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| 19 minutes read

NFT projects in Germany – legal issues

GM. So far, Germany has no uniform and comprehensive legal framework for non-fungible tokens ("NFTs"). However, this does not mean that NFTs move in a legal vacuum. Rather, existing laws can also apply to NFTs in many cases. However, since most of these existing laws were neither enacted against the background of NFTs nor were they adapted specifically for NFTs, numerous application and demarcation problems arise in practice, which can, unfortunately, lead to some legal uncertainty.

Below we provide an overview of some of the legal issues that, based on our experience to date, may repeatedly arise for NFT projects in Germany:

  • Are NFTs regulated?
  • Does a prospectus have to be issued for NFT projects?
  • What rights are acquired when minting an NFT?
  • Is the minting of an NFT subject to the strict requirements in e-commerce?
  • Is KYC required for NFT projects?
  • Is a gambling licence required for NFT projects?
  • Is my NFT project subject to VAT?
  • Can I offer my NFT project as a DAO?
  • Can I avoid the application of German law by offering my NFT project to a company based abroad?
  • Can I exclude liability by adding "NFA, DYOR"?
  • Will the MiCA regulation change the regulation of NFTs?
  • Can this article replace legal advice in individual cases?

Are NFTs regulated?

No, NFTs are currently generally unregulated and, in particular, are not subject to supervision by the Federal Financial Supervisory Authority (BaFin). However, the specific design of the respective NFTs is crucial, and further regulatory developments should also be kept in mind.

More detailed answer:

One of the most important legal questions regarding NFTs is their classification under supervisory law. Depending on the design of the specific NFT, various facts come into consideration, which may even lead to a licensing requirement. Experience shows that issuers of NFTs want to avoid regulation and, in particular, the obligation to obtain a licence because the associated regulatory burden (in terms of both time and money) would restrict the project too much.

Therefore, NFTs are typically offered as pure utility tokens, which are currently unregulated and are not subject to any authorisation requirement, because their use serves to obtain a real economic service and does not focus on a financial consideration. Nevertheless, it should be examined in each individual case whether the functionality of the NFT and the roadmap of the project support this classification.

In particular, the following supervisory facts may become relevant:

  • NFTs could be financial instruments in the form of crypto assets (Sec. 1 (11) sentence 1 no. 10 KWG). Crypto assets are defined as digital representations of a value that has not been issued or guaranteed by any central bank or public body and does not have the legal status of currency or money, but is accepted by natural or legal persons as a means of exchange or payment or serves investment purposes on the basis of an agreement or actual practice and which can be transmitted, stored and traded electronically (Sec. 1 (11) sentence 4 KWG).
    • In this respect, there is controversy about the extent to which NFTs are covered by the definition because they may "serve investment purposes". The broadest possible view seems to consider NFTs to be for investment purposes, if only because there are some very successful NFT projects whose NFTs have risen sharply in value after the mint. However, we believe that it is always the specific NFT project that should be considered and that the mere fact of being able to sell them (for example, on marketplaces like OpenSea) does not make NFTs crypto assets. In our view, it depends on what exactly is promised in the project's roadmap and communication (e.g. on the website, via Twitter and Discord). If no investor-like expectation of the performance of the NFTs is fuelled, it should be possible to argue that the NFTs do not serve investment purposes. For example, to the extent that there is a move away from promises of price performance, resale or any profit sharing and, instead, a focus on the non-monetary benefits of the NFT, it can be argued that the NFT serves this utility and not investment purposes. Such utilities could be, for example, rights to use the artwork, later free airdrops with additional features such as virtual clothing for an avatar in the metaverse, or access to a token-gated community. However, much is still under discussion, and further developments should be kept in mind.
    • It can also be argued that NFTs are not tradable in the sense of the definition of crypto assets, because tradability presupposes exchangeability, which is precisely not the case with genuine "non-fungible" tokens.
  • There are also good arguments against the classification of NFTs as securities within the meaning of Sec. 2 (1) WpHG. In addition to the tradability, which is also relevant here, the BaFin requires for securities that they embody participation rights or property rights under the law of obligations and are comparable to shares in this respect. However, this is regularly not the case with NFTs because they do not embody any such rights of the holder vis-à-vis the NFT creator, at least if only utility in the sense described above is associated with them.
  • Based on this utility argumentation, NFTs are also not asset investments pursuant to Sec. 1 (11) sentence 1 no. 2 KWG in conjunction with Sec. 1 (2) VermAnlG, in particular insofar as they do not represent shares that grant a participation in the result of a company or promise comparable results, for example in the form of interest or other increases in value. In this respect, too, it is crucial that only utility is promised as an advantage of the NFT and not monetary participation, which is usually associated with asset investments.
  • NFTs are normally also not units of account within the meaning of Sec. 1 (11) sentence 1 no. 7 var. 2 KWG. Unlike virtual currencies, which are regularly regarded as units of account by BaFin in any case, NFTs do not serve as alternative means of payment. There is normally no payment function associated with NFTs.
  • Lastly, NFTs are usually no e-money within the meaning of Sec. 1 (2) sentence 3 ZAG. According to this provision, electronic money is any electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions and which is accepted by a natural or legal person other than the issuer. However, NFTs are usually not monetary assets that are used to carry out payment transactions. NFTs therefore do not regularly qualify as e-money and their issuance is therefore not subject to the authorisation requirement under Sec.11 ZAG.

