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I. What is a Blockchain Game?

A blockchain game is a game that uses the blockchain and uses crypto assets, tokens or NFTs (Non-Fungible Tokens).

In a typical game the following occurs:
(1) user purchases game assets that belongs to the game operator rather than the user,
(2) such game assets cannot be freely transferred, sold, or lent out, and
(3) even time-consuming data disappears after game distribution ends.

Whereas in blockchain games, it is said that the following occurs:
(1) the user is the holder of the token (game asset),
(2) the token can be transferred, sold, or lent out to third parties,
(3) third parties can also use the token, and
(4) as long as the blockchain exists,1the recorded digital assets will exist in perpetuity.

Ⅱ. Laws to Consider and Conclusions

When providing a blockchain game to Japanese residents, the laws listed below should be taken into account. Here is a summary of the laws that pertains to this matter:

(1) Fund Settlement Law and Security Act
To issue and sell NFT itself is not regulated in Japan. Exception to it is (i) if tokens are deemed as crypto assets, such as fungible token which might be used as a payment method, they might be regulated under the Fund Settlement Law and (ii) if tokens are deemed as security, such as tokens including dividend feature, they might be regulated by the Financial Instrument Exchange Act.
(2) Act against Unjustifiable Premiums and Misleading Representations (hereinafter refer to Premiums Law or Premium and Representation Law)
Blockchain Game players might be given tokens, digital currencies, NFTs, digital assets or other gifts which have financial value when a user register, login, play a blockchain game. These gifts might be considered “premiums” or “free gifts” under the Premiums Regulations of the Premiums Law and the value of them are limited. 
If the Play to Earn games allow players to (a) purchase NFTs and (b) earn some reward (e.g., NFTs or tokens) by playing the game, the reward portion may be subject to the prize regulation. There is an argument that depending on the game design, the reward may not be considered an extra (premium) and may not be subject to the Premiums Law.

III. Legal Considerations

The following is a discussion of each legal issue.

1. Crypto Asset Law and Security Act

(a) Where is the problem?
Under blockchain games, the game operator frequently sells game characters, items, weapons, and land etc. as NFTs to users in exchange for ETH or other crypto assets.

Japanese law does not regulate sales of pure NFT, but regulate sales of crypto assets and sales of securities. Thus, whether sold tokens are not deemed as crypto assets or securities are crucial issue.

(b) What are crypto assets?
Under the Fund Settlement Act, the seller, Crypto Asset is defined as follows:

Definition of Crypto Assets (Article 2 Section 5 of the Fund Settlement Act
Definition of Type 1 Crypto Asset
A property value that is recorded in electronic record and transferred electrically, that can be used to pay for the purchase of goods or receive services to an unspecified person, and that can be purchased and sold to an unspecified person (excluding some stable coins and securities).
Definition of Type II Crypto Assets
Crypto Asset that is recorded in electronic record and transferred electrically which can be mutually exchanged with the Type I Crypto Asset with an unspecified party (excluding some stable coins and securities).

Selling or providing custody of crypto assets are highly regulated and must generally be handled by registered crypto asset exchange operator and also it is not feasible for a blockchain game operator to obtain registration.

At this moment, whether tokens are considered as crypto assets is determined by the number of issued tokens and whether the tokens can be used as some form of payment. NFTs are generally not considered as crypto assets, but if a game operator says it is an NFT, and the NFT has payment features etc., it may be considered a crypto asset.

(c) What are Securities?
Japanese Financial Instrument and Exchange Act (FIEA or Security Act) governs the issuance or sales of securities. Securities includes stocks, bonds, mutual funds, collective investment scheme etc. We have been often asked by blockchain game operators whether it is legal in Japan to sell NFTs, such as land, which generate “income” or “dividend”. If NFTs generate income without the participation of players, they may be classified as securities. Thus, when selling profit-generating tokens, the game should consider including features of players’ effort, such as editing land to attract customers.

2. Gambling offenses

(a) General Remarks
The crime of gambling under the Penal Code is established by (1) contesting the gain or loss of property profits by (2) winning or losing by chance. In addition, not only money but also “property interest” is considered to be the object of gambling, and rice, land, and debt collection are all considered to be “property interest” subject to the crime of gambling. Crypto assets are also considered to fall under the category of property interest.

Article 185 (Gambling)
A person who engages in gambling shall be punished with a fine of not more than 500,000 yen or a fine. However, this shall not apply when the betting is limited to betting on objects provided for temporary entertainment.

(b) Gacha (Loot Box), Reveal and Gambling Law
Some blockchain games have features of Gacha (loot box) and reveal. Users pay money or crypto assets to a gaming company and get NFTs randomly. For example, users pay 1ETH to get a game character NFT. Game characters may include Julius Caesar, Guanyu, Genghis Khan, Napoleon, George Washington etc, and those characters have different strength, powers, rarity etc, and what users can get is not revealed to users.
It was believed that these sales might be considered as gambling because (i) users pay property value, (ii) users receive property value which differs by chance, and (iii) there is winning or losing (of property value) by chance. However, in 2022, blockchain industries talked with a famous criminal law professor and some regulatory authorities and issued the guideline which states certain Gacha and reveal is not considered as gambling. Although the guidelines have no effect to police or criminal courts, the industry is now considering how following the guidelines may reduce the likelihood of criminal penalties.

