A Global Guide for In-House Counsel: Doing business in a rapidly changing world

Commercial – Crypto & NFTs

What are the biggest investment opportunities in digital – and how can clients decide on the best entry point for them?

We do not give investment advice to clients. The UK wealth management industry generally urges caution in relation to investing in cryptocurrencies or NFTs due to the lack of regulation, high market volatility and requirement for the investor to acquire detailed market knowledge. They note instead the continuing development and expansion of blockchain technology as tending to suggest tech equities and growth funds as potentially attractive opportunities for investment.

Crypto can be a volatile market: how do you advise your clients to mitigate risk when trading in digital currencies?

Accepting cryptocurrency as payment for goods and services offers the potential attractions of low fees, fast cross-border transactions and the potential to engage with new groups of consumers.

However, cryptocurrencies are prone to huge fluctuations in value, sometimes on an hourly basis. As a result, few UK businesses currently accept direct payments in exchange tokens such as Bitcoin and Ethereum, choosing instead to adopt indirect methods to engage with the sector, for example:

  • Allowing consumers to use cryptocurrency to purchase gift cards which may then be used to purchase goods. This is the preferred route for many leading retailers.
  • Using payment gateways such as Bitpay, which lock-in exchange rates for up to 15 minutes while customers complete their order.

Meanwhile, the UK government’s preferred approach is to encourage the use and acceptance of stablecoins via their proposed regulation, with the objective of making the country “a global hub for crypto-asset technology and investment”.

How is your jurisdiction managing the legal challenges of NFTs: for instance, taxation on purchases, IP, ownership and theft?

Intellectual property challenges come into sharp focus when an NFT is minted or purchased that relates to an asset containing real-world IP rights, such as a piece of physical or digital art, or a digital replica of a real-world branded item. Such NFTs could contain IP rights such as trademarks, designs, copyright in art, text or cinematic works. Ownership of the NFT will not confer any IP rights in the underlying asset. The NFT authenticates ownership, rather like a signed print of a physical artwork but, like a signed print, it does not grant the buyer the copyright in that work.

Where a buyer wishes to commercialise the NFT, e.g. reproducing and selling the artwork represented by the NFT, due diligence is crucial. The usual real-world steps should be taken to ensure that the owner of the IP in the underlying asset grants to the buyer right to use that IP when they purchase the accompanying NFT. Typically, this would involve a licence from the rights holder. A buyer may value an exclusive licence, whereas a rights holder may prefer to retain the right to use the IP itself or grant the rights to others. A rights holder may also wish to limit the purposes for which the buyer can use the IP, e.g. solely for use in the virtual world.

The other side of this equation is that the owners of brands and IP rights need to be vigilant to prevent unauthorised use of their IP (e.g. sales of goods containing that IP) in the NFT space. Traditional avenues for pursuing trademark infringement have yet to be tested extensively by the UK courts in the context of NFTs, but we would expect existing principles to continue to apply. A trademark owner can seek to sue for infringement under the Trade Marks Act 1994, or under the common law action of passing off. Claims for passing off have historically succeeded for brand owners against so-called domain name “squatters” registering internet domains names featuring well-known brands, where the brand owners were able to demonstrate use of the domains as a “tool of deception” to infer a connection between the unauthorised website and the brand. We might expect to see claimants take a similar approach against unauthorised NFT minters and buyers.

There is currently no HMRC tax guidance dedicated to NFTs. Until such guidance is published, it seems reasonable to expect that NFTs will be treated much like any other chargeable asset:

  • Profits and losses on sale or transfer will be subject to capital gains tax.
  • NFTs will be chargeable assets for inheritance tax purposes.
  • Transfer is likely to be subject to VAT, though whether as a supply of goods or services has not been determined.

In addition, trading in NFTs may create corporation tax or income tax liabilities. It is also possible that written instruments reflecting an underlying smart contract might attract stamp duty. Care and sound professional advice are essential.

Despite the apparent transparency and security of the blockchain, NFTs have been shown to be open to abuse. From wallet heists and pass key crackers, to fake NFT stores and ‘pump and dump’ schemes, fraudsters have found multiple ways to steal valuable NFTs and sell fakes.

In the landmark OpenSea case, the victim’s NFT wallet was hacked and two of her NFTs stolen. She traced the stolen NFTs to where they were held and was granted an injunction to freeze those assets. However, she could not identify the physical owners of the new wallets. An injunction was granted against both on the untraceable hackers and the NFT trading platform, OpenSea. The judgment highlights the courts’ strong approach to protect victims of NFT fraud and theft, but also how difficult it can be to identify anonymous perpetrators (while metadata can be used to verify the author and owner of an NFT on the blockchain, it cannot link that identity to a physical person). Given this difficulty, it is important to ensure that appropriate safeguards are put in place, such as:

  • Using clear and comprehensive written contracts for NFT sales and accompanying grants of rights.
  • Keeping comprehensive records of underlying digital files linked to the NFT.
  • Using strong pass keys.
  • Putting in place clear policies and training staff.

“The NFT authenticates ownership, rather like a signed print of a physical artwork but, like a signed print, it does not grant the buyer the copyright in that work”

TOP TIPS

Exploring digital asset investments

  • Assess your appetite for risk. NFTs, cryptocurrencies and other digital assets are high risk investments. The market is highly volatile with high price fluctuations. Valuation of assets can be difficult. Transactions are anonymous and irreversible, attracting scams, fraud and cyberattacks. However, these issues have not slowed the continuing trend of institutional investors increasing their exposure to the sector, the prevailing view being that the upside opportunity outweighs the risk.
  • Understand the options for investment. It is possible to invest directly in NFT tokens on marketplaces like OpenSea and Rarible. However, this exposes investors to the full volatility of this asset class. An alternative approach is to invest in NFTrelated stocks, focusing on companies at the cutting edge of finance, technology and digital assets.
  • Do your homework. NFTs are unregulated in the UK. There is no obvious trusted source for investment advice in the sector and investors must rely on their own due diligence on NFT creators, community and contracts. This may present opportunities to ‘get ahead of the curve’. Social media forums, online communities and industry blogs have become prime research targets.

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