Does a prospectus have to be issued for NFT projects?

No, as a rule, NFT projects are not subject to the prospectus requirement. Because as far as NFTs are not securities and not asset investments, as described above, there is also no prospectus requirement as regulated in the EU Prospectus Regulation for securities and in the Asset Investment Act for asset investments.

What rights are acquired when minting an NFT?

This depends on the specific design of the NFT project.

An NFT is often associated with a pictorial representation, which is usually linked from the NFT to an external storage location (e.g. IPFS).

These visual representations are often protected by copyright – therefore, on the one hand, contractual agreements between the creator and the publishers of the NFT project are necessary (often within the framework of a licensing agreement), and on the other hand, it must also be clearly contractually stipulated during the minting process whether and, if so, which rights the minter (quasi the "owner" of the NFT) should receive to the NFT.

The right of use can be structured very differently depending on the project, giving the owner exclusive rights or the right to commercial exploitation. Individual NFT projects are also published under certain so-called Creative Commons licences, which then give everyone very extensive rights to the pictorial representation of the NFT and not just the owner of the NFT.

More detailed answer:

The subject matter of an NFT is often visual representations, such as avatars or characters. From a copyright point of view, two levels in particular must be differentiated with regard to the visual representation to which the NFT refers.

  1. In the first step, the visual representations were designed or compiled by an artist, for example. The individual composition of the avatars is often computer-aided, meaning that a computer program is given various character features such as eyes, face shapes or accessories, which the computer program then combines at random. The threshold for these avatars to enjoy copyright protection is very low, and protection is therefore quickly achieved. These rights lie with the creator of the visual representations. The publisher of the NFT project can have rights granted to him under an employment contract in the case of employees or an individual contractual agreement in the case of freelance developers. In order to be able to dispose of the rights, such a contractual agreement is strongly recommended, often in the form of a licence agreement.
  2. In a second step, these rights can also be granted to the holder of the NFT, for example, when minting, to an extent to be determined. However, this is not automatic. For when minting – to put it simply – it is only recorded in the blockchain that a certain person has acquired a certain NFT and that this person can now dispose of this NFT via their wallet. A granting of rights to the avatar linked to the NFT is not automatically associated with this, especially since the pictorial representation of the NFT is not necessarily stored in the blockchain itself, but is often only stored "off-chain" as a URL reference. In the context of minting, it should be determined via terms of use whether, and to what extent, rights are granted to the asset linked to the NFT. In principle, there are no limits to the freedom of design here. For example, very extensive rights can be granted, even for commercial exploitation. Limits can also be set on the value of commercial exploitation (e.g. a maximum of 50,000 EUR per calendar year), or the image can even be placed under a specific Creative Commons licence, which may also allow third parties to use the image. In the meantime, templates for granting licences are also becoming established, e.g. the "Can't Be Evil NFT Licenses", which were inspired by Creative Commons. The licences are freely available and serve the particular purpose of helping creators to protect their intellectual property rights, granting NFT holders a basic set of rights that are irrevocable, enforceable and easy to understand, and helping creators and holders to unleash the creative and economic potential of their project (Disclaimer: DLA Piper was also involved in the creation of the aforementioned template licences).

Is the minting of an NFT subject to the strict requirements in e-commerce?