The requirement is that the issuer and operator of games do not sell the same NFTs at different prices (for example, if the issuer sells NFTs that include Napoleon with 1ETH via Gacha, the issuer is not allowed to sell Napoleon NFT at a different price in another method), and do not buy back NFTs in a secondary market (for example, the issuer cannot buy back Napoleon NFT in 0.5ETH or 1.5ETH). In such cases, there is either winning or losing), and the issuer and operator shall not overstate the value of some NFTs in Gacha over other NFTs in Gacha.

(c) Synthesis
The same theory that applies to Gacha may apply to synthesis, but because synthesis is not discussed in the guidelines, we take a more cautious approach to synthesis.

3.Premiums and Premiums Law

(a)Initial Start
Developers often ask us of blockchain games if it is possible to give NFTs, game currency, crypto assets, other property to users free as a login bonuses, playing bonus and ranking bonuses etc. When conducting such distribution, it is necessary to consider the relationship with the Premiums and Representation Law.

(b) About the Premiums and Representation Law
The Premiums and Representation Law prohibits the offering of excessive premiums.
Premiums are (1) offered as a means of inducing customers, (2) offered incidental to a transaction, and (3) economic benefits such as goods or money. As the definition of economic benefits is broad, crypto assets, NFTs, in-game currencies, and other benefits might be considered as economic benefits.

Excessiveness will vary depending on whether the sweepstakes is general sweepstakes, joint sweepstakes, or all-inclusive sweepstakes, Still, it will be based on the following criteria to the extent that it is considered relevant to the game.

  Description Example Limits on Premium and Prizes
Total Prizes Offering prizes to anyone who uses the products or services or visits the store, not through sweepstakes. Gifts for all purchases, gifts for all visitors, etc. Transaction value less than 1,000 yen – Premiums up to 200 yen.
Transaction value is over 1,000 yen – Premiums are capped at 2/10ths of the transaction value

General Sweepstakes

Offering prizes to users of goods or services by chance, such as lotteries, or by the superiority of specific actions. In-store raffles, quiz and game competitions. Transaction value less than 5,000 yen – 20 times the transaction value.
Transaction value of more than 5,000 yen – 100,000 yen.
(Both are capped at 2% of the total expected sales amount)

(c) Ranking Rewards and the Premiums and Representation Law
In traditional smart phone games, the top-ranking players frequently receive in-game currency. The economic value of in-game currency has been treated as zero or very low by game operating companies, and there is no issue under the Premiums and Representation Law.

In blockchain games, crypto assets and NFTs, which can be sold outside of the game might be given as prizes. In this case, the general sweepstakes restrictions apply. The transaction value determines the amount of the prize. Although it is difficult to determine how much the transaction value is, a reasonable approach would be to set the minimum charge as the transaction value and allow rewards of up to 20 times the minimum amount or 100,000 yen, whichever is lower.

(d) Play to Earn and the Premiums and Representation Law
If we consider a Play to Earn game as a game where players (a) purchase NFTs or game currency and (b) earn some reward (e.g., NFTs or game currency) by playing, the reward portion may be subject to the Premiums Regulation.

However, whether earned NFTs or game currencies will be considered “premium” is unknown. There is an argument that the Premiums Law does not apply to Play to Earn games because the rewards are not “extras (premiums),” but rather the purpose of purchasing NFTs and playing the game itself. Lottery winnings and game-play prizes, for example, are not considered “premiums,” but rather “the purpose” of the transaction itself (gambling law shall be discussed lottery winnings and game-play prizes). This issue has not been resolved in Japan, and careful deliberation is required.

Reserved Matters
The contents of this document have not been verified by the relevant authorities and are merely a description of arguments considered reasonable under the law. It is only the current thinking of our firm, and our firm’s thinking is subject to change.
This document does not recommend using blockchain games or purchasing NFTs.
This document is intended for blogging purposes only. Please consult your lawyer if you need legal advice on a specific case.

Introduction

Clients often ask us whether it is possible to structure a Decentralized Autonomous Organization (DAO) in Japan. Currently, Japan does not have regulations targeting DAOs, unlike Wyoming State or the Marshall Islands. So, we have written this article summarizing what is typically considered when forming a DAO in Japan.

1.DAO

1.1 What is DAO?

A decentralized autonomous organization (DAO) is a new legal structure with no central authority and members committed to acting in the organization’s best interests. DAOs are used to make decisions in a bottoms-up management style and have gained popularity among cryptocurrency enthusiasts and blockchain technology.

1.2 Classification of DAOs

There are several classifications of DAO described below:

1.     Investment DAO
 
Investment DAOs are for-profit DAOs aim at co-investing in a project. They are more likely to attract funds than Grant DAOs because they aim to generate profits mainly through “economic capital.”
Examples: Genesis DAO, The LAO, BitDAO, etc.
 
