Art in the digital world and NFT

The development of cryptocurrencies in recent years has caused a huge interest in investments in the digital world, which has caused an increase in transactions the subject of which were crypto assets. According to published information, the year 2021 was particularly successful for NFT. What is an NFT and how is it legally regulated?

NFT in short

NFT is an abbreviation for "non-fungible token.“ In simple terms, we can think of an NFT as a digitally encrypted token that represents rights to digital images, videos, photos, or other digital files.

NFTs are based on a computer code and are recorded on distributed ledger technology, that is, blockchain. The difference from virtual cryptocurrencies is that NFTs are non-fungible by nature. The essence of an NFT is that this token connects the owner of the NFT to a specific digital file.

There are several well-known cases. Jack Dorsey, Twitter CEO, sold his first tweet as an NFT, Vodafone sold the first sent SMS as an NFT, the artist Beepl sold his digital collage as an NFT and many more. NFT is currently a fast-growing crypto-asset industry. According to Reuters agency, in the third quarter of the year 2021, the volume of NFT sales increased to $10.7 billion USD.

Crypto assets in Slovakia

In Slovakia, the legal regulation of crypto assets is stern. We can find it in two acts and one methodological guideline of the Ministry of Finance of the Slovak Republic.

The act on the prevention of legalization of proceeds from criminal activity and terrorist financing and on amendment of certain acts [1] (hereinafter referred to as "AML") defines virtual currency as a digital carrier of value that is not issued or guaranteed by a central bank or public authority , is not necessarily tied to legal currency, and which does not have the legal status of currency or money, but is accepted by some natural persons or legal entities as an instrument of exchange that can be electronically transferred, stored or traded electronically.

This definition was incorporated into the AML in the year 2020. Together with this definition, new definitions of virtual currency wallet service provider and virtual currency exchange service provider were introduced, which are categorized by the AML as obligated persons, which entails new legal obligations for such persons. The virtual currency wallet service provider and the virtual currency exchange service provider is obliged to obtain a trade license for these activities.

In addition to the AML, the field of crypto assets in Slovakia is also regulated by tax law regulations, namely the Income Tax Act[2], which complements the methodological guidelines of the Ministry of Finance of the Slovak Republic. The Income Tax Act does not define what is considered as virtual currency, it only defines the method of its taxation. The methodological guidance of the Ministry of Finance of the Slovak Republic within the procedure of taxation of virtual currencies understands virtual currency identically to the AML. The term virtual currency means a digital carrier of value that is not issued or guaranteed by a central bank or public authority, it is not necessarily tied to legal currency, does not have the legal status of currency or money, but is accepted by some natural or legal persons as a means of payment and which can be transferred, stored or traded electronically.

How is the legal regulation of NFTs within the European Union?

In September 2020, the European Commission presented a proposal for Regulation on crypto-asset markets[3] (hereinafter referred to as the "MiCA Regulation[4]"). The proposal of this regulation regulates crypto assets to a much wider extent than the Slovak legislation.

In addition to "crypto assets", the proposed wording of the MiCA Regulation distinguishes other related concepts. For example, "crypto-asset issuer", "asset-backed token" (often referred to as "stablecoin"), "e-money token'' (often referred to as "stablecoin"), "crypto-asset service provider" or "utility token". As technological developments in this area are gaining a rapid pace, the Commission can currently adopt delegated acts to specify some technical elements of the definitions in order to adapt them to market developments.

The MiCA Regulation defines a crypto asset as a digital expression of value or rights that can be transferred and stored electronically using distributed transaction database technology or similar technology. From the point of view of the MiCA Regulation, NFTs differ from other crypto-assets and NFT issuers are exempted from the obligation to draw up the so-called "whitepaper"[5], which establishes a special regime for them.