An NFT is often minted via an interface similar to that of an online shop. It is very likely that if German law applies, a wide range of design requirements must be met here.

More detailed answer:

Under German law, minting is usually a purchase of rights with certain service elements. If the sale is made by a company to a consumer, this often leads to a distance selling transaction, which is subject to strict legal requirements.

Again and again, we are confronted with the fact that clients would like to avoid the effort and expense associated with these requirements. This is often done with the argument that other market participants do not adhere to these strict requirements either and thus save considerable effort in designing the mint process. Unfortunately, the argument that many market players do not adhere to these strict requirements does not help here. Just because other market players may not behave in a legally compliant manner does not legitimise their own (at worst illegal) actions.

In any case, at least a risk-based approach should be chosen here – the better known the project is, or even a big brand is behind the project or associated with it and the more strongly the NFT project is oriented towards the German market, the more it is recommended to ensure full compliance with the consumer protection requirements from e-commerce. This leads, in particular, to a variety of information obligations and design requirements, for example, when minting the NFT.

If the NFT project decides to observe the obligations of a distance selling transaction, these are for example, the following:

  1. Information duties: A distance selling transaction is subject to a variety of information obligations (see in detail Art. 246a EGBGB). It follows from this that, for example, it must be presented transparently and clearly what the object of purchase actually is. If certain utilities are associated with the NFT (e.g. physical objects which the holder of the NFT can claim, if necessary also in a recurring cycle) or if certain characteristics of the NFT result in a rarity of the respective NFT, such aspects must be prepared in an extremely transparent manner before the minting and presented to the interested buyer. Further obligations relate to the identity of the publisher of the NFT project, contact details, the total price (according to the view expressed here, of course, without any surcharges for "gas", as these are variable costs that simply cannot be determined in advance by the NFT project), or information on statutory rights to defects.
  2. Right of withdrawal: Under certain circumstances, the user may have a right of withdrawal after the mint; theoretically, the user can withdraw from the contract concluded with the creator of the NFT project within 14 days. The creator of the NFT project must then also inform the minter of the existence of such a right. Practically, exercising a right of withdrawal will often be difficult to implement, as the corresponding transaction on the blockchain cannot be reversed. At most, a retransfer of the NFT affected by the exercise of the right of withdrawal could be considered. Theoretically, one could first wait for the expiry of the withdrawal period before dropping the NFT into the wallet. However, this seems unnecessarily complicated, especially since the NFT cannot be traded by the minter in this interim phase (i.e. it cannot be "flipped" quickly to achieve a certain profit). It seems to make more sense if the minter directly waives his right of withdrawal to the digital content when minting, as Sec. 356 (5) BGB allows. The question of the right of withdrawal becomes interesting if, for example, the NFT provides for the delivery of goods within the scope of a utility, i.e. the holder can claim an item of clothing with his NFT. Here, an individual choice may exist, which then already grants no right of withdrawal anyway (Sec. 312g para. 2 no. 1 BGB). In any case, for the right of withdrawal to be waived, the customisation must be recognisable to the consumer. However, if customisation is merely the internal practice at the NFT project, this is irrelevant and the right of withdrawal does not lapse. Caution is therefore advised if all NFT holders can receive an identical T-shirt or other goodies as a utility.

Is KYC required for NFT projects?

No, in principle, NFT projects are not subject to the due diligence obligations of the German Anti-Money Laundering Act (GwG) to identify customers (Know Your Customer – KYC). In principle, these obligations only apply to those obligated parties that are exhaustively listed in Sec. 2 (1) GwG, e.g. credit institutions (No. 1), payment institutions (No. 3) or gambling operators (No. 15).

However, there are exceptions, depending on what exactly is involved in the respective NFT. Thus, dealers in goods, art brokers and art warehouse keepers are also subject to the AML requirements (No. 16). However, KYC measures only have to be carried out if art objects are involved and the transaction amounts to at least 10,000 EUR (Sec. 10 (6a) No. 1 lit. a) and No. 2 GwG). These requirements are usually not fulfilled for NFT projects as far as the purchase price is below 10,000 EUR. And even if the price is higher, the requirements only apply to "art objects". In this regard, we would argue that only embodied art, e.g. a (also 3D) print, is meant here. In our view, purely digital works are not covered.