2.     Grant DAO
 
The community contributes monies to the grant pool and votes on funds allocation and distribution decisions in a Grant DAO. Innovative DeFi projects are funded using these DAOs, showing how decentralized communities are more flexible with funding than traditional organizations.
Examples: MolochDAO, MetaCarteDAO, Aave Protocol, Uniswap Grants, etc.
 
3.     Protocol DAO
 
When tokens serve as a voting metric for implementing any changes in the protocol, such a governance structure represents protocol DAOs. For instance, MakerDAO has revolutionized the DeFi space with its DAI stablecoin.
Examples: Maker, Compound, Uniswap, Aave, Yearn, Sushi, etc.
 
4.     Service DAO
 
A Service DAO is a decentralized working group. They can receive tokens as compensation for their projects.
Examples: RAID GUILD, DXdao, PartyDAO, etc…
 
5.     Social DAO
 
A Social DAO offers digital democracy where opinions are heard, and people can share common interests.
Example: Bored Apes (BAYC)
 
6.     Collector DAO
 
Artists who use nonfungible tokens (NFTs) to create art rely upon collector DAOs to establish ownership of their art.
Example: PleasrDAO
 
7.     Media DAO
 
Media DAOs allow product owners of content (i.e., readers) to contribute directly without involving advertisers for the native token as a reward in return for their contributions.
Example: Fore Front (FF), Bankless DAO, etc…

Source https://cointelegraph.com/daos-for-beginners/types-of-daos

1.3. Example of an Existing Overseas Law

A few places where DAOs are regulated are Wyoming State and the Marshall Islands. Below is a short description of forming a DAO in the Marshall Islands.

The Legal Form of a DAO on the Marshall Islands

Marshall Islands proposes a non-profit corporation (limited liability company) as a legal entity form for DAO, which stands out from the general practice to establish DAO as a foundation. Such a company is established in compliance with the general corporate law of the Marshall Islands with specific features that:
  • No part of the income or profit of the corporation is distributable to its members, directors, or officers; and
  • Members’ ownership of such a company may be defined in such a plain document as the register of members AND in the company’s smart contract.
  • You must clearly state the company’s purpose and connect it to the non-profit activity. The purpose will be furtherly indicated in the Certificate of Incorporation.

How does this work?

Generally speaking, such a company works as a limited liability company managed by its members. It has three essential constitutional documents: Certificate of Incorporation, Operating Agreement, and Charter of the Company.
The Operating Agreement should include the most crucial matters of your DAO management:
  • additional governing bodies;
  • voting and counting of votes of such governing bodies;
  • amendment of a smart contract;
  • creation and management of treasury.

You can amend any of these matters by the members’ decision in compliance with the procedure prescribed in the previous version of the Operating Agreement. 

Registering a Marshall Islands LLC for DAO


Here’s what the process of establishing a legal wrapper for DAO on the Marshall Islands looks like: 
  • You start by clearly defining the name and purpose of your DAO. Once again, the purpose of your DAO should indicate the non-profit element;
  • At least three founding members draft the Operating Agreement (you may amend the Operating Agreement at any time upon establishment of the company; therefore, it is a common practice to use the template at the first stage to speed up the process);
  • The founding members should pass the KYC process with the local regulator. Apart from the founders, anyone who holds 10% or more governance rights over the company must pass the KYC process
  • The founding members sign the drafted Operating Agreement, Certificate of Incorporation, and Foreign Business Investment License form and file these documents with the regulator;
  • If everything is alright with the documents, the regulator sends the Charter of the limited liability company to the founders.

The above is a reference from Taras Zharan Web 3 Virtual Legal Officer.

 https://legalnodes.com/article/marshall-islands-llc-as-a-dao-legal-wrapper

2. Financial Regulations on DAOs

2.1. Points to Consider

When structuring a DAO, one must consider the financial regulations and the legal form characteristics.

Here are several points to keep in mind:

1. Security regulation under the Financial Instrument and Exchange Act (“FIEA”) may apply when tokens have the possibility of dividends or redemption of the principal of more than 100% (dividends and redemption of the principal of more than 100% are from now on collectively referred to as “dividends, etc.”). As a general rule, token sales of such DAO must be conducted by a Type 1 Financial Instrument and Exchange Business Operator (“Type I license”) or by obtaining a Type 2 Financial Instrument Exchange Business Operator license (“Type II license”).

2. When selling Fungible Tokens without dividends, etc., it is necessary to have a Crypto Asset Exchange Operator conduct the sale or to obtain a Crypto Asset Exchange Operator license.

In contrast, these financial regulations generally do not apply when selling NFTs without dividends, etc.

3. You also need to consider the tax benefits. If you want to pursue tax advantages in an Investment DAO with dividends, etc., you can use a partnership or GK-TK scheme. If tax advantages are not particularly important, an association without rights, a general incorporated association, or a limited liability company can be considered a scheme to issue tokens. For the issuance of Fungible tokens or NFTs without dividends, etc., it may be better to have no particular legal structure.

2.2. Reference Table of Conclusions

The table below summarizes the legal scheme and financial regulations that should be considered in establishing a DAO.

