Legal Attributes and Risk Governance of "NFT" in the Context of Digital Economy

Source: Supreme People's Procuratorate

Editor’s Note

Riding the "numbers" to lead the future. With the global popularity of digital economy-related technologies and concepts such as "blockchain" and "metaverse," emerging application scenarios like NFTs (Non-Fungible Tokens, essentially a digital asset certificate recorded on the blockchain) have become the focus of market attention. As a new application of blockchain technology, NFTs have certain development potential. However, due to their status as an emerging field, relevant legal norms and regulatory rules are not yet perfect, which, while generating high interest, may also trigger financial risks, management risks, cybersecurity risks, and particularly legal risks, which have drawn close attention from procuratorial authorities. This issue of "Views · Special Topic" invites experts and scholars, as well as practitioners, to discuss the legal attributes and risk governance of NFTs from multiple perspectives. Please pay attention.

Core Views

Wang Xiafang

For new business forms brought about by the development of information technology, procuratorial authorities must accurately grasp the boundary between innovative development and illegal activities, protecting "true innovation" in accordance with the law while being able to promptly identify and precisely punish "pseudo-innovation" that commits crimes under the guise of innovation, thus avoiding the phenomenon of "bad money driving out good."

Sun Shan

The trading of digital works as NFTs involves four types of subjects: copyright holders, minters, platforms, and purchasers. Among them, the copyright holder and the minter may overlap in identity, which is the most ideal state for maintaining transactions. However, when the identities of the copyright holder and the minter do not overlap, the platform's compliance governance regarding copyright becomes particularly important.

Ruan Shenyu

From the perspective of property rights, consumers do not enjoy ownership in the civil law sense over the NFT digital assets they purchase, nor can they prohibit others from accessing, copying, or disseminating the digital assets represented by the NFTs. What consumers enjoy is merely an exclusive right to prohibit others from tampering with the ownership recorded on the blockchain.

Wang Xiafang:

Digital collectibles refer to unique digital certificates generated by blockchain technology corresponding to specific works, artworks, or publications, which, based on the protection of their digital copyrights, achieve authentic and credible digital distribution, purchase, collection, and use. Their core value lies in the assetization of digital content. As an emerging industry, digital collectibles are widely regarded as having promising prospects in protecting intellectual property, promoting the development of cultural and creative industries, and enriching the digital economy.

The "Opinions on Promoting the Implementation of the National Cultural Digital Strategy," issued by the General Office of the Central Committee of the Communist Party of China and the General Office of the State Council in May 2022, pointed out the need to "promote the transformation of cultural stock resources into production factors," support legal and compliant cultural data transactions by legal entities and individuals, and clarify the general direction of encouraging innovation in the development of cultural digital-related industries. However, it should also be noted that the entire industry is still in its early stages of development, with industry norms and regulatory systems not yet sound. As a form of application of NFTs, digital collectibles inherently carry attributes of virtual assets, and blind and disorderly development can easily lead to multiple risks such as illegal fundraising, fraud, and malicious speculation, which urgently need attention.

The disorderly development of the industry has shown a tendency towards financialization. In April 2022, the China Internet Finance Association, the China Banking Association, and the China Securities Association jointly issued the "Initiative on Preventing Financial Risks Related to NFTs" (hereinafter referred to as the "Initiative"), which mentioned that "no centralized trading (centralized bidding, electronic matching, anonymous trading, etc.), continuous listing trading, standardized contract trading, and other services should be provided for NFT transactions, which would be a disguised violation of the establishment of trading venues." In light of this, some leading digital collectible platforms have explicitly prohibited secondary transfers or only support non-compensatory transfers under restricted conditions. However, in the absence of a sound regulatory system and industry norms, there are platforms that directly or indirectly open secondary trading under the guise of "consignment," "resale," or "repurchase." The bidding mechanisms of some consignment platforms, along with rapid buying and selling, are similar to the electronic matching and continuous listing trading specified in the "Initiative," while other platforms engage in price speculation through self-built "rat trading," leading to the continuous accumulation of financial risks in digital collectibles.

Additionally, the "Initiative" specifically mentions in "resolutely curbing the financialization and securitization tendencies of NFTs" that "NFTs should not weaken their non-fungible characteristics through methods such as splitting ownership or bulk creation, nor should they engage in disguised token issuance financing (ICO)." Currently, the "one NFT, multiple issuances" model is quite common, with a single image being issued in tens of thousands, which undermines the unique characteristics of NFTs that are inherently non-reproducible, indivisible, and unique, affecting their non-fungible attributes.