Another exception are traders in goods with transactions in other goods where they make or receive cash payments of at least 10,000 EUR themselves or through third parties (Sec. 10 (6a) No. 1 lit. c) GwG). In the case of high-value goods, such as watches and jewelry, the limit is already 2,000 EUR (Sec. 10 (6a) no. 1 lit. b) GwG). However, this only becomes relevant if an NFT project actually accepts cash payments. As a rule, payment is made non-cash, particularly with crypto values or by credit card.

Consequently, KYC under the GwG is regularly not required for NFT projects on digital goods without cash payment. However, a future extension of the AML obligations to NFT providers is conceivable.

Is a gambling licence required for NFT projects?

No, as a rule, NFT projects do not require a gambling licence.

A gambling licence is only required if gambling is offered within the meaning of the State Treaty on Gambling 2021 (GlüStV 2021). According to this, a game of chance exists if, within the framework of a game, a fee is charged for the acquisition of a chance to win and the decision on the win depends entirely or predominantly on chance (Sec. 3 (1) sentence 1 GlüStV 2021). Games of chance are also bets against payment on the occurrence or outcome of a future event (Sec. 3 (1) sentence 3 GlüStV 2021), for which no game is required. A lottery is a game of chance in which a majority of persons are given the opportunity, according to a specific plan and for a specific fee, to win money, property or other benefits of monetary value (Sec. 3 (3) GlüStV 2021).

Accordingly, a gambling licence is required if typical games of chance, e.g. sports betting, lotteries or online casino games are offered. This also applies to virtual gaming opportunities in the metaverse. It is sufficient if German players are able to participate (Sec. 3 (4) GlüStV 2021). The location of the operator, on the other hand, is not decisive.

As a rule, however, NFT projects do not offer typical games of chance in this sense. In our view, this also applies to NFTs with rarity and reveal after the mint, i.e. NFTs are sold whose properties are not yet known to the buyer at the time of purchase. Rather, these properties are only revealed later and then it is possible that one receives a rare NFT that is worth more on the market than other NFTs of the same project. In well-known PFP projects, these were, for example, pictures with golden figures, zombies or aliens. Here, however, the property as a "game" is probably already regularly lacking. Rather, the sale is a normal economic process (e.g. sale of digital images) and comparable to the purchase of a goody bag, where one knows beforehand what one is buying (e.g. a digital comic image of an animal), but does not know the specific properties (e.g. whether it is a normal image or a rare one).

The provisions of gambling law should also be kept in mind when raffles are held for holders of NFTs. As a rule, such raffles are raffles that do not require a licence if they are not gambling and participation is possible free of charge. However, it can become problematic if a raffle is announced in the roadmap before the paid mint. In this context, the mint price could be regarded as a (partial) payment for the raffle, which could lead to a classification as gambling. However, this can be avoided at best by designing the mechanics of the game and the conditions of participation accordingly in each individual case.

Is my NFT project subject to VAT?

In the case of commercial NFT projects in Germany, VAT is usually levied, i.e. 19% VAT may have to be paid to the tax office for each NFT sold.

However, exceptions to this can arise, e.g. through the small business regulation according to Sec. 19 UStG. There is also discussion about how to deal with buyers who are based abroad. In this regard, according to the country of destination principle, the VAT liability in Germany could be waived if the buyer of the NFT is demonstrably located abroad, for example by querying not only the wallet at the time of purchase, but also the buyer's country of origin. In this regard, however, some detailed questions have not yet been conclusively clarified and the advice of a tax advisor should be sought in individual cases.

Can I offer my NFT project as a DAO?

This is only partially possible in Germany. The Decentralised Autonomous Organisation (DAO) is unfortunately not (yet) recognised as an independent form of company in Germany. There is a so-called numerus clausus of company forms, i.e. there are only those company forms that are regulated by law. If one joins forces for an NFT project, one usually establishes a civil law partnership (GbR, Sec. 705 BGB). This becomes a general partnership (OHG) as soon as the company "by its nature or scope requires a business established in a commercial manner" (Sec. 105 with reference to Sec. 1 para. 2 HGB). When this is the case depends on several factors. As a (very) rough guideline, however, a turnover of about 250,000 EUR can be used as a threshold.

For liability reasons (partners of a GbR or OHG are normally liable without limitation, also with their private assets) as well as for tax reasons (in this respect, too, the advice of a tax adviser should be sought in individual cases), another form of company is often chosen in practice, in particular a limited liability company (GmbH).

