China: Industry organizations release Initiative for Preventing the NFT-related Financial Risks

In brief

On 13 April 2022, the National Internet Finance Association of China, the China Banking Association and the Securities Association of China jointly issued the Initiative1 to Prevent relevant Financial Risks of Non-fungible Tokens ("Initiative"). This is the first Non-Fungible Token (NFT) themed official document involving NFT compliance since the rapid development of NFT in China over the past years. Although the Initiative is only a self-regulatory statement and not mandatory regulatory rules, considering the special status of the three associations as official industry self-regulatory organizations, to a great extent it still represents the regulatory attitude and trend of supervision. We discuss the details of the Initiative in more depth below.


Contents

Affirms the positive role of NFT and points out the related risks

  • The Initiative mentions that "China's NFT market is getting increasingly hot in recent years", and translates "NFT" into "非同质化通证" instead of "非同质化代币". Not only does such Chinese translation give an official Chinese translation for NFT for the first time, it also affirms the application of an NFT concept in China and explicitly distinguishes it from cryptocurrencies (tokens, "代币") which are strictly prohibited in China.
  • It also defines NFT as an innovative and distinct application of blockchain technology and confirms that NFT has certain value in contributing to China's digital economy and promoting the development of cultural and creative industries. Moreover, it points out that NFT may be accompanied by the potential risks of speculation, money laundering and other illegal financial activities as well.

Encourages innovation and uses NFT to motivate the real economy

  • It advises adopting reasonable selection of application scenarios and to standardize the application of blockchain technology to give full capacity for the positive role of NFTs in promoting a digital economy.
  • It proposes that the value of NFT products should have sufficient pricing basis, and a false high price deviating from the basic law of value should especially be prevented.
  • It suggests that the intellectual property rights of an NFT's underlying assets should be protected.
  • It requires truthful, accurate and complete disclosure of NFT product information so as to protect the consumer's right to know, right of choice and right of fair trade.

Sticks to the "bottom line" and prevents financial risks

The Initiative resolutely seeks to stop any financialization and securitization tendency of NFTs, strictly prevent the risks of illegal financial activities, and proposes six specific codes of conduct as below with which to comply.

  • It stresses that securities, insurance, loans, precious metals and other financial assets should not be included in the underlying assets of an NFT, that is, NFTs must not be used in the issuance and trade of any financial products.
  • It prohibits any initial coin offering (ICO) business in distinguished form, more specifically, it does not allow anyone to weaken the non-fungible characteristics of NFTs through methods like dividing ownership or creating batches.
  • It does not allow the set-up of any trading venues in violation of regulations to provide centralized trading (centralized bidding, electronic matching, anonymous trading, market maker, etc.), continuous listing trading, standardized contract trading and others services for NFT trade. From the expression of this point alone, it cannot be said that NFT platforms are completely prohibited. If NFT platforms follow the prior mentioned restrictions and do not use NFTs for any purpose of issuing and trading any financial products, they still have the opportunity to conduct normal NFT business, i.e. providing services related to the purchase of NFTs of the underlying digital artworks. In practice, to avoid the trend of financial speculation, many NFT platforms in China do not allow NFT secondary transactions, transfers, or otherwise allow the purchaser of the NFT to transfer it to others as a gift.
  • It strictly prohibits the use of cryptocurrencies such as Bitcoins, ETH and USDT in pricing or settling NFTs. This is consistent with China's current strict prohibitions on cryptocurrencies wherein cryptocurrencies do not have the same legal status as legal currencies and cannot be circulated in the market as currencies or pricing tools.
  • It urges processing of real name authentication for NFT issuers, buyers and sellers and keeping customer identity information and issuance transaction records properly, while actively cooperating with anti-money laundering work. NFT platform operators should pay special attention to this point.
  • It does not allow investment in NFT directly or indirectly or providing any financing support for such investment. This should be understood as restricting investors from investing in NFTs as financial products for the purpose of financial investment profit, rather than forbidding general users to purchase NFTs for practical purposes such as private artwork collection. In practice, many NFT platforms in China are operated as digital collection platforms and only allow individual users to register.

Give tips to NFT consumers

  • It warns consumers to establish a correct consumption concept and enhance self-protection, and consciously resist and stay away from illegal financial activities.
  • It also reminds consumers to report relevant illegal activities proactively and on time.

In addition, it is also worth mentioning that on the day after the launch of the Initiative, to respond to the suggestions of the Initiative, the China Mobile Communication Metaverse Consensus Circle (CMCA-MCC) and the China Communications Industry Association Blockchain Specialized Committee (CCIAPC) jointly issued The Self-Regulatory Requirements on Regulating the Healthy Development of Digital Collection Industry2 ("Self-Regulatory Requirements"). Both the CMCA-MCC and CCIAPC are social organizations under the guidance of the Ministry of Industry and Information Technology of the PRC and registered with the Ministry of Civil Affairs of the PRC. As digital collections are based on NFTs and the development is still at an early stage with unclear value standards, the Self-Regulatory Requirements mainly reiterate relevant requirements in the Initiative and propose reasonable expectations.

In short, the Initiative confirms the concept and development of NFT in China, not only puts forward the code of conduct, but also defines the regulatory red line, which is of great significance. The Initiative also demonstrates the current general attitude of regulators on NFT is to prevent financialization and securitization of NFT rather than prohibit NFT itself. This is good news for the realization of a cultural and artistic value of NFT and will facilitate NFT developing in a positive and healthy way.

To discuss how our experience can assist you, or if you have any questions on any of the matters above, please do not hesitate to liaise with your usual contact or the lawyers listed in this Alert.


1 Please see https://www.china-cba.net/Index/show/catid/14/id/40730.html

2 Please see http://dgh.tcc2017.org.cn/article/item-501.html

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