Excessive prices hide the risk of "explosive crises." From related news reports, it can be seen that many digital collectible platforms use marketing methods such as "airdrops," "blind boxes," "limited releases," and "synthesis" to create a market appearance of supply exceeding demand, with instances of sales being sold out in seconds. The issuance thresholds vary widely, leading to some collectibles lacking cultural significance and artistic appeal, and even infringing on copyrights, being fervently "sought after," indicating a trend where everything can become an NFT. Under the disorderly speculation of the secondary market, some collectibles have been speculated from a few yuan to tens of thousands or even hundreds of thousands in a short period. The inflated prices lack a reasonable pricing mechanism and sufficient value support, easily deviating from basic value laws, leading to accelerated market bubble formation.

"Concept" speculation can easily become a tool for crime. First, "false on-chain" poses fraud risks. Digital collectible platforms are built on the system of "digital publications + blockchain," where the value of blockchain technology lies in confirming rights and ensuring that the unique digital certificate of the collectible is not tampered with. If a digital collectible platform forges blockchain registration information or fabricates "on-chain" facts, and engages in illegal profit-making through false issuance and price speculation, it may be suspected of false advertising at best, or constitute fraud at worst. Second, "new user incentives" pose pyramid scheme risks. Based on the trading characteristics of blockchain smart contracts, the content of smart contracts can be set to pay a certain percentage of commission to the minter or upstream party for each transaction. Coupled with the frequent bundling of digital collectibles with concepts like the metaverse and blockchain, marketing models such as new user rewards and dynamic rights can easily evolve into illegal pyramid schemes that reward or rebate based on the number of recruited personnel.

Third, "promised returns" pose illegal fundraising risks. Platforms induce consumers to purchase digital collectibles for investment purposes through static returns, rights empowerment, premium buybacks, and physical cashbacks. When the behavior meets the characteristics of illegality, publicity, sociality, and inducement in illegal fundraising, it may involve crimes such as illegal absorption of public deposits or fundraising fraud.

The legal risks that may exist in the technology characteristics, issuance, and transfer of digital collectibles have drawn close attention from procuratorial authorities. It is essential to bring all types of financial activities under regulatory oversight in accordance with the law, insisting on a dual focus on punishment and governance, and actively combating and preventing related illegal activities.

First, accurately strike against criminal activities disguised as new technologies and new business forms. For new business forms brought about by the development of information technology, procuratorial authorities must accurately grasp the boundary between innovative development and illegal activities, protecting "true innovation" in accordance with the law while being able to promptly identify and precisely punish "pseudo-innovation" that commits crimes under the guise of innovation, thus avoiding the phenomenon of "bad money driving out good." For fraud crimes using digital collectibles as a gimmick, illegal fundraising crimes promising high returns, and activities involving illegal pyramid schemes using digital collectibles, procuratorial authorities must promptly combat them in accordance with the law, effectively safeguarding the interests of the public and accurately delineating the "red lines" of the industry.

Second, proactively fulfill legal duties, insisting on a dual focus on punishment and governance. Comprehensive use of prosecutorial functions should be employed, actively collaborating with administrative agencies to carry out source governance and comprehensive governance, guiding administrative agencies to fully utilize existing legal provisions and industry norms to bring financial activities disguised as new business forms under regulatory oversight, preventing and mitigating financial risks. The procuratorial authorities should leverage their functions in crime prevention and social governance, actively proposing relevant prosecutorial suggestions, guiding the industry to strengthen its own compliance construction, deeply rooting itself in cultural and artistic connotations, continuously enriching high-quality application scenarios, and exploring development paths for digital collectibles to empower the real economy.

Third, strengthen risk assessment and legal awareness promotion. Collaborate with relevant regulatory departments to enhance risk assessment, deeply analyze the regulatory risks and industry hidden dangers existing in the current digital collectibles field, and study the financial risks and social risks that may arise from the development of emerging technologies, providing decision-making advice for financial risk prevention and regulatory system improvement. In light of the phenomenon of ordinary consumers blindly chasing trends, procuratorial authorities should strengthen publicity efforts, guiding consumers to rationally recognize the price risks, financial risks, and policy risks associated with current digital collectibles, and to be adept at identifying illegal financial activities disguised as NFTs, the metaverse, etc., avoiding falling for so-called "high returns," "guaranteed profits," and "value preservation" gimmicks, and effectively safeguarding their own property security.

