What regulatory framework for tokens?

The AMF published on June 19 a discussion paper on the regulation of the DeFi ecosystem. At the same time, the Inspectorate General of Finance (IGF), often in charge of advising and verifying public organisations, published a report on the case of digital tokens. The IGF notably recommends including NFTs in the MiCA project, or attaching NFTs to the movable property regime. Decryption of legal developments for the cryptocurrency sector.

A report for digital tokens

THE IGF report highlights important regulatory issues in the field of NFTs. Indeed, the use of NFTs has multiplied in many areas. For example, the feat of the first auction combining real works and NFT took place in Paris. In fact, NFTs are used both in the field of Art, in the field of luxury, but also in the field of video games. In this respect, games would represent up to half of the uses identified.

NFTs thus concern more and more areas, although the volumes observed on the market are still much lower than those observed in 2021 and 2022. Consequently, it is in this context that the IGF has taken up the legal issues raised by NFTs. Indeed, France and Europe do not have a regulatory framework truly adapted to the emergence of digital tokens. NFTs are not considered to confer ownership of movable property. The IGF remarks as follows:

“One of the primary use cases for NFTs is to present the token holder as
being the owner of the artwork that is the underlying file, most often a
picture. […] The analysis of the legal qualification of “artistic NFTs”, developed in 1.2, nevertheless shows that they cannot in any way be considered as a work or, more generally, as a form, even degraded, of ownership of a work or its support. »

REPORT AND APPENDICES – Commercial tokens in the French economy: use cases and legal issues (finances.gouv.fr)

NFT use cases

Even so, NFTs address multiple use cases. Moreover, not all NFTs are intended to confer ownership and the IGF specifies several cases.

  • First, we distinguish commercially oriented NFTs. These are intended to market various content, to attach a digital property based on an underlying, or to be objects in their own right on the Metaverse.
  • Then, we distinguish the NFTs as utility token. Some brands use NFTs for marketing in the context of events, communication, etc. This case demonstrates a utilitarian function and less attached to property.
  • Finally, NFTs can be used for cultural purposes. Some events issue NFTs in the form of certificates, supplements, souvenirs, etc. In this case, the NFTs sometimes take on the aspect of patronage and donations more than ownership.

NFTs legally attached to their underlying

Regulators ask themselves a central question: Are NFTs associated with the good they represent when they are, or do they remain digital assets that confer no ownership?

The General Inspectorate of Finance specifies that NFTs cannot be a property right or a work of art. However, NFTs could be “titles of concession of the economic rights associated with the works to which they point”. The challenge would therefore be to reconsider NFTs as accessories to the good transmitted. That is to say that at the same time as the transfer of the property, the rights attached to the thing, including the NFT, would be transmitted. The good would then be inseparable from the NFT. In this case, the tax on capital gains would be identical to that on movable property (36.2%).

In the event that the NFTs are not incidental to the asset, the consideration of the NFTs as digital assets also entails tax consequences, since the tax rate on capital gains is 30%. Unless it is a resale with capital gain against another digital asset. The report also highlights VAT issues. A sale of NFT to a customer is generally made without knowing his country of residence, the IP address could then serve as the basis.

As a result, the IGF thus proposes to “Make association mandatory for any commercially oriented token
issued or/and exchanged in the European Union of a contractual document defining the
rights and obligations incorporated as the underlying from which the holder of the token benefits”
. Indeed, NFTs often give rise to rights for their holder (access to a platform, to a particular space, etc.).

The Question of Art

Finally, the report also clarifies an essential point in determining whether NFTs are works of art. The legal consideration of NFT in matters of art would therefore be that of “technical tool” which serves as an immaterial support for a work (stored in photo on a server for example).

It should be clarified that NFTs cannot be considered as works of art in
tax matters. Indeed, the tax doctrine specifies that the works of art covered by the CGI must
be produced in a maximum of twelve copies, which is not possible for a file
digital. Therefore, the regime of precious objects and works of art cannot be applied
and only the movable property regime seems possible for NFT transfers with the underlying.

REPORT AND APPENDICES – Commercial tokens in the French economy: use cases and legal issues (finances.gouv.fr)

MiCA’s ambiguity with NFTs

If the regulation of stablecoins and the various altcoins is recorded with MiCA, the ambiguity remains significant with NFTs. Technically, NFTs are not part of the regulatory project. However, the authorities retain some leeway to decide on what is (or is not) fungible, and therefore what falls within the scope of regulation.

The entry into force of MiCA will pose particular difficulties with regard to
the NFTs.
Indeed, NFTs are excluded from the scope of the regulation by its recital 1014 and
its article 2, but the criterion of non-fungibility is not sufficient.
In order to avoid circumvention of the regulations, the text provides for the requalification
possible from technically non-fungible tokens to tokens subject to the MiCA regulation

REPORT AND APPENDICES – Commercial tokens in the French economy: use cases and legal issues (finances.gouv.fr)

Through the MiCA regulatory project, the authorities reserve the right to reclassify an NFT as a fungible token, and therefore applicable to regulation, under certain conditions.

Issuance of crypto-assets as non-fungible tokens in large series or collection should
be taken as an indicator of their fungibility.
The only assignment of an identifier
unique to a crypto-asset is not in itself sufficient to classify it as unique and non-fungible. For
that the crypto-asset is considered unique and non-fungible, the assets or the
rights represented are also unique and non-fungible. […] This regulation should
also apply to crypto-assets that appear to be unique and non-fungible, but whose
de facto characteristics or characteristics that are related to their de facto uses
would make either fungible or non-unique
[…]. »

MiCA regulation. Excerpt mentioned by REPORT AND APPENDICES – Commercial tokens in the French economy: use cases and legal issues (finances.gouv.fr).

The AMF begins discussions on DeFi

At the same time, the AMF carries out comprehensive and detailed work. While recalling that the valuation of the DeFi sector has gone from more than $260 billion at the start of 2022 to nearly $80 billion at the start of 2023, the AMF takes the sector seriously and is starting discussions. Terra Luna’s collapse is at the heart of the regulator’s consumer fears. In fact, this event showed the risks and opacity for some users of DeFi protocols. The AMF very appropriately calls for regulation “progressive and proportionate” so as not to stifle innovation.

Finally, another regulatory issue arises with DAOs, for decentralized autonomous organization. In a DAO, token holders have rights (vote, possible financial benefits, etc.). The DAO is thus very close to the current principle of shares or bonds. Moreover, many projects already exist. And some countries like Switzerland are already far ahead in this area, both in terms of regulation and effective innovations. We will also notice the existence of leaders in tokenization on the principle of actions like tZero. This raises questions of KYC (identification of the holder), anti-money laundering, the fight against manipulation, and many other legal necessities.

“Within DeFi protocol DAOs, these tokens are used to take part in protocol governance votes. Depending on the case, voting mechanisms show some similarities and differences when compared to shares issued by traditional legal entities. […] Consequently, and in the absence of legal clarifications, the members of these organizations do not have the traditional legal means to protect them. […] In France, work is currently being carried out by the Haut Comité juridique de Place (HCJP), which is studying in detail the modes of structuring and governance of DAOs and their different typologies, with a view to clarifying the legal framework that could apply to these structures. »

Microsoft Word – AMF Discussion Paper on Decentralized Finance VF.docx (amf-france.org)

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