Since a DAO is not a recognised company form, it cannot replace this choice of law for the appropriate company form. In addition, there are mandatory legal formalities that cannot be replaced by a DAO structure either, for example the appointment with the notary public that is still required for the formation of a GmbH, even though it can now be carried out online.

What is possible with a DAO, however, is the implementation of decisions (which do not require a special form) within the company and the NFT project. A DAO can thus support the implementation of certain decisions within the company. DAO structures can be set up to involve the holders of NFTs in the decision-making process and then implement the decisions taken via smart contracts, for example, how to deal with unsold NFTs or what the proceeds from the sales are to be used for.

Can I avoid the application of German law by offering my NFT project with a company based abroad?

Partially, but essentially no.

We have often heard the recommendation in the market – or at least been asked – whether one could circumvent the complex German legal situation by founding a company abroad for one's new NFT project. Cyprus or Dubai, for example, were often mentioned in this context.

Proponents of decentralisation go even further, arguing that no conventional legal system should be applicable to a project in the metaverse at all, i.e. it is practically a lawless space.

However, neither of these can lead to the complete exclusion of German law. For as far as, for example, the initiators of the NFT project are located in Germany and/or address their project to customers in Germany, at least parts of the German legal system are applicable.

It is true, however, that when a foreign company form is chosen, its foreign company law and, with regard to the company itself, also tax law are applicable. However, the law applicable under the aspect of the country of domicile can also be complex to determine, for example, if several creators from different countries join forces.

However, the situation is usually different with regard to the regulatory requirements described in relation to the NFT project itself. These requirements are often based on consumer protection considerations. Here, the application of German law usually results from the fact that the products are actively offered and advertised to German customers. Mandatory supervisory, criminal and tax law requirements specific to a country cannot normally be "deselected" by relocating the operating company. For this, one would rather have to exclude the participation of German customers.

In this context, one can at most consider whether one is practically protected from the enforcement of German law abroad, for example, because there is no (sufficient) judicial cooperation between the states. In our experience, however, this question is more likely to arise in the case of projects that deliberately accept violations of the law.

Can I exclude liability by adding "NFA, DYOR"?

No, the standard statement of "No Financial Advice" (NFA) and/or "Do Your Own Research" (DYOR) in connection with statements about NFT projects, cannot constitute a disclaimer.

This should regularly already result from the fact that this statement is not clear and comprehensible, in particular, if the abbreviations are only used unreflectively (cf. Sec. 307 (1) sentence 2 BGB).

For the rest, it depends on the context in which this is used. The creator of an NFT project is regularly obliged to make truthful statements about its offer and not to mislead (potential) customers about the functioning and advantages of NFTs (general legal principle, see Sec. 5 and 5a UWG). To then label any promises about the performance of the NFT with "NFA, DYOR" could for instance, be considered contradictory and therefore misleading and thus inadmissible.

Will the MiCA regulation change the regulation of NFTs?

Probably not directly.

NFTs are not yet to be covered by the preliminary agreement on the new Markets in Crypto-Assets (MiCA) Regulation, which will, for the first time, subject crypto assets, crypto issuers and crypto service providers to a single EU-wide regulatory framework. Rather, NFTs are to be excluded from the scope of application unless they fall into one of the existing crypto asset categories. As shown, NFTs are, in our view, fundamentally not crypto assets.

However, the European Commission is to be tasked with developing an evaluation and, if necessary, a regulatory proposal within 18 months of the MiCA Regulation coming into force. This means that an EU-wide NFT regulation is also conceivable in the future.

However, further details remain to be seen until the final text of the MiCA regulation is available.

Can this article replace legal advice in individual cases?

No. With this article, we would only like to give an initial overview of some essential legal questions that repeatedly arise in Germany in connection with NFT projects. Many questions have not yet been conclusively clarified, neither by the legislator nor by the authorities or even the courts. We have only presented the manifold arguments in an incomplete and creator-friendly manner. For an individual case consultation, on the one hand, the concrete facts of the case must be looked at closely, especially the exact functioning of the respective NFT. On the other hand, the various arguments must be examined in more detail, and current developments must also be taken into account.


The German version of this article originally appeared on our IPT Germany Blog.

Tags

germany, europe, media, gambling, nft, nfts, metaverse

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