(Authors are the Director of the Fourth Procuratorial Department of the Zhejiang Provincial People's Procuratorate and the Director of the Third Procuratorial Department of the People's Procuratorate of Yuhang District, Hangzhou.)

Sun Shan:

In the era of the digital economy, various digital assets, including digital works, have become an important form of wealth for people. In recent years, the trading of digital works as NFTs has developed rapidly both domestically and internationally, and the copyright compliance governance of trading platforms has attracted increasing attention. The trading of digital works as NFTs involves four types of subjects: copyright holders, minters, platforms, and purchasers. Among them, the copyright holder and the minter may overlap in identity, which is the most ideal state for maintaining transactions. However, when the identities of the copyright holder and the minter do not overlap, the platform's copyright compliance governance becomes particularly important.

The legitimacy of the source of rights of the work itself is a decisive factor for the healthy and orderly development of digital works as NFTs. A major issue in the trading of digital works as NFTs is that the validity of the copyright of the work is not verified before the work is minted and put on-chain. This may lead to doubts from purchasers regarding the legality of the transaction, thereby affecting the stability and reliability of digital works as NFTs. Meanwhile, if the minter has not obtained permission from the copyright holder of the work being minted, then the trading of digital works as NFTs will constitute infringement, and the platform may also bear responsibility due to negligence in management.

Guaranteeing the validity of rights between the minter and the platform can alleviate purchasers' anxiety about the legality of transactions. Currently, the commonly adopted model for guaranteeing rights validity in the trading of digital works as NFTs is through agreements between the minter and the platform. The minter needs to provide relevant copyright proof documents before the digital work is put on-chain to demonstrate the copyright ownership status and the legitimacy of the source of rights. The platform also needs to review the documents provided by the minter to ensure their authenticity and legality.

However, this model for guaranteeing rights validity heavily relies on the integrity of the minter and the review capabilities of the platform, and this reliance carries many hidden dangers. First, there is a risk that the copyright ownership proof documents provided by the minter may be forged. Second, there is a significant disparity between the number of works and the review capacity of the platform. Third, the platform's need to review the ownership proof documents provided by the minter will inevitably consume a large amount of time and human resources, thus affecting the efficiency of transactions.

To address the issue of rights validity, it is necessary to comprehensively utilize legal means and technical measures to strengthen copyright compliance governance of digital works as NFT trading platforms. First, future legislation could stipulate that consortium chain platforms should fulfill necessary regulatory obligations, including the real-name authentication of platform users' personal information and the obligation to provide user information when necessary. The establishment of regulatory obligations can enhance the platform's enthusiasm for fulfilling its responsibilities while fully protecting the legitimate rights and interests of copyright holders and purchasers. Second, in addition to self-review by the platform, it may be considered to have relevant departments manage related platforms as third-party institutions to intervene in the review process. If no rights defects are found during the review, it can be regarded as preliminary proof of rights validity. Compared to the review capacity of a single platform, relevant management platforms have advantages in addressing information asymmetry, and their professionalism, independence, and authority are also beyond doubt. Third, in conjunction with the current industry status dominated by consortium chains in China and the application of infringement identification technologies such as content analysis and intelligent monitoring, timely detection and correction of infringement information should be carried out.

The trading of digital works as NFTs is one of the application scenarios of blockchain technology, which can ensure the transparency, immutability, and security of NFT transactions, but this guarantee is limited to information changes after being put on-chain. China's digital works NFT trading platforms primarily use consortium chains, which gives us the opportunity to correct erroneous information on the blockchain at a lower cost, which is a comparative advantage of consortium chains over public chains.

Prohibiting transactions using cryptocurrencies is an important guarantee for restoring the normal market price of digital works and mitigating potential legal risks. From the current situation, the excessively high prices of digital works are closely related to blind speculation in the market and the use of cryptocurrencies for transactions. The price volatility of cryptocurrencies can affect the market stability of digital works as NFTs. Moreover, conducting transactions using cryptocurrencies presents numerous issues.