The following regulations apply to token sales of Investment DAOs with dividends, etc. (assuming dividends or principal redemption of more than 100%).

Type of Member’s Rights Form under Japanese Law Free distribution of Tokens Token Sale Investment Management
DAO member’s rights as shareholders’ rights in Limited Liability Companies and Joint-stock Companies Tokenization of shareholders’ rights of limited liability companies, etc. Free distribution of the shareholders’ rights is not allowed under corporate law, etc.

Sales by a third party for an issuer need a Type I license. A Type II license is necessary for the self-offering of a limited liability company. No license is required in the case of self-offering of a joint-stock company.

In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc.

No regulation
DAO member’s rights (with dividends), not including shareholders’ rights TK investment, partnership investment, tokenization of rights that are difficult to classify into prescribed legal forms, etc. Unregulated

Sales by a third party for an issuer need a Type I license.

Self-offering needs a Type II license.

In the case of solicitation of 50 or more people, there needs to be a submission of a registration statement regarding securities, etc.

No regulation

(Possibility of Investment Management Business license in the case of securities investment)

On the other hand, a DAO without dividends, etc., is also possible. Its regulations are as follows:

Tokens/NFT Free Token Distribution Sale of Tokens Investment Management(Assuming no dividend)
Utility Tokens No regulation Crypto Asset Exchange Business regulation No regulation
NFT No regulation No regulation No regulation

With respect to possible legal forms for DAOs, the following comparisons can be made:

Status Legal Form Limited Liability Is it possible to distribute? Avoid Double Taxation Others, Comprehensive Evaluation
No Legal Entity Status Association without rights +Tokens with unclear rights 〇? ×

△~〇 High degree of freedom. A good scheme if there is no problem with double taxation.

Civil Law Partnership + Partnership Equity Token ×

△~〇 High degree of freedom. A good scheme if there is no problem with limited liability.

Investment Business Limited Liability Partnership + partnership Equity Token

× Although other points are reasonable, there are restrictions on investment destinations and businesses, such as not being able to purchase NFTs. It’s usually hard to use this scheme as DAO.

Limited Liability Partnership + Partnership Equity Token

× There are valid points; however, to use as a DAO is problematic because of the need to register the name of the union member.

DAO has Legal Entity Status

Corporation (*1) + Tokenization of Anonymous Partnership (e.g., TK-GK scheme)

△ It is necessary to operate in accordance with the Companies Act and the General Incorporated Associations Act. It should be noted that TK holders do not have the right to instruction. The good point is that there is no double taxation and limited liability.

Corporation (*1) + Token with unknown rights

〇?  〇 × △ ~ 〇 It is necessary to operate under the Companies Act and the General Incorporated Associations Act. Besides that, it has a high degree of freedom and is a good scheme if you don’t mind the double taxation problem.

Corporations (*1) + Tokenization of shareholders rights (*2)

 〇  〇(× For general incorporated associations) ×

× Is there a low degree of freedom due to the need to operate per the Companies Act and the General Incorporated Associations Act? For example, it is necessary to manage members as shareholders.

*1 Legal entities include limited liability companies, stock companies, and general incorporated associations. LLCs are generally easier to establish and operate than joint-stock companies. If you want to have a more public image, use a general incorporated association.
*2 Membership rights of a limited liability company, stocks of a stock company, membership rights of a general incorporated association.

2.3 Tokenization of Rights

Tokenization of rights of funds or partnership, where there is an investment of funds (including money and crypto assets), investment management, dividends, or redemption of the principal of more than 100%, would be broadly considered a collective investment scheme (fund) under Japanese law. Below is the summary of the Definition of a Collective Investment Scheme.

Summary of Definition of Collective Investment Scheme
Rights that satisfy the following (i) to (iv)
(i) Rights under a partnership agreement as defined in Article 667(1) of the Civil Code, a silent partnership agreement as defined in Article 535 of the Commercial Code, an investment limited partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment Business, or a limited liability partnership agreement as defined in Article 3(1) of the Act on Limited Liability Partnership Agreement for Investment
(ii) The existence of a business (the “Invested Business”) in which money (including cryptographic assets) contributed or contributed by the person who has such rights (the “Investor”) is allocated to the Invested Business;
(iii) The investors are entitled to receive dividends of profit generated from the invested business or distribution of assets related to the invested business;
(iv) There are no exceptional circumstances, such as all investors being constantly involved in the business.

The revised Financial Instruments and Exchange Act, which came into effect on May 1, 2020, created the legal concept of Electronic Record Transfer Rights. The rights of tokenized collective investment schemes usually fall under the Electronic Record Transfer Rights below.

Outline of Definition of Electronically Recorded Transfer Rights
Rights that satisfy the following (i) to (iii) but exclude (iv) (Article 2, Paragraph 3 of the FIEA):
(i) Rights listed in each item of Article 2, Paragraph 2 of the FIEA (funds, trust beneficiary rights, members’ rights of general partnerships, limited partnerships, limited liability partnerships, etc.);
(ii) When they are expressed in property values that can be transferred through an electronic data processing system;
(iii) When recorded in electronic devices or other objects by electronic means;
(iv) Cases provided in the Cabinet Office Ordinance have considered the nature of distribution and other circumstances.

