Hong Kong Watchdog Warns Against Legal Risks Surrounding NFTs

The Securities and Futures Commission (SFC), Hong Kong’s financial regulator, has issued a statement warning against the financial and legal risks linking to non-fungible tokens (NFTs). By description, NFTs are the digital representation of collectibles such as music, video, image, and artworks.

Although these digital representations do not fall under the SFC preview, the financial watchdog claims that NFTs are not only prone to the typical security vulnerabilities of crypto but also constitute financial assets bound by SFC regulation.

In a June 9 press report, the regulatory commission alleges that there are already some NFTs that have crossed the boundary from being digital collectibles to becoming collective investment schemes (CIS). The publication wrote:

 “Where an NFT constitutes an interest in a CIS, marketing or distributing it may constitute a ‘regulated activity.”  Parties carrying on a regulated activity, whether in Hong Kong or targeting Hong Kong investors, require a license from the SFC unless an exemption applies.”

Notably, the NFT market started gaining mainstream adoption in 2021, with NFT recognized as simple collectibles or speculative items. At the time, the most valuable collection included the Bored Ape Yacht Club and simple images of rocks.

In the past few months, the NFT space has evolved to incorporate various new forms of utility, including staking and Metaverse interoperability. According to Gary Vaynerchuck, the CEO of Vayner Media, NFT will soon be part of every contract, including buying homes, cars, and financial assets.

In the meantime, the Hong Kong financial regulator has warned anyone aiming to join the NFT space as an investor. The publication reads:

“As with other virtual assets, NFTs are exposed to heightened risks including illiquid secondary markets, volatility, opaque pricing, hacking, and fraud.”

SFC Classifies Collective Investment Schemes

Based on the SFC, a “collective investment scheme” is an investment arrangement where the investors pool money for a particular property managed by an escrow. Notably, the investors benefit from the investment but have no active control over the asset.

Just licensed and exempted institutions can operate some of the available collective investment schemes according to SFC. In that context, fractionalized NFTs represent shared ownership in NFTs. Thus, the investment can be split into thousands or millions of fungible tokens by locking them in a secure vault on a decentralized platform.

The SFC also placed ‘fungible NFTs’ under the same criteria, representing assets comparable to the tokens associated with particular NFT projects or collections.

U.S Legal Approach to NFTs

For now, there is proper NFTs regulation alongside the rest of the digital assets. Cynthia Lummis, the United States Republican Senate Representative for Wyoming; is set to table her digital assets regulation bill before the end of this week. Unfortunately, her new legislation has not included NFTs regulations, with Lummis citing difficulty in defining them.

Despite the regulatory uncertainty in the country, U.S authorities do not take NFTs for granted. Earlier this month, the United States prosecutor in Manhattan filed charges against Nathaniel Chastain; the former product manager at OpenSea, for illegally trading NFT in September 2021. While commenting about Chastain’s case at the time, New York attorney Damian Williams said:

 “Today’s charges demonstrate the commitment of this legal office to stamping out insider trading – whether it occurs on the stock market or the blockchain.”