Introduction
“A non-fungible token (NFT) refers to a unique and non-replicable entry on a cryptographic blockchain ledger that points to the metadata of a particular digital item on the web and is the newest mysterious entity to pop out of the complex world of financial technology.”
Fungibles are a common practice, for example if a person exchanges a 100 rupee note with another, there is no change in the cash that the person holds, it is merely exchange of the same amount. cryptocurrencies are a type of fungible where one bitcoin in exchanged with the other, without any difference in its value. The example of non-fungible can be one blue diamond, which cannot be exchanged or interchanged with other because of its different cuts or shape. The complexity arises in the case of fungibility is the working of NFTs in the digital sphere. So, in India a new regulatory framework is required to regulate the working of NFT. This article will also highlight the current regulatory framework as well as legal status of NFTs in India. The article will also look into the regulatory problems that are associated with NFTs and the probable ways in which this could be dealt with.[i]
keywords: non-fungible tokens (NFTs), blockchain, global markets, consumer protection, securities laws, and intellectual property rights.
Page Contents
The Technological Aspect of NFT
Cryptocurrencies and NFTs are frequently grouped together. This is due in part to the fact that both are fundamentally altering how we think about financial markets and how technology fits into them. They do, however, have a more profound link on a scientific level because they are both fundamentally built on blockchain technology. A blockchain is an electronic, additive ledger, without getting too technical.[ii] It is a method of decentralized data storage that also precludes the deletion or change of earlier entries. All network participants share duplicate copies of the data. The NFT is kept on a blockchain, which is a network of computers that serve as “nodes” for the blockchain and are dispersed over the globe. The entry is kept on each of the nodes.[iii]
Each item of data is kept in blocks, which are collections of sequential data. Fresh data is placed into a new block, which is subsequently connected or chained to the preceding block, after a block has been full, i.e., reached its storage limit. As each block has its unique fingerprint, or hash, and as each block also retains the hash of the preceding block, anything that has been recorded is safe and secure once it has been done so. Additionally, each record is time-stamped and uniquely transcribed. Combining two hashes into one creates an extra degree of protection. The procedure is repeated numerous times until there is finally just one hash (known as the root hash or Merkle root; the complete data structure is known as the Merkle tree) for the full collection of blocks.
Any prior block’s hash and all ensuing blocks’ hashes will change if any data in a previous block is modified. Hacking or altering the recorded information is nearly difficult since such a modification will not go unnoticed and will be rejected because the complete record of all data kept on the blockchain is accessible on all computers in the network (nodes). Importantly, blockchain technology offers a mechanism to store various types of data in an effective manner owing to its safe nature and fingerprinting (unique identifier) function.
Digital Collectibles
Individuals accumulate a wide range of items, including but not limited to coins, barbie dolls, stamps, ancient weapons, autographs, paintings, and other objects. Given the pervasive influence of the information technology revolution on contemporary society, it can be assumed that soon people will also start collecting digital items too. The Louvre Museum in Paris houses the sole existing Mona Lisa artwork, physical painting the same can only be seen at the museum.
Individuals access tweets, images, or memes on the internet at any given moment and from any location. How can one acquire a digital artefact that is publicly accessible? The Non-Fungible Token (NFT) has emerged. The Non-Fungible Token (NFT) functions as an exclusive certificate that is generated on the blockchain, providing evidence of possession of a digital asset. Every digital entity present on the internet is associated with a distinct Uniform Resource Locator (URL) and possesses a unique set of metadata. Due to the potential for traditional URLs to experience breakdowns or hosting issues, NFTs are progressively utilizing the IPFS (InterPlanetary File System), which employs multiple hosts to maintain the online presence of digital files. The non-fungible token (NFT) is programmed with publicly accessible metadata, as well as information pertaining to its transactional history. As it presently exists, an NFT has the potential to be associated with a digital entity on the internet, commonly digital artwork, although it can also pertain to non-artistic collectibles such as tweets. NFTs can be likened to a property’s title deed in this context.[iv]
NFTs offer a practical and appropriate method for claiming ownership of a digital collectible. Essentially, the buyer of the corresponding NFT holds a token that serves as proof of their ownership of the digital artwork, similar to how the Mona Lisa is owned by the French Republic or a unique and valuable stamp is owned by a private collector. The distinction lies in the fact that the exclusive possessor of a stamp in physical form is the sole individual who can fully appreciate its magnificence, whereas a digital artwork, tweet, or any other uniform resource locator (URL) can be accessed by anyone.