The sale of this electronic record transfer right requires a Type 1 Financial Business registration. If soliciting more than 50 people, it will be a public offering (Article 2, Paragraph 3 of the Financial Instruments and Exchange Act), and a securities registration statement must be submitted based on Article 5 of the FIEA.

If the sale is limited to qualified institutional investors or wealthy people of 49 or less, and even if there is resale, there are technical restrictions so that other people cannot become DAO token holders.

When the Investment DAO is formed, it can be sold in such a limited form at first, and after it grows, it can be sold to the general public while complying with increased regulations.

2.4 Tokenization of Company Membership Rights and Financial Registration Regulations

Regarding tokenization of company membership rights, a Type I FIBO license is necessary when a third party sells the rights, and Type II is essential in the case of self-solicitation. In the case of tokenization of company membership rights (shareholders rights) of a joint stock company, a Type I license is necessary in the case of solicitation by a third party, and no license is required in the case of self-solicitation.

2.5 Regulations on Public Offerings, etc.

 If any of the following applies, it becomes a public offering. In principle, it is necessary to submit a securities registration statement.

(i) When soliciting the acquisition of securities from 50 or more persons (excluding Qualified Institutional Investors (QII) in the case there are restrictions on resale other than QII);

(ii) When it does not fall under any of the following categories: Private Placement for QII, Private Placement for Professional Investors, and Private Placement for Small Groups.

2.6 Financial Regulations for DAOs without Dividends

If DAOs have no dividends, etc., they are not considered securities, but different financial regulations may apply.

Tokens/NFTs Free token distribution Token Sales Investment Management (Assumption without dividends)
Utility Tokens Unregulated Crypto Asset Exchange Business License Unregulated
NFTs Unregulated Unregulated Unregulated

Disclaimer

The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future. This article does not recommend investment in DAO. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

In this post, we analyze non-fungible tokens (NFTs), play-to-earn scholarships, and the Yield Guild DAO under Japanese laws. With respect to the scholarships, it is worth noting that they are mainly offered overseas – presumably in compliance with the relevant laws – and that Japanese laws only apply if Japanese residents are involved. The following post is written under the assumption that this is the case.

You can find more information about the legal and regulatory environment for NFTs in our previous posts:

  1. ‘Play to Earn’ under Japanese Laws (September 2, 2021)
  2. NFTs: An overview of the current state in Japan, the legal and regulatory environment, and the latest guidelines by the JCBA and BCA (April 27, 2021)
  3. Buyer Beware – Digital Art and Non-Fungible Tokens (NFT) (March 22, 2021)

1. Overview

1.1. Play-to-Earn (P2E)

The P2E model was pioneered by Axie Infinity. Axie Infinity is an online game that allows players to receive rewards in the form of Smooth Love Potions (SLP) when playing the game. SLP are tokens that are needed for breeding new Axies and which can be traded on global crypto exchanges.

1.2. Scholarships

To play Axie Infinity, a player needs at least three Axies. In August 2021, the price for three Axies was around USD 1,000 and as such unaffordable for many players. Yet, despite the high costs, the game continued to gain popularity – especially in countries with low incomes. One of the reasons behind the continued success were scholarships. Under the scholarship program, owners of Axies give their Axies to players who in turn use them for playing the game. When earning SLP as rewards, players must share them with the owners of the NFTs. The percentage players retain is somewhere between 40 and 75 percent, depending on the provider of the scholarship and scholarship program.

Scholarship programs in a nutshell
  1. Owners of Axies search for scholars on discord and other platforms.
  2. Scholars sign scholarship agreements with an owner and start playing the game.
  3. Rewards earned in the game are shared between the players and the Axies’ owners.
Even though scholars may use Axies for playing, they are not authorized to sell them under the scholarship agreement.

1.3. Yield Guild Games

Yield Guild Games (YGG) describes itself as a “play-to-earn gaming guild, bringing players together to earn via blockchain-based economies”. YGG initially raised funds from a16z and other investors in exchange for YGG tokens and invests those funds into NFTs that are used in blockchain games. Proceeds from utilizing the NFTs – for example from lending the NFTs to players of P2E games or selling them on the market – are distributed to YGG token holders.

In some cases, YGG further brokers scholarships for NFT holders who want to put their NFTs to use and earn a passive income. Initial activities focus on Axie Infinity, The Sandbox, and League of Kingdoms. Further games will be added in the future.

While the core team of YGG currently manages all activities, YGG aims to become fully decentralized in the future. Once the transition is completed, decision-making will be transferred from the core team to the YGG DAO, i.e. the YGG token holders.

2. Analysis under the Applicable Laws and Regulations

2.1. Legal Structures of Scholarships

Scholars and managers enter into scholarship agreements on an individual basis. Usually, the agreements are initiated via Discord or other channels. Under Japanese laws, the following structures may be considered.

2.1.1. Lease Agreement

Where a scholar promises to pay a certain amount of money for the use of Axies and to return the Axies at the end of the agreement to the manager, the agreement might be considered some form of lease. Since Article 601 Civil Code only covers the lease of tangible assets, it cannot be applied directly to the lease of intangible assets such as Axies. Applying Article 601 ff Civil Code by way of analogy seems, however, possible.

