On April 13, the China Internet Finance Association, the China Banking Association, and the Securities Association of China jointly issued the Initiative on Preventing Financial Risks Related to NFTs (hereinafter referred to as the "Initiative"), which clearly put forward six prohibited codes of conduct to resolutely curb the financialization and securitization tendencies of NFTs.
The background of the introduction of the "Initiative" is that in the past year, the issuance and trading of NFTs can be described as booming in the mainland.
What does the Launch of the Initiative mean for NFTs or the sought-after digital collection? Can NFTs be legally traded on the mainland? Where exactly are the regulatory boundaries of digital collections? How should the compliance path of digital collection platforms in the Chinese market be planned?
The special experts of the Internet Law Review, starting from the compliance requirements of the trading entities of digital collections and the legal nature of the transaction objects, combined with the bottom-line behavior and financial risk tips proposed by the Initiative, pointed out that avoiding "derealization to virtuality" is the long-term way for the steady development of digital collections in the mainland.
First, the business model of the existing digital collection in the mainland
At present, the commercial operation mode of the digital collection of mainland Internet platforms (NFT projects) varies:
Some Internet platforms rely on their own developed alliance chains to release digital collections, and strictly prohibit resale, eliminating secondary market transactions; some platforms choose public chains as the underlying technology, which is more consistent with international NFT products; and some platforms open resale functions, allowing users to trade after purchase, and the price of such collections has risen after speculation.
2. Compliance requirements for digital collection trading entities
At present, the mainstream digital collection platform mainly adopts the basic mode of independent creation by the copyright owner or co-creation with the platform, and distribution to users after casting by the platform. The operation process of digital collections mainly involves three types of transaction entities: platform, copyright owner and user. As a service provider, the platform needs to fulfill its corresponding compliance obligations in accordance with regulatory requirements.
From the perspective of the digital collection operation mode of the Internet head enterprises, most of them sign agreements with the author or relevant rights holders to chain the works that originally existed in the form of video, audio or images, cast them into corresponding digital collections, and use the influence of the platform to market and distribute them to users on the platform.
Under this type of business model, the digital collection platform is involved in at least three activities: casting, distribution and operation. Therefore, the digital collection platform needs to at least file a blockchain information service and obtain the corresponding ICP administrative license.
For digital collection platforms, in addition to meeting the qualification requirements of basic administrative supervision, it is also necessary to pay attention to the legal risks of civil disputes that may arise in the process of intellectual property authorization and transfer.
Works within the meaning of the Copyright Law are cast into digital collections through NFT casting, which may involve various rights such as reproduction rights, exhibition rights, and information network dissemination rights.
Therefore, the digital collection platform should clearly stipulate the license transfer of relevant rights through the agreement, and establish appropriate platform management rules to avoid the infringement risk caused by the defective rights from affecting the platform itself.
3. Compliance requirements for digital collection transaction methods
As a special virtual commodity, the whole process of digital collection transaction includes three major links: casting, distribution and circulation. How is the compliance of transaction behavior at different stages? How is it evaluated in law? Where is the boundary between the behavior of the platform and the user? These issues are worth exploring in depth.
1. The prohibition of secondary trading in digital collections is a mainstream trend of compliance
In the circulation link, many digital collection platforms on the market have adopted the model of prohibiting resale and resale, and users can only use them for personal collection after purchasing collections.
At present, the regulator has not yet made clear restrictions or prohibitions on the legal nature and transaction mode of digital collections, but through the analysis of the regulator's long-term regulatory policies on virtual currencies and other fields, it is not difficult to find that preventing speculation and prohibiting illegal financial activities has always been the core bottom line of supervision.
Digital collections originated in non-fungible tokens, so digital collections are naturally inextricably linked to virtual currencies that are strictly banned on the mainland.
The resale of digital collections actually greatly increases the risk of hype, which in turn may affect financial security and stability, and even undermine the financial order. Mainstream Internet platforms adopt the form of prohibiting secondary transactions, mainly from preventing the risk of speculation, weakening the financial attributes of digital collections.
At present, the digital collection trading functions developed by the head Internet platform do not support the resale model, but there are still some small and medium-sized digital collection trading platforms on the market that support the resale of digital collections.
It is worth noting that on March 29, 2022, a number of public accounts or mini programs related to digital collections on the WeChat client were closed, and they are mostly small and medium-sized digital collection platforms. After searching, it was found that most of these banned digital collection platforms support secondary market transactions, that is, users can resell and make a profit after purchasing digital collections.
On March 30, Tencent's WeChat team issued an announcement that the action of banning public accounts related to digital collections was a standardized rectification of public accounts and mini programs that speculated and sold digital collections for the second time.
At present, the official account only provides digital collection display and first-level transactions, and does not support second-level transactions; Mini Programs only support digital collection display and first-level gifts, and transactions and multi-level circulation are within the scope of not being opened. Therefore, it is reasonable for Tencent to rectify relevant WeChat accounts and Mini Programs.