It is of significance to note that the Non-Fungible Token (NFT) possesses value solely on the condition that the connection between the blockchain entry that was sold (i.e., the NFT) and the digital collectible remains intact and unimpaired. If the digital collectible referenced is no longer present at the specified URL or is not currently stored on the InterPlanetary File System (IPFS), the non-fungible token (NFT) signifies possession of the metadata associated with a file that is no longer extant, rendering it devoid of significance. The emergence of NFTs has brought to the forefront several significant legal concerns pertaining to regulation, copyright, taxation, and other related matters. With the increasing prevalence of platforms facilitating NFT trading and the growing mainstream adoption of NFTs, it is imperative to consider the appropriate legal and policy responses to this novel form of collecting and the unique ownership framework it engenders.[v]
Rights and Ownership
According to the definition given above, an NFT is a token created on the blockchain that certifies ownership of a certain digital item. Its legal position is a little trickier, however. Dealing with matters like copyright and taxes requires a thorough understanding of their legal position and nature, in addition to the rights they provide to its owner. There is not much clarity since NFTs are new and because financial and regulatory legislation is complicated. The fact that ownership of an NFT does not give a discrete and predetermined set of rights further complicates the situation since the underlying smart contract determines which rights are granted when a certain NFT is purchased. This means that purchasing an NFT of a piece of digital art may only provide the owner certain rights, such as the right to non-commercial uses.
Issues That Arise in Context of NFT Ownership:
- The conferred rights are not static and are contingent upon the contractual agreement that underlies them.
- The assertion is that the transaction involving the sale of a Non-Fungible Token (NFT) represents the sale of an entry on a blockchain-based additive ledger, rather than the actual work being sold.
- It is possible for an NFT to be generated by an individual other than the original author of the digital content.
It is crucial for NFT buyers to exercise caution and diligence in familiarizing themselves with the purchase terms and conditions. This is because various NFTs offer distinct entitlements, such as the potential transfer of intellectual property rights by the copyright holder, which may not be applicable to all NFTs.
Given that ownership of a non-fungible token (NFT) does not entail the transfer of a clearly defined and distinct set of rights, regulatory measures must exercise prudence in light of this unique aspect of NFT ownership. It is important to recognize the contrast between NFT ownership and other forms of ownership, such as land ownership, which do involve a distinct set of rights. The possession of a non-fungible token (NFT) does not impose any limitations on the individuals who are able to view, reproduce, capture an image of, or acquire the associated digital asset. Additionally, the ownership of an NFT does not equate to the ownership of the underlying digital asset to which the NFT is linked.
NFTs, which are created using technology, do not necessitate the consent of the owner or creator of the digital artefact for their production. This is a significant aspect to consider. The prevalence of tokenized public works, including paintings by renowned artists in the form of NFTs, is indicative of their widespread adoption. Non-fungible tokens (NFTs) have the potential to be generated by any individual or entity, without the concern of ownership being a factor in the creation phase. At present, there exists no insurance policy that provides coverage for the associated risk. The sole source of solace lies in the fact that an NFT lacking verification from the artist holds negligible value. While certain trading platforms have implemented stricter regulations, it is not yet a universally adopted practice.
The distinctive feature of NFTs, in contrast to other asset categories, lies in the centrality of ownership and property rights. While a company’s shares are exclusively issued by the company, an NFT can be generated by any individual, including a stranger to the artist. The acquisition of an NFT by a buyer in good faith may result in a problematic scenario with regards to ownership, as the NFT in question may have been produced without the consent of the artist or copyright proprietor. The decentralized nature of NFT marketplaces results in a wide variance of policies across different NFT trading platforms, ranging from stringent checks to unrestricted access. It is imperative to exercise caution in order to prevent the infringement of artists’ rights, and to establish a regulatory framework that can effectively reduce the likelihood of fraudulent activities or security breaches.
Are NFTs Legally Classified?