Assuming Articles 601 ff Civil Code can be applied analogously, scholars would not be allowed to sublease Axies to third parties without the prior consent of the managers (Article 612(1) Civil Code). In cases where the contract period is not specified by the scholarship agreement, the agreement may be terminated by either party by giving the other party one day’s notice (Article 617(1)(iii) Civil Code). As it is not clear whether courts will allow for an analogous application of Articles 601 ff Civil Code, it is advisable to cover all matters comprehensively in the scholarship agreement.

Since the use of Axies is not subject to restrictions under the Copyright Act, it is further advisable to implement proper measures to ensure that owners are sufficiently protected (e.g. prohibition to use Axies for breeding, prohibition to create merchandise with the Axie).

2.1.2. Contract for Work or Delegation

Managers may among others specify how many hours a scholar must play per month, require daily logins, or instruct scholars to only use Axies with certain characteristics for breeding. In addition, the scholarship agreement may stipulate a minimum amount of SLP a scholar must earn during a pre-defined period. In exchange, the manager agrees to pay a remuneration to the scholar.

Depending on the exact arrangement, the scholarship agreement may either be considered a contract for work (Article 632 Civil Code) or delegation without legal authority (Article 656 Civil Code). In both cases, scholars would have to deliver earned SLP to the NFT’s owner (Articles 632 and 646 Civil Code. Where the scholarship agreement is structured as a contract for work, NFT owners may further require scholars to complete the agreed work (Articles 559 and 562 Civil Code).

It is our understanding that the rewards collected by scholars are generally passed to the manager. Based on the scholarship agreement, the manager will then return a predefined amount to the scholar for playing the game. The situation is, therefore, similar to revenues generated by tenants of farmland.

2.1.3. Fund

The scholarship arrangement may further be structured as a partnership according to Article 667 Civil Code or a silent partnership according to Article 535 Commercial Code. In these cases, both the owners of the NFT and the scholar make contributions in kind – the owner by providing his Axies and the scholar by contributing his labor. Profits generated by the partnership or silent partnership are then distributed between NFT owners and scholars according to the scholarship agreement.

In a partnership, the owner may for example invest Axies and appoint the scholar as an executive of the partnership (Article 670(2) Civil Code). Here, the NFT owner would have the right to inspect the scholar’s business but lose the right to manage the partnership on his own (Article 673 Civil Code). If the scholar does not play the game and defaults, the agreement cannot be canceled (Article 667-2(2) Civil Code). Instead, the manager may request the dissolution of the partnership (Article 683 Civil Code). A voluntary resignation from the managing position by the scholar appointed as the manager of the partnership would only be possible if the scholar has a valid reason for resignation (Article 672(1) Civil Code).

NFT Owners’ Rights and ObligationsScholars’ Rights and ObligationsOther
Lease
  • receipt of royalties
  • obligation to provide Axies to the scholar
  • obligation to replace Axies that do not conform with the characteristics outlined in the scholarship agreement
  • obligation to return Axies upon expiration or termination of the scholarship agreement
  • obligation to manage the Axies with the care of a good manager
  • prohibition to sublease the Axies
  • right to demand the reduction of royalties in cases of defect
If the term is stipulated in the scholarship agreement, the agreement is automatically terminated with its expiration. Otherwise, it can be terminated by either party by giving one day’s notice.
Delegation / Contract for Work
  • obligation to pay remuneration
  • obligation to provide Axies to the scholar
  • right to decline or reduce remuneration in case of non-performance by the scholar
  • obligation to process certain paperwork and to complete the work
  • obligation to deliver SLP rewards to the manager
  • payment for performed services
The agreement may automatically terminate upon expiration of the term (if specified) or can be canceled by the manager at any time. If the manager decides to cancel the agreement which constitutes a contract for work, he must generally compensate the scholar for losses. If the agreement constitutes a delegation agreement, it may be terminated at any time by either party.
Fund
  • obligation to invest Axies as an in-kind-investment
  • right to inspect the status of the business
  • right to participate in profits
  • right to demand dissolution of the partnership
  • obligation to invest labor as an in-kind-investment
  • obligation to perform certain services
  • right to participate in profits
  • right to demand dissolution of the partnership
If the partnership has achieved the purpose for which it was set up, it is automatically dissolved. It is also dissolved if there are other reasons for dissolution which are stipulated in the scholarship agreement.

Proceeds are distributed in proportion to each partners’ contribution in case of liquidation.

 2.2. Regulatory Considerations for the Different Scholarship Structures

The regulatory considerations vary greatly depending on the legal structure of the scholarships. For scholarships structured as leasing arrangements, money lending regulations may be considered. For agreements structured as partnerships or silent partnerships, the Financial Instruments and Exchange Act (FIEA) may be applicable. For scholarship structured as delegation agreements or contracts for work, no particular regulations apply.

