Leading Cryptocurrency Lawyer in London – guiding you through efinance

A Practical Legal Guide for UK Based Crypto and NFT Creators and Investors

NFTs continued high-profile sales in 2021. Policymakers and compliance officers are upping their game to deal with the issues of misuse, manipulation, and fraud issues. There is also the considerable threat of civil litigation from disgruntled investors especially following a successful ICO.

Here is a heads up on what you should be considering as you create and trade crypto/NFTs on decentralised or proprietary marketplaces.

1. Determination of market prices

There are several platforms where vast numbers of NFTs/Crypto are listed, bought and sold. Deciding which decentralised platform to use will be influenced by the features of each platform.

The most popular platforms include OpenSea and Binance. Coinbase does not currently enable NFTs but plans to do so soon.

The platforms offer two main sale options when it comes to pricing. A trader can either sell via auction or set a minimum fixed price, dictated by factors such as the current floor price of similar tokens on the site. Whether the token represents a high-value premium asset can also influence its selling price.

Along with the selling price, buyers must also factor in transaction fees ranging from 1% to 15% of the NFT value. Binance charges a transaction fee of 1% and offers royalties at a similar rate to the minter. On the other hand, OpenSea charges a rate of 2.5%. In addition, all sales attract additional gas fees, which are essential in completing the various related transaction on the ledger. Gas fees on the Binance smart chain are lower than on Ethereum.

2. Owning the NFT versus The Original Owner's Rights

When you buy an NFT, you purchase digital rights to the original copy. Buying digital rights to the original copy means that the copyright of the digital asset you are buying, be it an image, meme, tweet, or art, rests with its creator. Under the existing copyright laws, you cannot use an NFT to a digital image to sell printed shirts of the same image. To easily understand this concept, consider the physical art of collecting items in the hope of reselling them in the future. While you can collect classic Chanel perfumes, they remain a product of Chanel unless the company relinquishes their ownership rights to your specific collection.

You only get rights to the cryptographically signed receipt. Having rights to the blockchain receipt means that you only own the rights to the unique version of whatever original you bought, and you get an access key that allows you to control this specific asset. Even then, the parties involved on a case-to-case basis can vary the terms of which proprietary rights are transferable upon the purchase of an NFT.

3. NFT Wallets and liability of crypto-wallet businesses

When you purchase an NFT, you only buy a digital access key. The NFT is stored on the blockchain. The NFT is stored on the blockchain, and digital wallets are used to facilitate payments. The NFT wallet is your transaction interphase. It allows you to store and access your crypto key, enabling various transactions, including re-sales.

The NFT wallet can be in the form of an app, or other software, or even a thumb drive. If you lose your crypto wallet, you lose your key and your rights to your digital assets. As such, you must use a trusted provider. Businesses Moonpay have evolved to meet the demand for trusted third party payment providers by providing payment facilities in multiple currencies and Cryptocurrencies over several time zones.

We also assist ultra-high-net-worth investors in purchasing Crypto assets of £1 million or more.

When it comes to third parties' liability to investors, most third-party payment providers, including Moonpay, have a disclaimer that they merely serve as sales agents who facilitate the investors' transactions without playing any active roles as financial advisors. Third-party payment providers offer no protection to Cryptoasset owners on disputes relating to payment transactions.

As such, a consumer has to be very vigilant and intentional while transacting in NFTs and other cryptocurrencies. At PAIL Solicitors, we are here to help and guide you in every step of your transactions, mainly if you provide the Crypto asset and are concerned about your exposure to lawsuits relating to transactions. We also assist ultra-high-net-worth investors in purchasing Crypto assets of £1 million or more.

4. Obligations of Third-party Identity and Compliance Providers

As the world shifts to a customer-owns-digital-property model, people are excited about the prospects of selling both digital and physical assets as NFTs. Due to their anchorage on a blockchain, it is possible to trail original and subsequent ownership of a given NFT asset. Even then, the emergence and popularity of NFTs are creating challenges associated with money laundering, which are similar to those experienced in the physical sale of artistic works. Despite applying the EU's Fifth Anti-Money Laundering Directive (AMLD5) following its adoption into UK domestic laws, this regulatory challenge persists. As such, there has been a going concern for implementing the 'Know Your Buyer' (KYB) policy, suggested by The Royal United Services Institute (RUSI), as an effective means of curbing money laundering digital financial fraud.

Third-party identity providers such as Persona support the KYB and Anti-Money Laundering objectives by providing monitoring services of data sources, user-tracking services, and case management and investigation services that support a seller's due diligence process. However, with the current laws on data privacy in the UK, there are limitations to how involved and effective Persona and other similar sites can be in the long run. As such, traders dealing in NFTs and other cryptocurrencies ought to invest in the services of a certified legal professional who specialises in this subject.

