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Non-Fungible Tokens and Applicable UAE Law

Published on : 25 Apr 2021

To or Not to NFT

NFTs (non-fungible tokens) are a type of crypto asset that exists on the blockchain, which is a network that supports other types of cryptocurrencies. Furthermore, crypto assets in their NFT form are non-transferable, making them one-of-a-kind. Likewise, it is because of its rarity and uniqueness that it is highly sought after by collectors.

Getting to Grips with Tokenization

NFTs are designed in such a way that their tradability and usability are limited to the blockchain. A blockchain, in this context, is a distributed database that can store any sort of data, with a consensus mechanism ensuring that each new entry complies with and is compatible with previous records on the same database.

Any entity/user with access to the distributed ledger, depending on the type of blockchain, can inspect and validate all elements registered on it, as well as potentially add to the existing records.

Tokens are “units of value that are connected to digital properties,” to put it another way. Similarly, tokenization can occur in a variety of genres, ranging from coin-related tokens to stocks, properties, and shares, among others.

The commonality, on the other hand, was recorded on a distributed ledger. Notably, the technological architecture and norm of a blockchain determines token compatibility. Many NFTs already use Ethereum's blockchain for transactions.

Similarly, non-fungible tokens can be distinguished from fungible tokens, which can be replaced by an equivalent token and whose value can be exchanged. The fungibility of crypto coins such as bitcoin is an example of this point. Non-fungible tokens, on the other hand, are non-divisible and distinct from other non-fungible representations of a digital or physical asset.

As previously mentioned, NFTs need a blockchain-based network to operate properly, which supports the technological environment that allows non-fungible token transactions.

Similarly, in order for NFTs to exist on the blockchain, they must first be minted, which means they must be produced or generated and then registered on the Ethereum compliant blockchain. Following that, the newly created NFTs are registered on the same distributed ledger or blockchain, indicating ownership of the token in question.

Likewise, after the minting is completed, the NFT transactions will be charged in a measure known as gas. The term "gas" refers to the amount of computing power needed to complete a blockchain transaction in units.

As a result, the amount of gas needed to complete a transaction will be variable. As a result, the fees should preferably rise in tandem with the platform's traffic.

NFT’s in the Artistic Realm

NFTs have taken over the creative world, with virtually stored photographs being sold to potential customers on the blockchain. The NFTs can also be sold online since they are non-fungible and tokenized.

 More notably, NFTs authenticate art forms in their virtual form, where its special non-fungible coding could be used to specify art objects, effectively rendering it a one-off, similar to the demand for one-off physical art pieces.

Similarly, with questions about originality and authenticity posed in relation to an art piece, it is worth noting that an NFT is more likely to be marketable, since it is difficult to reproduce and no two NFTs are alike, their notoriety and scarcity are likely to increase.

The first tweet of Jack Dorsey (Twitter's CEO), which was tokenized and marketed as an NFT for a large sum, is a good example of an NFT.

NFT Thought Spectrum

NFTs can be found on either side of the spectrum. On the one hand, they are widely regarded as ground-breaking for aspiring artists, especially in terms of making their craft more viable.

They are, on the other hand, seen as the most recent example of two systemic issues with blockchain-based technologies, wherein their potential for deceptive or at least speculative reasons, as well as their disproportionately negative environmental impact, are questioned.

Types of Tokens

  •  Utility tokens are like a paying API key that acts as a portal to a digital system, allowing token holders to access the features of a network or decentralized platform, such as ether.
  •  Security tokens are tokens that signify ownership of an asset and grant token holders’ rights that are equivalent to or identical to those granted to holders of securities. These privileges could include voting rights, dividends, benefit shares, and a stake in an issuing entity's performance.

Security tokens are also known as digital, critical, and liquid contracts for parts of an asset that already have value attached to them. Such tokens serve as security assets, stock assets, security assets, and debts in terms of economic operation.