According to the Committee of the European Parliament for Economic and Monetary Affairs, this approach was insufficient in the MiCA Regulation, and in the amendment proposal it requested to absolutely exclude NFTs from the scope of regulation of the MiCA Regulation. The Committee justified this by saying that the criterion for bringing crypto assets under the scope of this regulation should be the purpose and use of the token and not the technology used. At the same time, the Committee said that NFTs representing intellectual property rights, certificates of authenticity, guarantees or any right not linked to rights to financial instruments should not fall within the scope of this regulation.

The Committee stated that it proposed to consider creating a separate regime for NFTs under the framework applicable to creative and non-financial industries. Thus, the Committee does not see NFTs as a financial instrument. The Committee's position clearly shows the intention to categorize NFTs as a separate crypto-asset and to distinguish NFTs from other crypto-assets due to their specific properties and functions.

Legal regulation of NFT in Slovakia

It is obvious that the Slovak regulation lacks the distinction between NFTs and other crypto assets. In our legislation, we only find a definition of the term "virtual currency". In principle, NFT itself meets the definitional criteria of a virtual currency, but due to the above description, it is necessary to separate NFT from cryptocurrencies.
This raises the question of whether NFT falls under the regulation of virtual currency in the Slovak legal order. NFT is not issued or guaranteed by a central bank or public authority, is not necessarily linked to legal currency, does not have the legal status of currency or money, can be accepted by some natural persons or legal entities as an instrument of exchange, NFT can be electronically transferred, stored or traded electronically. These are the criteria that match the statutory definition. Technically, we can equate the stated legal requirements with NFT[6].
When conceptualizing the definition of virtual currency in terms of Slovak standards, neither a restrictive nor extensive interpretation is excluded. From the point of view of how the creation of the legislative process in the European Union develops and is shaped, it is possible to lean towards a restrictive interpretation, and thus not to perceive NFT as a store of value. This follows from the main goal of NFT, which is to record the originality of a specific digital file and the person of the owner. In the case of a digital file transfer, the NFT proves the originality of the digital file and its associated owner but does not store the value of the digital file. The value of the digital file is created independently of the NFT.
 
At the moment, only the decision-making practice of the relevant public authorities, a normative act that will reflect the current development of crypto-assets including NFTs, or unifying European legislation can bring a solution.
This article was prepared for you by Vladimír Poberežník and Jakub Žák.

From the legal characteristics, it is still necessary to determine whether the NFT is a digital value carrier. In the first part, we mentioned several cases where NFT was connected to the transfer of specific digital content. Undoubtedly, the digital file itself (tweet, sms, digital collage) has value for the acquirers, NFT only authenticates the owner of a specific digital file. It is therefore questionable whether a unique NFT, which proves the originality of a specific digital file, is also a store of its value.

For the above-stated reasons, we can thus come to the conclusion that NFT should not fall under the scope of the AML, the Income Tax Act and the methodological guidelines of the Ministry of Finance of the Slovak Republic, since NFT does not completely match the definition of virtual currency in these regulations.

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[1]  The Act No. 297/2008 Coll. on the prevention of legalization of proceeds from criminal activity and terrorist financing and on the amendment of certain acts.

[2]  Act no. 595/2003 Coll. on income tax.

[3] REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on crypto-asset markets and amending Directive (EU) 2019/1937. The expected date of the MiCA regulation entering into force is 2024.

[4] Stands for „Markets in Crypto-assets“.

[5] A whitepaper is a document that contains detailed information about a publicly offered crypto asset required by the MiCA.

[6] It is necessary to point out in particular that the purpose of NFT is not to use it as a tool of exchange. Hypothetically, however, an agreement between legal entities or natural persons that will use NFT as an instrument of exchange in transactions cannot be ruled out, but in such a case, the digital file itself, which constitutes the value, must also be part of such a transaction. In other words, an agreement between legal entities or natural persons that the reward for a delivered good or service will be an NFT and a specific digital content. Just as legal or natural persons would agree that the reward for the delivered goods or services will be a work by Pablo Picasso with a certificate of originality.