Non-Fungible Tokens are the talk of the town. It is no exaggeration to call what has taken hold of the crypto community for almost a year now a hype. The special feature of NFTs is that they are individually definable tokens which can be transferred directly between users on a compatible blockchain. Prior to the emerging of NFTs, crypto tokens were usually created via smart contracts in a predetermined quantity and they also were identical in terms of the underlying issuance and therefore fungible. From a technical point of view, NFTs therefore allow for the digital, tokenized representation of individual objects. Currently, examples for NFTs can be found especially in the art business, where the tokenization of pieces of art has become an ever-growing trend. There are also a lot of NFTs that can be found on the internet which are merely connected via a link with a video or a sound file, e.g. with a certain song or an interview. The idea behind is that the ownership of the NFT shall represent the authorization for the usage of the content which is connected to the individual NFT. The individually applicable national civil law determines if and how this is legally possible. Within the German jurisdiction, especially operators of exchanges for NFTs often are exposed to the question whether the individual tokens do qualify as financial instruments in the regulatory sense.

Trading Activities with Financial Instruments May Trigger Authorization Obligations

Blockchain tokens are based on blockchain technology, just like Bitcoin and comparable cryptocurrencies. Because BaFin very early qualified cryptocurrencies as financial instruments, the question arises, if blockchain tokens such as NFTs also generally qualify as financial instruments in Germany. At the latest since 2013, BaFin is of the opinion that Bitcoin and comparable units are units of account which are a category of regulated financial instruments in Germany. In early 2020, the German legislator introduced crypto assets as a new type of financial instrument into the German Banking Act (KWG). Commercial activities with blockchain tokens may qualify as a regulated activity if the respective tokens qualify as financial instruments. If so, market participants that are intending to conduct such activity require a prior authorization by BaFin. Conducting an activity which is subject to authorization without BaFin’s authorization is a criminal offense. Especially, trading financial instruments in a professional extent – e.g. as the operator of an exchange – can trigger authorization obligations.

Can NFTs be Units of Account or Crypto Assets?

BaFin defines units of account as alternative means of payment which are used by virtue of private-law agreements or customary exercise in multilateral settlement accounts. NFTs generally do not fulfill the payment characteristic of the aforementioned definition. This is due to their individual design, which makes them unsuited as a means of payment. A qualification of NFTs as units of account will therefore almost never be viable. In comparison, the legal definition of crypto assets is not limited to a payment characteristic. A qualification of specific objects as crypto assets may also be viable, if the objects in question serve investment purposes. This cannot be categorically ruled out with NFTs. NFTs have enjoyed a substantial increase in market values over the last couple of months. Should in certain cases the motivation for the creation of an NFT be based on the mere intention to generate monetary gains by trading the token, the NFT may actually qualify as a crypto asset, because in these cases the investment purpose is the driving reason behind the creation of the NFT. Of course, all the other legal requirements of the definition of crypto assets must also be fulfilled for triggering the regulation.

Attorney Lutz Auffenberg, LL.M. (London)