What is an NFT, and what laws apply to it?
An NFT, or non-fungible token, is a unique unit of data stored on a blockchain database that represents ownership of a specific item. It is important to note that an NFT is unique; at any given time, it can have only one owner, never two. An NFT can be a video, an image, a GIF, or another type of data file. It is currently enjoying significant popularity, having entered the public consciousness alongside the cryptocurrency Ethereum. NFTs are characterized primarily by their uniqueness, meaning that NFT owners can prove that it truly belongs to them. Just like cryptocurrencies, NFTs have entered the public consciousness and, of course, have become the subject of commercial transactions; it is reasonable to assume that the popularity of NFTs—and, hand in hand with it, NFT trading—will only grow over time. Its founders even suggest that, over time, it might be possible to prove ownership of a car or real estate using NFTs, which only confirms the wide-ranging practical applications of NFTs.
In this context, however, several questions arise, such as regarding the taxation of income from the sale of NFTs or the legal obligations for entities engaged in the sale and brokerage of NFTs.
The fundamental legal regulation that must be relied upon is Act No. 297/2008 Coll. on the Prevention of Money Laundering and the Financing of Terrorism and on Amendments to Certain Acts (hereinafter the “AML Act”). This Act defines obligated entities and also sets out the obligations they must comply with in the course of their business activities, such as the mandatory development of an internal compliance program, customer due diligence, reporting of suspicious transactions, etc. Through the transposition of Directive (EU) 2018/843 of May 30, 2018, amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing and Directives 2009/138/EC and 2013/36/EU (hereinafter referred to as the “5th AML Directive”), entities providing virtual currency wallet services or virtual currency exchange services were added to the list of obligated entities under the AML Act (Section 5(1)(o) and (p) of the AML Act).
The 5th AML Directive defines virtual currency as a digital store of value that is neither issued nor guaranteed by a central bank or public authority, is not necessarily linked to a currency established in accordance with the law, and does not have the legal status of currency or money, but is accepted by natural or legal persons as a medium of exchange that can be electronically transferred, stored, and traded. The AML Act also contains an almost identical definition of virtual currency in Section 9(l), with the sole change in the AML Act being the replacement of the phrase currency established in accordance with the law with legal tender. In other sections, this definition remains unchanged. However, we note that, in our opinion, this change in wording is not essential for defining virtual currency as such.
We have determined that, for the purposes of the AML Act, providers of virtual currency exchange services and providers of virtual currency wallet services are also obligated entities—this is beyond any doubt, as they are explicitly listed in the AML Act. At the same time, in accordance with the 5th AML Directive and the AML Act, we have defined what is meant by the term “virtual currency.” Therefore, if we wish to determine whether NFT trading platforms are also obligated entities under the AML Act, we must determine whether NFTs constitute virtual currency or not. This step is necessary because current legislation does not explicitly classify these platforms as obligated entities; that is, these platforms will be obligated entities under the AML Act only if they can be subsumed under one of the obligated entities explicitly listed in Section 5 of the AML Act. The above applies to the legal situation at the time of publication of this article, as we cannot rule out the possibility that the relevant legislation may be amended in the future and that NFT trading platforms will be explicitly classified as obligated entities.
However, since these platforms are not currently obligated entities, it is necessary to assess whether NFTs can be understood as virtual currency within the meaning of the aforementioned definition and, consequently, whether NFT trading platforms must be considered obligated entities under the AML Act.
We note that, in our legal opinion, NFTs cannot be considered virtual currency under the AML Act for several reasons.
Right at the outset, we provided a brief overview of the world of NFTs, based directly on the founders of this technology. We stated that an NFT represents a unique unit of data that proves ownership of a specific item. However, a fundamental element of the definition of virtual currency is that it is a digital store of value. An NFT, however, does not represent a digital store of value, but rather proof of ownership of a specific item.
It goes without saying that the item that is the subject of an NFT will have a value expressible in money, as confirmed by current transactions where individual NFTs are traded for hundreds of thousands of euros; however, we believe that an NFT as such is not a digital store of value, in the sense of the aforementioned definition. The second part of the definition of digital currency states that digital currency is accepted by natural or legal persons as a medium of exchange,which can be electronically transferred, stored, and traded. We do not rule out that NFTs may be and are used as a medium of exchange in commercial transactions; however, we believe that if they serve as a medium of exchange, it is only in the form of “barter,” i.e., exchanging one NFT for another. We believe that in practice, NFTs are more often the subject of a transaction than a medium. We believe that the essence of NFT technology is not its use as a medium of exchange, as is the case, for example, with cryptocurrencies, which we can illustrate with a simple example. The founders of NFT technology also created Ethereum, currently the second most popular cryptocurrency, which can clearly serve—and does serve—as a medium of exchange. For example, various e-shops, whether Slovak or foreign, offer the option to pay using cryptocurrencies. This means that it is possible to select a specific product or service and then pay the purchase price using cryptocurrency. However, this does not apply to NFTs, as NFTs themselves cannot be used to pay the purchase price; thus, de facto, they are not a medium of exchange, but we again arrive at the conclusion that they are merely a unique proof of ownership of a specific, concrete item.
Based on the above, it can therefore be concluded that, under the current legal framework as of the date of publication of this article , entities engaged in the sale and intermediation of NFT sales do not meet the definition of an obligated entity under the AML Act, as they cannot be classified as providers of virtual currency wallet services or virtual currency exchange services, and therefore the obligations under this Act will not apply to them. These entities are therefore not required to have an internal compliance program, verify customer identification, report suspicious transactions, or fulfill other obligations imposed on obligated entities.
However, as with cryptocurrencies, the fact that NFTs are enjoying ever-increasing popularity and their practical use is growing it is reasonable to assume that more comprehensive legal regulation will be introduced in the future, which may result, among other things, in an amendment to the AML Act, and entities focused on the sale and brokerage of NFTs will also become obligated entities under the AML Act.