First, the significant price volatility of cryptocurrencies can amplify market price changes of digital works when used as a pricing standard, leading to unnecessary speculation and panic. The digital works market is an emerging market characterized by severe price fluctuations and unpredictable market changes. Once transactions are conducted using cryptocurrencies, the price fluctuations of both will create a compounding effect. Second, cryptocurrencies are not legal tender, and the costs for various parties to obtain cryptocurrencies vary significantly, making it much easier to manipulate the market price of digital works using cryptocurrencies than with legal tender. Particularly for those who entered the cryptocurrency field early, they possess a large amount of cryptocurrency along with professional knowledge, experience, and other asymmetric information. If they start manipulating the market price of digital works using cryptocurrencies, the only ones who will suffer losses are the purchasers who are at a disadvantage in terms of information processing. Third, using cryptocurrencies for transactions carries risks of money laundering, fraud, and illegal capital flows. The anonymity and decentralization of cryptocurrencies make regulation difficult, and some criminals choose to exploit this trading method for fraud, illegal capital flows, and money laundering activities.

If digital works NFT trading platforms allow transactions using cryptocurrencies, it will increase the probability of these risks occurring, thus threatening financial security and social stability. Fourth, the legality of cryptocurrencies has not yet been confirmed in China, and using cryptocurrencies for transactions may violate relevant laws and regulations, leading to legal disputes. For the above reasons, it should be strictly prohibited at the legislative level for digital works NFT trading platforms to conduct transactions using cryptocurrencies, with legal tender transactions being the only legitimate trading model.

The "royalty" sharing mechanism lacks legitimacy at the legislative level. In the trading of digital works as NFTs, the "royalty" sharing mechanism has become an industry practice both domestically and internationally. According to current practices, the minters of digital works can typically receive a percentage of the transaction amount from each transaction of that work, based on the terms in the smart contract. However, from the perspective of actual operation, the "royalty" sharing mechanism has some shortcomings, particularly in terms of lacking legitimacy at the legislative level.

From a legal standpoint, the "royalty" in digital works NFT trading is not the same concept as royalties in Chinese law. According to the National Copyright Administration's "Measures for Paying Remuneration for the Use of Literary Works," royalties in the conventional sense are payments made by the publisher to the copyright holder, and no royalties are required when reselling the work, which complies with the principle of the exhaustion of the right of first sale. The "royalty" in digital works NFT trading is paid by the purchaser of the work's carrier to the minter of the digital work, who may not necessarily be the true copyright holder, with the payment being contingent on resale, which contradicts the principle of the exhaustion of the right of first sale. In comparative law, this type of "royalty" is closer to the droit de suite, which is not stipulated in Chinese legislation and lacks legal basis. The establishment of the droit de suite through smart contracts constitutes an extralegal grant of rights, severely undermining the balance and fairness of transactions. Therefore, the "royalty" sharing mechanism embedded in smart contracts lacks legal effect, and platforms should remove such clauses from smart contracts.

[The author is a researcher at the Chongqing Intellectual Property Protection Collaborative Innovation Center, a key research base for humanities and social sciences at Southwest University of Political Science and Law. This article is a phased research result of the project "Copyright Law Response to Infringement Governance in the Short Video Industry" (Project No.: 22SKJD023) funded by the Chongqing Municipal Education Commission in 2022.]

Ruan Shenyu:

With the development of society, markets, and technology, new types of property rights may emerge in practice. NFT digital assets belong to this category of new property rights. NFT digital assets refer to non-fungible tokens (NFTs) recorded on the blockchain and the collection of digital or physical assets they represent.

On one hand, NFTs link off-chain assets through uniform resource locators; on the other hand, they indicate which account address a token belongs to through a mapping table of token IDs and account addresses. The original intention of NFT developers is to use NFTs as immutable, traceable, and distributed storage digital rights certificates.

The question arises: what property rights does a consumer acquire when purchasing an NFT digital asset? One viewpoint holds that consumers acquire ownership of the NFT digital asset. This viewpoint is open to debate. In everyday language, ownership may have a very broad meaning. However, in the civil law world, the meaning of ownership is narrow and definite. Article 240 of China's Civil Code stipulates that the owner enjoys the rights of possession, use, income, and disposition over their immovable or movable property.

Based on this provision, it cannot be simply assumed that consumers enjoy ownership over the NFT digital assets they purchase, because: first, NFT digital assets are information, not movable or immovable property; second, the owner can "directly control" their immovable or movable property according to their will (Article 114, Paragraph 2 of the Civil Code), but the transfer of NFT digital assets requires the assistance of unspecified "miners" to "mine." "Mining" refers to a computer network joining a specific blockchain network, subsequently listening to transaction broadcasts, verifying and assembling candidate blocks, and finding a random number that meets the target area value to make the candidate block valid. When other computer nodes accept the candidate block, the computer node that packages the candidate block can earn profits (block rewards), and the candidate block will be permanently recorded in the blockchain ledger. It is evident that the transfer of NFTs requires the assistance of "miners," which is different from the direct control that owners have without the assistance of others.