Currently, there exists no official directive or communication from the Government regarding the handling of Non-Fungible Tokens (NFTs). Nevertheless, the matter holds significant fundamental significance. In recent months, there has been a notable surge in the visibility and acknowledgement of NFTs as a viable asset for trading. Specialized marketplaces have emerged that focus solely on the commercialization of non-fungible tokens (NFTs). eBay has recently made the decision to permit the trade of non-fungible tokens (NFTs) on its online marketplace. Cryptocurrency exchanges, such as WazirX and BuyUcoin, are constructing specific marketplaces for Indian non-fungible tokens (NFTs) in India. Consequently, it is imperative for the Union to establish a policy regarding the issue. In this situation, the Government has a few alternatives regarding the NFT market.[vi]
- ban trading in NFTs altogether.
- let the market regulate itself.
- amend the existing framework to regulate the NFT market; or
- develop an entirely new regulatory framework specific to NFTs.
To date, no official declaration has been issued regarding the Government’s stance on non-fungible tokens (NFTs). In addition, it should be noted that NFT trading operates within decentralized crypto internet markets, and any attempt to prohibit this activity would likely result in the market being driven underground or towards offshore marketplaces, as has been observed with other forms of cryptocurrency assets. Consequently, the implementation of a ban would prove to be ineffective, given the presence of various methods to circumvent such legislation without detection by the authorities. This is primarily due to the arduous nature of enforcing a ban, which is compounded by the utilization of cryptocurrency for trading on NFT marketplaces, rendering the prohibition of cryptocurrency impractical. In addition, it is improbable that every auction site or marketplace has a structured protocol for addressing consumer grievances, particularly with the emergence of NFTs on blockchains beyond Ethereum, despite the fact that buyer rights are integrated into the marketplace.
NFTs as derivatives?
There is a perspective that posits the potential utility of categorizing NFTs as derivatives, as it may facilitate the establishment of a regulatory structure that operates within the confines of current rules and regulations. “The Securities Contracts (Regulation) Act” of 1956[vii] stipulates the establishment of recognized stock exchanges that oversee and govern contracts pertaining to the buying and selling of securities. The term “securities” encompasses the financial instrument known as “derivative”. The principal concern at hand pertains to the fact that the calculation of the derivative’s value is contingent upon the value of specific financial assets, whereas a non-fungible token (NFT) represents a non-financial asset. Hence, it presents a challenge to classify NFTs within the parameters established by (A) and (B). Commodity derivatives, such as the one denoted by (C), derive their value from underlying assets that are predominantly tangible, such as gold, crude oil, and soybean, rather than intangible assets like digital art.[viii] The aforementioned dissimilarity between digital art pieces and the Securities and Exchange Board of India’s classification of commodities as both fungible and tangible renders the latter inapplicable in this context. The classification of NFTs as commodity derivatives is not feasible as the intangible nature of the digital work precludes it from being considered a commodity. Under Section 2(ac)(D), the Central Government has the authority to designate NFTs as derivatives, which could potentially enable their trading through established stock exchanges with regulatory oversight from SEBI.
Every non-fungible token (NFT) possesses distinct characteristics. The acquisition of a specific NFT is contingent upon the willingness of the current owner to sell. The fungibility of securities distinguishes them from other types of assets. Shares of a particular company can be procured from any vendor in the secondary market, and there exists no distinction between the shares obtained from two different vendors. It should be noted that a single owner possesses a specific NFT, and due to their uniqueness, they are not appropriate for trading on exchanges that deal in fungible shares, such as stock exchanges. In the realm of trading, it is assumed that each unit of a given item being traded is indistinguishable. This means that two parties can exchange shares of equal value without any substantial alteration to the assets they possess. In contrast to other assets, NFTs possess distinct attributes that render them non-interchangeable with one another. In addition, the quantity of non-fungible tokens that can be produced is substantial and may pose a significant challenge in terms of monitoring and management. The distinct characteristics of a non-fungible token (NFT), which serves as an exclusive identifier of the metadata of a digital collectible on the blockchain, render it less appropriate for trading on a pre-existing stock exchange platform. Furthermore, it is noteworthy that non-fungible tokens lack a tangible asset as collateral, which distinguishes them from conventional derivatives and shares.
