Summary: Europe has a unique global regulatory framework for cryptocurrencies. This article explores how NFTs fit within that framework. The key challenge: legal, technical and business teams need to collaborate.

The global regulatory framework for crypto is uncertain. In China crypto is simply banned. In the US, crypto rules will crystalize only after the ongoing court battles between the SEC and the US crypto industry have been fought. Only the European Union has an actual comprehensive regulatory framework, based on existing financial services legislation.

Europe’s unique crypto act

This summer, Europe’s bespoke crypto act — the Markets in Crypto-Assets Regulation — entered into force and will apply as of end 2024, with some exceptions. Today, the sector is preparing for what’s to come.

Organizations that consider MiCA a ‘legal issue’ (only), are likely to fall behind and risk delayed authorizations or even enforcement measures. To succeed under MiCA, tech, business, and legal teams need to join forces. Determining the treatment of NFTs under MiCA is illustrative for the mindshift issuers and service providers need to undergo in their journey towards MiCA compliance.

NFTs under MiCA’s umbrella

Despit popular believe, NFTs are crypto-assets as defined in MiCA.

MiCA’s definition of crypto-assets is broad, since it has the intention to capture “all types of crypto-assets that currently fall outside the scope of Union legislative acts on financial services.”

MiCA defines crypto-assets as “a digital representation of a value or of a right that is able to be transferred and stored electronically using distributed ledger technology or similar technology”. As such, NFTs are captured by MiCA’s definition of ‘crypto-assets’.

However, the text can be confusing. MiCA does not apply to “crypto-assets that are unique and not fungible with other crypto-assets”. Even though this appears clear cut, this is where we see a lot of confusion in the market.

For software developers, the uniqueness of a token is primarily about its technical design. Token standards, like Ethereum’s ERC-721, are used to identify unique digital assets. This is what we refer to as ‘technical NFTs’.

For MiCA, however, the mere attribution of a unique identifier to a crypto-asset is not sufficient to classify it as unique and non-fungible within the meaning of MiCA.

While it might seem that technical NFTs are not covered by MiCA, it’s actually the genuinely unique crypto assets or ‘legal NFTs’ that are exempted. The two will often overlap, but not necessarily. Therefore, especially issuers of technical NFTs for non-art use cases, should be careful about assuming MiCA does not apply to them.

Uniqueness and non-fungibility in MiCA: what’s in and out?

So which crypto-assets are outside the scope of MiCA and which are in scope? First of all, it is important to note that MiCA is drafted on the basis of technological neutrality, meaning that the use case of a token determines the legal classification. Uniqueness and non-fungibility should be determined on the basis of a crypto-assets’ characteristics and the utility it gives to its holder. Some examples:

• Digital art and collectibles such as pictures of cute kitties and bored looking apes are clear examples of unique and non-fungible crypto-assets and therefore out of MiCA’s scope.
• Crypto-assets representing services or physical assets that are unique and non-fungible, such as product guarantees or real estate are out of MiCA’s scope.
• Hybrid NFTs which appear to be unique and non-fungible, for example by a unique art-like look and feel, but otherwise give their holders the same or very similar rights may fall in scope of MiCA when the actual reason for purchasing such NFTs is not related to the artworks. In other words: you cannot go around MiCA by adding unique but irrelevant characteristics to tokens that are otherwise in scope of MiCA.
• The issuance of NFT collections, or large series of technical NFTs, is an indicator of their fungibility in the legal sense, meaning that such NFTs are more likely to be in scope of MiCA. This is not necessarily an issue: if you have good arguments to the contrary indicating that the NFTs in the series or collection are truly unique and not fungible, such NFTs will still be excluded from the scope of MiCA. We do advise to have the argumentation for this standpoint documented up front, to be prepared for investigatory questions from regulators.
• The fractional parts of a unique and non-fungible crypto-asset should in any case not be considered unique and non-fungible.

Trading and investing NFTs

It doesn’t matter if crypto-assets are bought and sold in marketplaces or just collected as an investment. According to MiCA, a crypto-asset is considered ‘unique and non-fungible’ (often called NFTs) if it can’t easily be swapped with another, and its value compared to another unique crypto-asset can’t be determined by looking at existing markets or similar assets. These types of crypto-assets, NFTs, have limited financial use, so they’re seen as having less risk for owners and the financial system.

Conclusion

As with the classification of regulated instruments under other financial services legislation, regulators take a substance over form approach, whereby the features of the crypto-asset in question determine the classification and not its designation by the issuer. Ultimately, it is the use case that determines the classification.

Willem Roëll, financial innovation attorney at De Roos:

“MiCA requires developers, business teams and legal teams to better understand each other’s world in terms of language, assumptions and concepts. This is part of the cultural shift, from a largely unregulated industry that is taken in by one of the most heavily regulated industries, the financial sector.”

Crystal ball glazing

The inclusion of NFTs, together with DeFi and lending, was among the most heavily debated topics in the (legislative) process leading up to MiCA. By December 2024, the European Commission will analyze the NFT market and potentially propose new regulations.

To be continued! We will closely follow the process and new developments around MiCA.

Feel free to send Willem a message (via LinkedIn or [email protected]) to share your thoughts on this topic or if you have any questions.