants” were brought within the regulatory sector, following the UK’s ratification of the EU Fifth Money Laundering Directive (5MLD). This legislation imposed new compliance obligations on, amongst others, Art Dealers and Auction Houses (the Regulations). 

The new provisions apply, regardless of the size of a business, to any entity that "trades in or acts as an intermediary in the sale or purchase of works of art where the value of the transaction or a series of linked transactions is €10,000 or more". 

The requirements include the need to carry our Customer Due Diligence (CDD) on any new customers, establish the identity of the “ultimate beneficial owner” before entering into a transaction, and to register with the UK tax authority, namely H.M. Revenue and Customs (HMRC), as the supervisory body.  

Art dealers and auction houses "trade" in works of art and are therefore "Art Market Participants" for the purpose of the Regulations. Whilst it is unlikely that 5MLD was intended to catch artists, the Regulations, in the absence of any guidance, suggest that an artist who sells a work for €10,000 or more, must also register with HMRC as an Art Market Participant and carry out CDD procedures on the purchaser.  The term "intermediary" is not defined and it is unclear whether those who advise on art sales fall within scope of the Regulations.

Although NFTs do not technically fall within the definition of “works of art” under relevant UK law, the definition is nearly 30 years old, and as with any fast-moving market driven by explosive consumer interest and waves of money, regulators will likely take an interest and scrutinize market practices against existing regulations.

NFT marketplaces, or artist operating out of the UK, that provided NFTs that constitute art or collectibles, should obtain legal advice about their particular NFTs or platform is subject to the UK regulator sector.