2.2.1. Money Lending Business Act

Article 2(1) Money Lending Business Act defines money lending business as the business of lending money (including the provision of funds by discounted bills, the sale of mortgages, or similar methods) or acting as an intermediary for the lending of money. Businesses engaging in money lending services must register with the Financial Services Agency (FSA) (Article 3(1) Money Lending Act).

Since Axies neither constitute money nor a currency-denominated asset, the lending of Axies does not fall under the Money Lending Business Act. It is therefore not necessary to register with the FSA.

2.2.2. FIEA

The FIEA applies to a wide range of financial instruments and provides a comprehensive registration regime for businesses engaging in financial instruments services (Article 2(8) FIEA). According to Article 29 FIEA, businesses providing financial instruments services must generally register as a financial instruments business operator (FIBO) with the FSA. This also applies to those soliciting the offer to sell rights in a partnership or silent partnership. Both are generally considered collective investment schemes under the FIEA (Article 2(2)(v) FIEA).

Axies do, however, not fall under the category of money or money equivalent as specified in Article 2(2)(v) FIEA, Article 1-3 FIEA Enforcement Order, and Article 5 FIEA Definitions Ordinance. Even where the owner of NFTs contributes his NFTs to the partnership or the silent partnership, the FIEA does therefore not apply.

2.3. Regulatory Considerations concerning YGG’s Activities

2.3.1. Scholarship Brokerage

Since NFTs do not constitute money or currency-denominated assets (see item 2.2.1 above), the brokerage of scholarships does not constitute an intermediary service for money lending and is therefore not regulated.

2.3.2. YGG Tokens

On August 19, 2021, YGG announced that it had raised USD 4.6 million from a16z and other major venture capital firms. In exchange for their investment a16z and the other investors received YGG tokens. The tokens allow them to participate in the revenues generated by the YGG. Assuming the tokens were sold to investors in Japan, it is highly likely that they would qualify as rights in a collective investment scheme under Article 2(2)(v) FIEA – and given the tokenization of those rights – as electronically recorded transfer rights (Article 2(3) FIEA). In order to offer electronically recorded transfer rights to the public, it is generally necessary to file a prospectus and to register as a type II FIBO (Articles 28(2)(i), 2(8)(vii), 29 FIEA). Where the rights are only offered to qualified institutional investors a notification under Article 63 FIEA is sufficient.

If the solicitation is, however, performed by a DAO with a sufficient degree of decentralization, the solicitation falls outside the scope of the FIEA as there is no eligible intermediary that could be regulated. As YGG is still managed by the core team, this degree of decentralization has most likely not been achieved yet.

Finally, it should be noted that collective investing schemes investing in NFTs are not subject to disclosure obligations under Article 4 FIEA, as NFTs do not constitute securities.

2.3.3. Investment in NFTs

A fund investing exclusively in NFTs does not invest “in securities or in rights connected with derivatives transactions, based on investment decisions that are grounded in an analysis of values of financial instruments” as stipulated in Article 2(8)(xii) FIEA. It is therefore unlikely that the investment management regulations apply to the investment manager (Article 28(4)(i) FIEA).

As NFTs are further not considered crypto assets within the meaning of Article 2(7) Payment Services Act, the buying and selling of NFTs for investment purposes does not constitute a crypto asset exchange business. It is therefore not necessary to register as a crypto asset exchange service provider.

Disclaimer

This post is for discussion only. The content of this post has not been confirmed by the relevant authorities or organizations mentioned in the post but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future.
This post does not recommend the use of or investment in NFTs, scholarships, or any other tokens or projects.
Axie Infinity and Yield Guild Games are only used for illustrative purposes. Given the format of the post, not all details of the game mechanics and token design have been considered comprehensively, so that the results of the assessment may deviate from the results by the regulator, or a legal opinion prepared by us or another law firm. By no means, the explanations should be understood as a legal opinion. If you need legal advice on a similar project, please free to contact us or consult with your lawyer.

Axie Infinity, the blockchain game by Sky Mavis, made major headlines recently. With more than 350,000 daily active players, the game is one of the most successful blockchain games so far. According to data from token terminal_, the game generated USD 581.7 million in revenue over the past 90 days. To put this into perspective, this is more than Ethereum over the same period of time.

So, what is behind the success of Axie Infinity?

Part of it can be attributed to the active Axie community and the cute pets – called Axies – that are used for battles. The other part is the new ‘Play-to-Earn’ gaming model. This model allows players to earn ‘real’ money by playing the game. Depending on the token price, the rewards are said to be somewhere between USD 300-500 per month. With the latest increase of AXS, they might be even higher.

The Play-To-Earn Model

To understand how the ‘Play-to-Earn’ model works, it is necessary to take a closer look at the game and the tokens involved.

There are basically three types of tokens in the game.

  1. Axie Infinity Shards (AXS)
  2. Smooth Love Potion (SLP)
  3. Axies, items, lands (NFTs)

To play the game players need at least three Axies. The Axies can be bought on the marketplace and currently cost around USD 200 or more.