5. Terrorist Financing and NFTs

Like other transactions involving digital currency and assets, NFTs are traded relative anonymously, and their sale involves price volatility. The anonymity and volatility of NFTs make them great channels for money laundering while posing a persistent concern relating to terrorist funding. To curb money laundering and terrorist financing through Crypto trade, the Financial Conduct Authority requires all crypto asset businesses, including wallet providers, to register with the FCA.

Their work is also governed by the provisions of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations of 2017, as amended by the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (the MLRs). Due to the growing popularity of NFTs, this law seeks to regulate NFTs by defining them as 'works of art'. This would mean that where the value of a transaction (or a series of linked transactions) amounts to €10,000 or more, Such persons are required to implement a risk-based AML/CFT program where they conduct initial and ongoing client due diligence to curb money laundering and terrorist financing.

A trader also should have a working knowledge of listed persons and actively avoid trading with them. A comprehensive list is found in the Office of Financial Sanctions and Implementation registry. However, given the anonymity aspect of NFT transactions, one may only realise that they have been involved in financial fraud after the event. In such a case, one must consult a legal advisor promptly. It is advisable to employ an MLRO in managing a successful Crypto/NFT operation.

6. Cross-jurisdictional trading and legal and regulatory frameworks on NFTs

The existence of distributed ledger technology avails global buyers and sellers of NFTs. It is, therefore, important that issuers, advisers, and purchasers of NFTs consider the legal status and regulatory frameworks across multiple jurisdictions before indulging in trade. As of December 2021, most states do not define the regulatory framework of NFTs. The lack of a clearly defined NFT regulatory framework is because of the distinct nature of the non-fungibility of these assets. Even then, some mechanisms have seen NFTs fall under the same regulatory framework as other cryptocurrencies in some instances, and there is continued commitment to developing more laws that specifically cover NFTs.

With this in mind, it is easier and preferable to indulge in NFT trade with individuals from states with definite or progressive laws on NFTs. Some states with clear regulations on NFTs and Cryptocurrency use include Italy, Germany, the United Arab Emirates, and China. Some states do not have specific laws governing NFTs, but they have clear regulations on when NFT transactions are covered under existing cryptocurrency laws. These states include the UK, EU, The Netherlands, and Singapore. Then there are states where there is an ambiguous application of laws relating to NFTs as an asset or as a medium of exchange. Such countries include the US. It is easier and safer to receive funds from investors with a robust legal framework on NFTs. The risks of trading with investors increase as you move towards countries with ambiguous or non-existent laws on NFTs.

7. Do I have a Utility or Security Token?

A token is a digital representation of an asset. Token also represent utility. A security token represents a valuable asset that an investor can trade for value in the real world. In NFTs, this would cover real property sold digitally as an NFT. Security tokens are used as a representative of value for investment purposes.

To ascertain whether a token qualifies as a security token, the courts utilise the Howey Test, which established that a security must;

a.     Be an investment of money;

b.     Be an investment in a common enterprise;

c.      Give rise to an expectation of profit from the work of the promoters or the third party.

If a token fails to qualify as a security token, it becomes a utility token. This usually only give the user rights to a product or a service. Utility tokens help fund (ICOs) Initial Coin Offering. According to the FCA, utility tokens remain less regulated unless defined as e-money or a security token. Utility tokens are more susceptible to exploitation for financial fraud. On the other hand, security tokens are regulated under the Regulated Activities Order.

Despite all the ongoing legal concerns and regulatory gaps related to NFTs, they are a new product that allows people to express ownership rights to various properties digitally. NFTs are an excellent and innovative way to invest and provide disruptive egalitarian services to change lives. NFTs are an excellent investment, and thus, if you want to launch a Crypto ICO or create and trade in NFTs, please consult PAIL Solicitors. We will be delighted to help guide you through the potential impact of your contractual obligations to investors and the risks from existing and forthcoming regulations and compliance frameworks.

We can work with you to help establish the necessary steps you must take to get authorised and be compliant with the FCA regulations, draft NFT contracts and digital asset eWallet payment and electronic payment corporations’ compliant terms, as well as prepare your general terms and conditions.

To obtain accurate advice about your business' legal compliance status and how we can help, please contact us on (020) 7305-7491 or at peter@pailsolicitors.co.uk, and we would be delighted to assist you.

The writer is an Internet and digital technologies + cryptocurrency law specialist, owner and principal solicitor at PAIL® Solicitors. Peter Adediran's specialist niche areas of practice are digital media business SMEs and IP, contentious and non-contentious. (Charge rates may vary)