2. There are compliance traps in the marketing behavior of platform issuance
At present, in the distribution process, there are many ways to distribute digital collections, and Internet product marketing methods such as airdrops, blind boxes, and new empowerment have blossomed in the distribution of digital collections.
Airdrop gives away digital collection benefits
Most of the digital collection platforms on the market will use the "airdrop" method, that is, to give away digital tokens to designated users (blockchain addresses) and send collections to users for free to increase the popularity of the platform, which is also a classic welfare marketing method in the blockchain field.
Blind box gameplay stacks digital collections
Some platforms choose to sell digital collection blind boxes directly to attract players with scarcity. But how scarce are blind boxes? What is the probability of extraction? Is the platform's behavior suspected of inducing non-player users to speculate and disrupt the normal trading order?
With reference to the "Shanghai Blind Box Business Activity Compliance Guidelines" promulgated by the Shanghai Municipal Market Supervision and Administration Bureau in 2022, it is obvious that such acts of using blind boxes for marketing should be cautious and cautious, and their compliance risks should not be underestimated.
Provide user rewards by pulling new campaigns
At present, in order to increase users and expand market influence, many platforms have adopted the method of encouraging old users to invite new users, reward rare digital collections according to the number of new users, and give super empowerment. This method of "pulling people's heads" is used in many industries, but how many people are pulling new ones? Is there a hierarchy? Where is the boundary between compliant marketing and illegal pyramid schemes?
When promoting users, it is clear that the platform should exercise restraint within the scope of legal constraints.
Spending on the rollback lottery
Some platforms stipulate that collectors who spend the most can share prizes and receive prizes. This marketing approach is intended to encourage users to further increase their spending, so that the collection of early risers has a floating profit.
Limited edition and sweepstakes
In this marketing model, is the prize sales information clear? Is the draw fair and reasonable? Is the total amount of prizes and the number of each region allocated publicly available in accordance with the law? Does the probability of winning the lottery clearly need to be confirmed from a compliance perspective?
In August 2019, the State Administration for Market Regulation issued the Interim Provisions on Regulating Promotional Activities such as Prize Sales (Draft for Solicitation of Comments), which puts forward compliance requirements for prize sales, and if the platform violates the corresponding regulations, it may be suspected of unfair competition or infringement of consumer rights and interests.
3. Illegal resale by users occurs
In addition to the issuance and marketing behaviors on the platform side may face compliance risks, some behaviors of digital collection users are also on the edge of the law.
Plug-ins can be illegal
Due to the high popularity of digital collections, especially the digital collections cast by some well-known IP, limited sales are even more difficult to find. Therefore, there are phenomena of illegal cheating and snapping up collections such as using scripts to maliciously attack websites, maliciously calling purchase ports, etc. The behavior of such users using plug-ins to attack the platform, depending on its severity, may be suspected of illegally damaging computer information systems.
Private resale has been repeatedly prohibited
Some users violated the relevant regulations of the platform and privately resold digital collections that were prohibited from resale. Such transactions violate the agreement between the platform and the user, so it is easy to be investigated and punished by the platform, and it is difficult to obtain legal protection. The resale behavior in the transaction process is often carried out privately by both parties, there is a risk of fraud, and the transfer fraud also occurs.
The risk of single hype is extremely high
Some users not only meet their own purchase needs, but also promote digital collection projects to unspecified majority of social groups through offline or online means, provide paid consultation, and even induce public investment. In this case, if the teacher uses his influence to buy low and sell high, or even induces other investors to take over, it is very likely to be suspected of fraud and other illegal and criminal acts.
Regardless of whether there is a paid order, users must grasp the scale when providing digital collection information consultation to others.
Fourth, the compliance points of digital collection transaction objects
At present, the legal nature of digital collections has not been clearly defined, and the discussion of whether digital collections belong to data, online virtual property, or works of art is inconclusive, and regulatory regulations have not been clarified.
However, according to the provisions of the Civil Code, the property attributes of digital collections should be protected.
From the perspective of the business of the digital collection platform on the market, the digital collection is mainly based on pictures and audio and video. Therefore, for the legal nature of digital collections, it is necessary to consider not only their nature as data or network virtual property, but also the object to which they are pointed and the legal nature of the content they carry.
At present, most of the digital collections are in the digital form of art, audio and video, online performances, online artworks and other content, so the platform also needs to decide whether to meet the licensing requirements related to the operation of specific products according to the specific type of digital collections issued.
1. Compliance requirements for the operation of digital collections of artworks
If the object of the digital collection is art, the platform may need to meet the relevant business compliance requirements for the art category.
The works of art stipulated in the Measures for the Administration of Works of Art include paintings, calligraphy, engravings, sculptures and other works and limited reproductions thereof. Acquisition, sales, leasing, economic, commercial exhibitions, etc. are all art business activities.
If the digital collections operated by the platform are directed to works of art such as paintings, photography, and arts and crafts, they may need to comply with the relevant provisions of the Measures for the Administration of Art Business and perform filing formalities in the corresponding cultural administrative departments. If the platform adopts the mode of auction or other models to sell digital collections of artworks, it shall also obtain the corresponding auction qualifications.
