MiCA and NFTs — Legal Clarity or More Legal Uncertainty
The European Council adopted MiCA on October 5, 2022. MiCA was suggested by the European Commission in September 2020 to protect EU consumers from crypto-asset risks.
Author: Amelia A. Bruderer
On October 5, 2022, the European Council approved MiCA, and at the next meeting of the Parliamentary Economics Committee on October 10, a vote is expected. MiCA was first proposed by the European Commission in September 2020 and finalised at the end of June to safeguard EU consumers from the dangers connected with investing in crypto-assets.
In June 2022, Ernest Urtasum, a member of the European Parliament, explained that through MiCa, “we will have a common harmonized EU-wide regime for crypto-asset issuers and service providers, that will provide security for investors and support sustainability, while reducing fragmentation and increasing legal clarity.” However, has legal clarity increased?
Definition of crypto-assets and whether NFTs fall within this scope
With the sale of ‘Everyday: The First 5000 Days’ by Beeple for $69 million in March 2021, and the sale of Pak’s NFT ‘The Merge’ for $91.8 million, NFTs became the new top trend in the crypto-world.
According to Art. 3 MiCA ‘crypto-asset’ is defined as “a digital representation of a value or a right which may be transferred and stored electronically, using distributed ledger technology or similar technology”. According to this definition, it would be reasonable to say that non-fungible tokens (NFTs) are included. However, paragraph 2a explicitly excludes NFTs by stating: “This Regulation does not apply to crypto-assets that are unique and not fungible with other crypto-assets.”
Further, MiCA provides that the regulation “should not apply to crypto-assets that are unique and not fungible with other crypto-assets, including digital art and collectibles, whose value is attributable to each crypto- asset’s unique characteristics and the utility it gives to the token holder. Similarly, it also does not apply to crypto-assets representing services or physical assets that are unique and not fungible, such as product guarantees or real estate.”
As NFTs are unique and not interchangeable, and their value does not depend on the value of another NFT or the NFT market, the Council stated that “these features limit the extent to which NFTs can have a financial use, thus limiting the risks for users and the system.”
However, the current situation leaves it open to whether NFTs could be seen as crypto-assets. MiCA provides that 18 months after the date of entry into force of the regulation and having consulted the European Banking Authority (EBA) and European Securities and Market Authority (ESMA), the European Parliament and the Council shall present a report that contains:
“…an assessment of the development of markets in unique and not fungible crypto-assets and of the adequacy of regulatory treatment of such crypto-assets, including an assessment of the necessity and feasibility of regulating offerors of unique and not fungible crypto-assets as well as providers of services related to such crypto-assets.”
ESMA should be mandated to publish guidelines on criteria and conditions for the qualification of crypto-assets as financial instruments. MiCA is a piece of legislation that is guided by the principles of ‘same activities, same risks, same rules’ and of technology neutrality. However, this does not clarify the issues surrounding NFTs. This means that one will only have increased legal clarity regarding NFTs once the guidance has been provided by ESMA and there is a possibility that NFTs, otherwise considered to be unique and not fungible with other crypto-assets, could be qualified as financial instruments.
Collections and fractional NFTs (F-NFTs)
MiCA provides that the ‘fractional parts of a unique and non-fungible crypto-asset should not be considered unique and not fungible. The issuance of crypto-assets as non-fungible tokens in a large series or collection should be considered as an indicator of their fungibility. The sole attribution of a unique identifier to a crypto-asset is not sufficient to classify it as a unique or not fungible.’ However, MiCA has not provided a definition of what ‘large series’ or ‘collections’ mean.
“If a token is issued as a collection or as a series – even though the issuer may call it an NFT and even though each individual token in that series may be unique – it's not considered to be an NFT,” said Peter Kerstens, the EU’s Commission’s Adviser for Technological innovation and cybersecurity. He noted that this would require issuers of NFT collections to publish a white paper outlining the protocol used by the NFTs and prohibit them from making “outlandish promises about future value that could mislead people into buying.”
F-NFTs are a relatively recent phenomenon. When a smart contract creates many fungible ERC20 tokens that are all linked to a non-fungible, indivisible ERC-721 NFT, F-NFTs are created. The NFT may only be released from the vault if all ERC-20 tokens are redeemed. F-NFTs allow multiple people to claim ownership of the same NFT. Holders of F-NFTs may additionally gain governance rights in connection to the underlying NFTs, or the smart contract may allocate money earned by the NFT to F-NFT holders. If ERC-20 tokens are issued, the question of whether F-NFTs are asset tokens arises since they may have the same structure and denomination. As a result, the way in which the NFT is sold is critical: as part of an investment, sold to non-users or promoters to expand the business, etc., and if it is proof of an investment contract. Therefore, a case-by-case assessment is currently inevitable. In general, it is advised that NFT issuers should avoid selling their NFTs as an investment.