In fact, for new property rights such as NFT digital assets to receive legal protection, they must either be encompassed under existing statutory property rights (such as ownership) or take the following two paths: first, explicitly stipulating this new type of property rights in legislative theory. For example, Articles 3 to 10 of the Liechtenstein Law on Tokens and Trusted Technology Services provide civil foundations for tokens. However, there is currently no explicit provision for NFT digital assets in China's existing laws. Second, exploring whether NFT digital assets conform to the general structure of property rights in interpretative theory.

Article 113 of China's Civil Code broadly states that "the property rights of civil subjects are equally protected by law," indicating that all types of property rights are equally protected under Chinese law. Meanwhile, Articles 114 to 127 of the same law specify property rights, creditor rights, various intellectual property rights, equity, and other investment rights, as well as data and virtual property. Based on these provisions, if the legal status enjoyed by consumers over NFT digital assets meets the general structure of property rights, it should be protected equally by law.

So, what is the general structure of property rights? I believe that regarding an external object (including both physical and informational objects), the rights holder enjoys the right to demand that others do not utilize (or utilize in a certain way) that external object, and can dispose of that demand right according to their will. Thus, the rights holder enjoys property rights over that external object. In other words, property rights should possess exclusivity and transferability.

According to this standard, NFT digital assets inherently possess transferability from a technical perspective. Of course, in terms of legal policy, some legal systems explicitly stipulate that consumers enjoy the right to dispose of NFT digital assets, while others restrict or even temporarily prohibit the trading of NFT digital assets for risk prevention reasons; however, consumers can still transfer NFT digital assets through means such as gifting. Therefore, these legal policy stances do not alter the characteristic of transferability of NFT digital assets. The further question to discuss is whether consumers enjoy exclusivity over NFT digital assets. For this question, it is necessary to distinguish between NFTs and the digital assets they represent.

On one hand, consumers enjoy factual exclusivity over NFTs, which is sufficient to substantiate that consumers enjoy property rights over NFTs. Specifically: first, when consumers possess an NFT, they are actually controlling the semantic information recorded on the blockchain ledger through a key. Second, the technical architecture of the blockchain imposes an obligation on other parties not to tamper with the semantic information recorded in the account address (public key) of the holder without the holder's consent. This is because, in a blockchain system, only when the holder uses their private key to digitally sign the transaction instructions they publish will "miners" validate and record those transaction instructions in the ledger. This is the technical architecture and general consensus that allows the blockchain to exist. It is this technical architecture and general consensus that impose an obligation on unspecified individuals not to tamper with the account address corresponding to the NFT without consent, granting the holder a legal status of exclusivity over the NFT.

On the other hand, consumers do not automatically enjoy exclusivity over the digital assets represented by NFTs. This is because the digital assets represented by NFTs are typically stored in a database operated by a certain operator, rather than on the blockchain. The technical architecture of NFTs only prohibits unspecified third parties from tampering with the NFTs recorded on the blockchain, but does not limit operators or other third parties from tampering with, deleting, or destroying the digital assets stored in the database; similarly, holders cannot prohibit unspecified third parties from accessing, copying, or disseminating the digital assets represented by NFTs.

When a third party copies the digital assets represented by NFTs without authorization, only the copyright holder of that digital asset has the right to demand that the third party delete the relevant work, whereas the holder of the NFT digital asset does not enjoy this right. Therefore, although the technical architecture of NFTs grants holders a property right of exclusivity over NFTs, this exclusivity does not automatically "transfer" to the holders regarding the digital assets represented by NFTs.

Thus, it can be seen that from the perspective of property rights, consumers do not enjoy ownership in the civil law sense over the NFT digital assets they purchase, nor can they prohibit others from accessing, copying, or disseminating the digital assets represented by NFTs. What consumers enjoy is merely an exclusive right to prohibit others from tampering with the ownership recorded on the blockchain. As Demsetz stated, the value of rights determines the value of the exchanged items.

The greatest risk facing NFT digital assets lies in the fact that while NFTs are stored on an immutable blockchain, the digital assets they represent are at risk of being tampered with, deleted, or destroyed. In such cases, even if consumers enjoy exclusivity over the NFTs, the value of this right will be very limited.