2. Compliance requirements for the operation of digital collections in the category of online culture
If the object of the digital collection is an online culture product, it must meet the compliance requirements for the operation of the network culture product. Digital collection platforms that distribute cultural products such as online artworks through the Internet may be identified as commercial Internet cultural activities, and according to the Interim Provisions on the Administration of Internet Culture (Revised in 2017), it is necessary to obtain an online cultural business license qualification.
3. Compliance requirements for audio and video digital collections
If the object of the digital collection is audio and video programs, the platform's business activities may be regarded as engaging in Internet audio-visual program services. According to the Provisions on the Administration of Internet Audio-visual Program Services, it is necessary to obtain the license qualification for the dissemination of audio-visual programs by information networks.
Of course, in many cases, these audio and video programs have been produced, and the digital collection platform only casts the fragments of the well-made audio-visual programs on the chain. In this case, it is necessary to obtain the same qualification and license as the directly distributed audio-visual programs, and it needs to be further clarified.
In addition, the main body engaged in Internet audio-visual program services is limited to wholly state-owned or state-controlled units, which may put forward certain restrictions on enterprises entering the field.
4. Compliance requirements for digital collections in the category of publications
Most of the digital collections on the market exist as single painting digital collections or single music digital collections in the fine art or music category, usually presenting the original works in a digital manner. Therefore, the publication of such digital collections may require the application of the Provisions on the Administration of Online Publishing Services and the acquisition of a network publishing service license.
However, the "online publications" in the Provisions on the Administration of Online Publishing Services refer to digital works that are provided to the public through information networks and have publishing characteristics such as editing, production, and processing, and the scope includes text, pictures, animations, audio and video readings, games, newspapers, periodicals, etc.
Although the objects of digital collections are text, pictures, and even newspapers and periodicals, these digital collections only present the original works in a digital way, and do not necessarily have the characteristics of editing, processing, production and other publishing. Therefore, whether a network publishing service license is necessarily required should be judged in combination with specific business scenarios.
In addition, according to the Several Decisions of the State Council on the Entry of Non-public Capital into the Cultural Industry, non-state-controlled enterprises cannot obtain online publishing service licenses in practice, which may impose certain restrictions on the development of most enterprises.
V. Risk boundaries for NFT projects in the context of the Initiative
The Initiative, released on 13 April 2022, while delineating risk boundaries for NFT projects, clearly proposes six prohibited codes of conduct, the purpose of which is to resolutely curb the financialization and securitization tendencies of NFTs.
It can be seen from the content of the "Initiative" that on the one hand, avoiding financial risks caused by NFTs has always been the bottom line of regulatory attention; on the other hand, the digital collection based on the background of cultural and creative background has also been positively affirmed by giving play to the role of NFTs in "industrial digitalization and digital industrialization".
The regulation around the NFT is basically consistent with the mainland's long-term warnings about virtual currencies and related speculation risks, as well as its attitude towards related illegal financial activities. The "derealization to virtual" NFT financialization, securitization tendency, as well as the hidden dangers such as speculation, money laundering, and illegal financial activities, will touch the regulatory bottom line.
In addition, artworks are originally the hardest hit areas of money laundering activities, and NFT artworks crowned with the aura of NFT are more likely to become a new channel for money laundering activities. Therefore, the Initiative prompts real-name authentication requirements for NFT transactions, and also prompts relevant entities to pay attention to anti-money laundering risks.
In addition, the Initiative also proposes that financial institutions must not directly or indirectly invest in NFTs, do not provide financing support for investment in NFTs, and also prevent funds from flowing into the NFT industry in disguise from the perspective of financing channels, thereby increasing the risk of speculation and affecting financial stability.
In fact, securities and finance are strongly regulated industries in all countries in the world, and the prohibition of NFT financialization and securitization in the Initiative is consistent with the relevant regulatory trends in various countries in the world.
Back at the Token Summit in March 2021, SEC Commissioner Hester M. Peirce warned that fragmented NFTs (F-NFTs), or split NFTs, could pass the Howey Test of U.S. securities law and be recognized as securities by the SEC.
If the issuer does not have the corresponding qualifications, it may be involved in the illegal issuance of securities and is regulated by the SEC. This coincides with the initiative's idea of "not weakening the non-homogenization of NFTs through division of ownership or batch creation".
Due to the mainland's strict ban on virtual currencies, the mainland market's exploration of monetized digital collections has opened up a completely different path for Chinese digital collections than overseas NFTs.
Although the mainland has not yet issued regulatory regulations on digital collections, there are already very detailed regulations around the Internet platforms that operate digital collections and the objects carried by digital collections.
The Initiative defines the boundaries of behaviour for digital collections in the middle and Chinese. Whether it is the entry of Internet enterprises into digital collections, or traditional cultural and art enterprises actively seeking digital breakthroughs, adhering to compliance operations in the context of Chinese, and avoiding "derealization to virtuality", is the long-term way for digital collections to develop steadily in the mainland.