The first NFT was known as “Quantum” coined in 2014. An exponential advancement has been seen in NFTs since then.
In 2021, leading singers, entrepreneurs, artists and brands have created and invested in their own NFTs. The prominence raises multiple questions about the technology involved, the legislations over-seeing and the wider application of NFTs.
NFTs are digital assets representing a real-world object consisting of art, music, in-game items, videos built using minting procedures or programming as cryptocurrency. The difference between a cryptocurrency and an NFT is that a cryptocurrency is fungible and facilitates trade and exchange amongst the same cryptocurrency or the other. NFTs cannot be traded amongst NFTs. The unique nature of each NFT makes it harder to be valued against each other, making them non-fungible/non-tradable. Each NFT comes with its digital signature thereby making it non-replicable.
EXISTING REGULATIONS GOVERNING NFTs
NFTs are created and held on blockchains, typically Ethereum and through smart contracts. They can be created through digital objects which represent both tangible and intangible items including art, GIFs, videos and sports highlights etc. Each NFT has its built-in authentication data to authenticate ownership of the NFT.
In the current form in India, the legislation applicable to NFTs seems to be the Securities Contract Regulation Act, 1956 (SCRA) which defines a derivative as a contract which derives its value from the prices, or index of prices, of underlying securities. In the broadest interpretation, NFTs are essentially fitting this description of derivatives, and Section 18A of SCRA makes contracts in derivatives legal only if they are traded on a recognised stock exchange. Additional provisions in the SCRA would render NFTs legal as derivatives only if they are on a recognised stock exchange, which does not exist for NFTs as yet in India and are still traded only on the virtual platforms which are not recognised by the SEBI and the RBI. Under such circumstances, the platform where NFTs are traded will have to apply for recognition as Stock Exchange with the Central Government.
As NFTs mainly surround the artistic and innovative world, pacing up the Intellectual Property Rights is also an important aspect in scrutinizing the legal parameters. Key issues involving IPR and NFTs are: the rights which are transferred pertaining to the purchase of NFT, ownership of copyright and its infringements with no legal pillars to standby the use of NFTs.
In the decision of IAMAI vs RBI, the Court recognized VDA as tangible property but did not legalise them, leaving scope for more ambiguity in understanding the legal prospect of digital-based assets.
The Finance Bill of 2022, has authorized the Central Government to include NFTs in specified VDAs for the proper functioning of Income Tax Regulations. This could lead to uncertainty as defining what and how NFTs would function is at the discretion of the Executive offering a challenge for the GoI.
Its easy transferability across the border without permanent storage, poses the risk of money laundering on nations with pressure on the authorities to provide legal sanctions on NFT transactions. The market base of NFTs is currently overflowing with monetary transactions risking financial implications by International Finance Bodies like the Financial Action Task Force.
The key Indian regulation governing money laundering at present is the Prevention of Money Laundering Act, 2002 and Rules which authorizes every user to abide by the specified KYC norms and due diligence processes to avoid fraudulent transactions in the future. KYC compliances have become mandatory for registration process to curb money laundering in marketplaces. This could aid user credibility with secured transactions on NFT exchanges.
For NFTs to grow in India one can expect the development of digital infrastructure surrounding intermediaries, tokenization platforms and e-commerce integration. Classification of NFTs will be complex given their non-fungible attribute separating them from regular securities. The GoI and the RBI have demonstrated measured steps, the classification and regulation remain to be seen.
This is only for informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.
Sources: Economic times, Clear tax and CoinDesk