Furthermore, security tokens derive their value from a known asset. Security tokens, on the other hand, reflect programmable ownership, giving their assets more practical characteristics such as higher liquidity, faster production, and lower issuance costs and the security-related procedures are more transparent.

  • Currency tokens are cryptocurrencies, which means they serve as a type of value storage and exchange. It is also worth noting that currency tokens like bitcoin, Ethereum, and Dogecoin are fungible.

Similarly, it is very possible that certain tokens are combinations that fall into none of the above categories but are hybrids that exhibit varying features wherein they have utility features and ownership rights.

  • Donation tokens do not fit into any of the categories mentioned above. To prevent regulatory classification, the tokens are known as a donation in the contribution terminology. Tezos is a donation token built on the concept of a "self-amending crypto ledger."

If Non-Fungible, what do they Represent?

NFTs also resulted in a great deal of ambiguity. In simpler terms, an NFT is timestamped metadata on a blockchain network, such as the Ethereum blockchain, where tokens are minted with a smart contract that indicates their uniqueness and rarity.

More specifically, a smart contract is a piece of software that runs on the blockchain. This, combined with if-then logic, considers the highest bidder in an auction and then rewards the auctioned NFT. At this point, the seller receives the agreed-upon sum.

When it comes to the legal implications of NFTs, it's necessary to remember that an NFT is not the object it refers to. Second, an NFT does not always indicate a digital file or entity. Similarly, due to potential technical problems, the object can be shifted or removed.

Furthermore, an NFT serves as a metadata representation with no significant relation. A few technological solutions, on the other hand, might be able to alleviate this bottleneck. To this end, the Interplanetary File System, or IFPS for short, fixes the problem by distributing copies of the work through many hosts, ensuring that content is maintained.

However, several NFTs may theoretically point to missing underlying files, making this approach problematic. This raises concerns about the true worth of such NFTs, as well as the ability for consumers and artists to file lawsuits for damages.

This is made more difficult by the fact that the attachments to the NFTs may have major variations. Supporting platforms such as Open Sea, which enable NFT minting and transactions, allows users to customize their token to increase its rarity.

Furthermore, since 2012, the bitcoin blockchain has been used to allow NFTs. They were known as coloured coins at the time, and they used and relied on bitcoin's initial infrastructure to grant and represent asset-specific rights.

This meant that they were built using a bitcoin-specific technological standard, which was a very basic blockchain platform. Decentralized asset management systems, on the other hand, arose, with the Ethereum platform being the most common.

NFTs were primarily created in the early stages of their development to be used as digital collectibles and to build gaming avatars. The collectible, e-sports, and trading card industries are also relevant to NFT.

NFT’s and its Uses

  • E-Sports— As previously mentioned, NFTs play an important role in the digital collectible industry, as they are used to advertise and generate buzz around digital implements such as avatars.

This, in turn, creates a bubble for esports-based NFTs, which rely on decentralized blockchain technology to preserve an NFT's rarity while relying on its creator's centrality for validation and protection.

  • Intellectual property — NFTs have the ability to tokenize intellectual property rights; an example would be a rare, digitalized art piece. As a result, developers and IP owners will have more influence over their work.
  • Physical property — Physical assets such as cars and real estate can be tokenized for mortgage purposes or to ensure the property's liquidity.
  • Records and Identification — NFTs can be used as a form of identity verification and can be used to represent personal identity documents including a national identity card, birth certificates, and medical records. Furthermore, both of these records can be stored on the blockchain, reducing the risk of forgery or replication substantially.
  • Financial records— In the commercial sector, NFTs can be used to tokenize and represent documents such as bills of lading, invoices, and bills, among other things.

Notably, NFT’s also carry the prospect of being used across a spectrum of industries, from KYC procedures to tracking global cashflows.

Understanding Crypto-asset Regulations in the Region

NFTs in the Gulf Cooperation Council (GCC), especially in Bahrain and the United Arab Emirates, have been steadfast in developing systems that are more accepting of the crypto-asset framework.