Ultimately, an NFT can be defined as a record on the blockchain, and its transaction represents the transfer of a record on a digital ledger. Given the restricted range of entitlements obtainable, it is implausible to contend that NFTs qualify as derivatives. Due to the aforementioned factors, it would be deemed unsuitable to classify an NFT as a derivative within the jurisdiction of India. Consequently, in the event that NFTs are classified as “derivatives” for regulatory purposes, it would necessitate a restructuring of the current stock exchange framework and the establishment of distinct infrastructure and regulations to enable such transactions. Thus, the third alternative, akin to the initial and second ones, does not qualify as a viable option. A more viable option would be to construct a distinct regulatory structure tailored to non-fungible tokens (NFTs). Furthermore, the ambiguous classification of cryptocurrencies as either commodities or securities presents additional challenges and requires a more comprehensive examination by regulatory bodies to establish a precise legal definition that aligns with the existing framework. [ix]
Conclusion
Notwithstanding their recent emergence, NFTs have gained significant prominence and have evolved into a rapidly expanding industry. In the initial six months of 2021, the worldwide NFT market exceeded $2.5 billion, a substantial increase from the $13.7 million recorded in the corresponding period of 2020. The need for regulatory oversight is pressing, given the potential for NFTs to be utilized in illicit activities such as money laundering and financing of terrorist operations, as well as other financial crimes that are not currently within the purview of this manuscript. [x]
The examination of legal frameworks in the United States and United Kingdom, along with the draught guidelines proposed by the Financial Action Task Force (FATF), suggests that Indian policymakers could potentially utilize these as a foundation to construct a domestic regulatory structure. The matter of NFT loss and burning necessitates prompt implementation of robust and equitable governmental regulations to safeguard purchasers from unscrupulous entities. Taxation is a multifaceted and contentious topic. However, a cohesive and unambiguous governmental position, coupled with frequent updates on emerging developments, will be advantageous for individuals engaged in NFTs and the broader financial landscape. With respect to copyright, the Indian Government’s policy ought to be more proactive than that of more developed nations like the USA and UK. This is because a regulated NFT market that safeguards the moral rights of creators could potentially enable Indian creatives to attain significant recognition on a global scale.
The legal classification of NFTs is a complex matter that defies easy categorization as either securities or goods. This underscores the need for the establishment of a regulatory body with comprehensive authority to oversee NFT marketplaces. Such a body would be responsible for determining the precise legal status of emerging NFT developments, as well as monitoring transactions and the smart contracts utilized in trading. The notion that NFTs merit substantial regulatory efforts underscores all the recommendations. Such efforts are expected to yield long-term benefits, given the likelihood of NFTs becoming integral to the development of Web 3.0. India stands to gain a competitive advantage by being at the forefront of this trend.
[i] Sharma, R., “Non-Fungible Token (NFT)” (Investopedia 18-3-2021).
[ii] Bradley, R., Blockchain Explained … in under 100 Words (Deloitte Switzerland 9-6-2021) accessed 26-3-2023.
[iii] Antonopoulos, A.M., “Chapter 7 : The Blockchain,” Mastering Bitcoin (O’Reilley Media 2014).
[iv] Conti, R., What You Need to Know About Non-Fungible Tokens (NFTs), (Forbes 17-6-2021).
[v] Steinwold, A., The History of Non-Fungible Tokens (NFTs), (Medium, 7-10-2019).
[vi] Clark M., You Can Now Buy NFTs on eBay, and “Blockchain-Driven Collectibles” are Coming Soon (The Verge, 11-5-2021).
[vii] Securities Contracts (Regulation) Act, 1956.
[viii] SEBI, Faqs on Commodity Derivatives, (SEBI August 2021).
[ix] Bine, P. and others, Regulatory Approaches to Non-fungible Tokens in the EU and UK : Insights : Skadden, Arps, Slate, Meagher & Flom LLP (Insights | Skadden, Arps, Slate, Meagher & Flom LLP.
[x] Howcroft, E., NFT Sales Volume Surges to $2.5 Bln in 2021 First Half (Reuters, 5-7-2021) accessed 28-7-2021.
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