NFT Risk Prevention Initiative

A A joint initiative to prevent risks associated with non-fungible tokens (NFTs) was released by China National Internet Finance Association, China Banking Association and Securities Association of China on April 13, 2022.

The Initiative to Prevent Relevant Financial Risks of Non-Fungible Tokens is the first official NFT-themed document involving compliance since the recent rapid development of NFTs in China.

The initiative is only a statement of self-regulation and not mandatory regulatory rules.

But given the special status of the three associations as formal industry self-regulatory bodies, this still largely represents regulatory attitude and oversight trend.

Affirms the positive role of NFTs and highlights the associated risks. The initiative mentions that “China’s NFT market is getting hotter and hotter in recent years”, and translates “NFT” to “非同质化通证” instead of “非同质化代币”. Not only does this give an official Chinese translation of NFT for the first time, but it also affirms the application of an NFT concept in China, and explicitly distinguishes it from cryptocurrencies (tokens, or “代币”), which are strictly prohibited.

It also defines an NFT as an innovative and distinct application of blockchain technology, and confirms that it has certain value in contributing to China’s digital economy, while promoting the development of cultural and creative industries.

He also points out that NFTs can come with potential risks of speculation, money laundering and other illegal financial activities.

Encourages innovation and uses NFTs to drive the real economy. The guideline advises adopting a reasonable selection of application scenarios and standardizing the application of blockchain technology to give full capability to the positive role of NFTs in promoting a digital economy.

It proposes that the value of NFT products has a sufficient pricing basis and that a falsely high price deviating from the fundamental law of value is particularly avoided.

It suggests that the intellectual property rights of the underlying assets of an NFT be protected.

It requires truthful, accurate and complete disclosure of NFT product information to protect the consumer’s right to know, right to choose and right to fair trade.

Sticks to the “bottom line” of financial risk prevention. The initiative resolutely aims to stop any trend towards the financialization and securitization of NFTs, to strictly prevent the risks of illegal financial activities and proposes six specific codes of conduct:

    1. It emphasizes that securities, insurance, loans, precious metals and other financial assets should not be included in the underlying assets of an NFT – namely that NFTs should not be used in the issuance and trading of financial products.
    2. It prohibits any initial coin offering (ICO) activity in the distinguished form. Specifically, it does not allow anyone to weaken the non-fungible characteristics of NFTs through methods such as dividing ownership or creating lots.
    3. It does not allow the establishment of trading platforms in violation of regulations to provide centralized trading (centralized auctions, electronic matching, anonymous trading, market maker, etc.), continuous quote trading, trading of standardized contracts and other services for NFT trading. From the mere expression of this point, it cannot be said that NFT platforms are completely prohibited. If NFT platforms comply with the above-mentioned restrictions and do not use NFTs for issuing and trading financial products, they still have the possibility to carry out normal NFT activities, namely the provision of services related to the NFT purchase of the underlying digital artwork. . In practice, to avoid the tendency of financial speculation, many NFT platforms in China do not allow NFT secondary transactions, transfers or the like, or allow the NFT buyer to transfer it to others as a gift.
    4. It strictly prohibits the use of cryptocurrencies such as Bitcoin, ETH, and USDT in the pricing or settlement of NFTs. This is in line with China’s current strict bans on cryptocurrencies, where they do not have the same legal status as legal currencies and cannot be released to the market as currencies or pricing tools.
    5. It urges the processing of real-name authentication for NFT issuers, buyers and sellers – and the correct retention of customer identity information and issuance transaction records – while actively cooperating with the works of combating money laundering. NFT platform operators should pay particular attention to this point.
    6. It does not allow direct or indirect investment in NFT, or provide financial support for such investment. This should be understood as preventing investors from investing in NFTs as financial products for the purpose of financial gain, rather than prohibiting general users from purchasing NFTs for practical purposes, such as collecting works of private art. In practice, many NFT platforms in China are operated as digital collection platforms and only allow individual users to register.

Advice to NFT consumers. Consumers are warned to establish a correct consumption concept and strengthen their self-protection, consciously resist and stay away from illegal financial activities. The initiative also reminds consumers to report relevant illegal activities proactively and in a timely manner.

In addition, it is also worth mentioning that the day after the launch of the initiative, in response to suggestions, the China Mobile Communications Association Metaverse Consensus Circle (CMCA-MCC) and the China Communications Industry Association Blockchain Specialized Committee (CCIAPC) have jointly released the self-regulatory requirements on the regulation of the healthy development of the digital collection industry. CMCA-MCC and CCIAPC are both social organizations under the supervision of the Ministry of Industry and Information Technology and registered with the Ministry of Civil Affairs.

As digital collections are based on NFTs and development is still at an early stage, with unclear standards of value, the self-regulatory requirements mostly reiterate the relevant requirements in the initiative and offer reasonable expectations.

In short, the initiative upholds the concept and development of NFTs in China – not only proposing the code of conduct, but also setting the regulatory red line, which is of great significance.

The initiative also demonstrates that the current general attitude of regulators on NFTs is to prevent financialization and securitization, rather than banning NFT itself.

This is good news for realizing the cultural and artistic value of NFTs and will facilitate their development in a positive and healthy way.

Business Law Digest is compiled with assistance from Baker McKenzie. Readers should not act upon this information without seeking professional legal advice. You can contact Baker McKenzie by emailing Howard Wu (Shanghai) at Subscription Announcement Red 2022