To that end, ADGM, a commercial enclave within the Emirate of Abu Dhabi, has developed a regulatory structure for the regulation of cryptocurrency transactions. The Financial Services Regulatory Authority (FSRA) has released the ADGM ‘Guidance on Regulation of Crypto Asset Activities' in collaboration with ADGM.

It's also worth noting that the preceding guidelines should be read in accordance with the Financial Services and Markets Regulations' 'Regulation of Initial Coin/Token Offerings and Virtual Currencies.' As a result, both sets of guidelines must be evaluated in light of ADGM's regulations for dealing in NFT transactions.

Similarly, the Securities and Commodities Authority (SCA) of the United Arab Emirates (UAE) has developed a regulatory framework for the offering and purchasing of tokens in Decision No. (21/R.M) of 2020.

Likewise, the Kingdom of Bahrain has developed a regulatory crypto sandbox in collaboration with the Bahrain Central Bank (CBB). The CBB sandbox needs the following under this framework:

  • Individuals or organizations wishing to conduct business in the crypto space must be licensed in one of the four categories it has developed.
  • To conduct crypto-asset transactions, the licensee must have evidence of capital funds after being granted a license.
  •  Only approved crypto-assets and related norms can be used in the transactions.
  •  Licensees of crypto-asset services could conduct transactions with/on behalf of individuals or businesses if the third party has been licensed as a "client."

As a result of examining the mechanisms in place for crypto asset transactions in the GCC, it is clear that the region's countries are eager to embrace the crypto and blockchain period.

Legal Implications of NFT’s

NFTs can be used to tokenize assets, but they cannot be used to represent a financial instrument. Furthermore, it is important to consider the number of rights given to token holders when minting a token.

Token holders, for example, will have profit-sharing privileges or anything similar; those tokens will be considered as security tokens and will be subject to financial regulations. NFTs, on the other hand, seldom grant such rights, often granting only access to future potential material or holding royalty payment rights.

Similarly, most NFTs do not give the token holder any rights against the issuer. Notably, the issuer has no decision-making authority over the project, and there is usually no way to interpret the asset supply. NFTs are also not transferable on structured market systems like Bit stamp, despite the fact that they are exchangeable and transferable.

NFT as an Intellectual Property

Since it does not translate into ownership of an original work, the NFT's utility in terms of IP rights is currently limited. Furthermore, purchasing an NFT does not imply that you are purchasing the content's IP rights.

An NFT serves as a digital receipt in terms of copyright, meaning that the token holder owns a version of a work. It is important to remember, however, that a buyer's perception of what they reasonably possess does not equate to legal ownership.

Licensing intellectual property rights can also be complicated, with the possibility of extensive deliberation. Despite their many advantages, NFTs have not been dynamic enough to prevent possible misunderstandings about tokenization and relevant privileges.

Exercising Due Diligence as an NFT Purchaser

When transacting in NFTs and tokens in general, it is critical to practice due diligence. For example, the token purchaser is responsible for contacting the IP owner, determining their ownership status, and obtaining their consent to the development of an NFT. Similarly, the purchaser of an NFT must use caution when applying the relevant laws to IP and token transactions.

Similarly, token buyers must research the site they are buying from, as well as the NFT and its terms. For example, the terms of resale in NFT transactions are a hotly debated topic.

As previously said, the blockchain platform used by the platform must also be considered. The Ethereum-based blockchain network, for example, is the most widely used blockchain platform for NFT transactions.

To summarize, the control of such tokens is still in its infancy. As a result, it's critical to think about whether a particular non-fungible token complies with relevant AML and financial regulations. Even if your NTF does not give you any property or monetary rights, it is important comply with the applicable foreign and national laws on tokenization, it's important to keep meticulous records of your purchased token.

Finally, kicking off the NFT revolution raises the possibility of moving away from fiat money and into a more decentralized economy in order to better assess the economic problems of the twenty-first century.





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