To breed new Axies, players need 4 AXS and a certain number of SLP. To control the Axie population, it becomes increasingly expensive to breed Axies with same parents. After being used for breeding 7 times, Axies become sterile and cannot be used for further breeding.

breed countbreed numberSLP cost
(0/7)1150
(1/7)2300
(2/7)3450
(3/7)4750
(4/7)51200
(5/7)61950
(6/7)73150

As all assets in the game are represented by NFTs and all rewards are paid in AXS or SLP, there are different ways for players to earn income:

» farming SLP and AXS by playing quests or battling other players
» participating in tournaments
» breeding new Axies and selling them on the marketplace
» speculating on rare Axies

In the future, it will also be possible to use AXS for staking. Staked AXS will allow token holders to earn additional AXS from the staking and treasury pool.

Legal and Regulatory Considerations

Now that we know the basic gaming mechanics and the functions of each token, it is time to get a better understanding of the legal and regulatory environment in Japan. As the results of the analysis vary considerably, it is necessary to assess each activity and token individually.

Farming of AXS/SLP: The farming of SLP and AXS by playing quests or battling other players is generally subject to the limitations under the Improper Premiums and Misleading Representations Act (IPMR). The IPMR provides limits for items and other assets that can be given away for ‘free’. In the case of play-to-earn models where players must make an initial investment to play the game, the amount that can be given away for free is limited to JPY 100,000 or 2 percent of the initial sales, whichever is higher, or – for initial investments below JPY 5,000 up to 20 times the price of the initial investment.

Gambling laws do generally not apply as users are not required to pay any fees to qualify for the rewards. The fact that users must purchase three Axies to play the game is irrelevant as the purchase is neither directly nor indirectly linked to the rewards earned by playing quests or battling other players.

As users are not required to pay any fees or other consideration – time and effort spent for playing the game are not considered – there is no purchase or exchange of crypto assets. Crypto asset regulations do therefore not apply to the issuance of AXS and SLP.

Tournaments: Where players are required to pay a fee to participate in a tournament and win rewards, there is a high chance that both the organization of the tournament and the participation in the tournament is considered illegal gambling. Something different only applies where the fees are only used to cover the expenses of the organizer. The expenses may include prizes for the winning players or teams.

Breeding of Axies: Since a user must pay a certain amount of SLP to breed new randomly generated Axies, there is a possibility that the breeding of new Axies is considered illegal gambling.

Selling Axies: When selling items combined with the promise of future returns, companies must comply with the Specified Commercial Transaction Act. Under the act, companies must not engage in certain advertising efforts and must disclose specific information, including the company’s name, to prospects. Given the ambiguous wording of the act, it is uncertain whether it applies to the sale of Axies by Sky Mavis. For sales by users, the act is irrelevant.

Selling AXS, SLP, NFTs by Users: The sale of AXS, SLP, and NFTs by the user is not regulated under Japanese laws.

Marketplace for AXS, SLP, NFTs: AXS and SLP are considered crypto assets under Japanese laws. Anyone who offers a marketplace for the exchange of AXS and SLP would therefore generally have to register as a crypto asset exchange. The same would apply to custodial wallets that manage the private keys controlling the users’ AXS and SLP.

NFT marketplaces for Axies, items, and lands are not regulated in Japan.

DISCLAIMER

The play-to-earn mechanism of Axie Infinity is only used for illustrative purposes. Given the format of the article, not all details of the game mechanics and token design have been considered comprehensively, so that the results of the assessment may deviate from the results by the regulator, or a legal opinion prepared by us or another law firm. By no means, should the explanations be understood as a legal opinion.

Capital and financial markets regulation is based on the principle ‘same business, same risks, same regulation’. At the same time, global standard setters and national regulators alike consistently highlight that regulations are meant to be technology-neutral.

So, what happens if the technology changes the risk profile of a business?

The risk profile is redefined.

In a blockchain context, this seems to be one-directional, however. Rather than considering the full transparency and auditability of permissionless blockchains when assessing the risk profile, the FATF and national regulators do not get tired of stressing the risks related to pseudonymity and peer-to-peer transactions. The fact that blockchain analytics companies can track every transaction on most major networks is only considered as part of the risk mitigation measures.

By then, the risk profile is already established and may cause financial institutions and other regulated entities to refrain from interacting with the blockchain space altogether.

If technology changes the risk profile, it should apply in both directions.

Non-fungible tokens (NFT) have been a topic in the Japanese crypto industry since early 2018. With the NFT craze in 2021, they have become increasingly popular and seen more mainstream adoption. It does, therefore, not come as a surprise that the Japan Cryptocurrency Business Association (JCBA) and Blockchain Contents Association (BCA), as two of the leading industry associations in Japan, issued NFT guidelines more recently.

In this article, we are taking a closer look at the state of the Japanese NFT market and the legal and regulatory environment for NFTs while considering the JCBA and the BCA guidelines.

JCBA NFT-guidelines (April 2021, written in Japanese)
https://cryptocurrency-association.org/dl/nft_guideline202104.pdf

BCA NFT-guidelines (2nd edition) (December 2020, written in Japanese)
https://eb3d626b-4b51-42f2-b2d4-0f682cc5645e.filesusr.com/ugd/e9a87a_2028e5c7115d4fcd933e9f55e6262762.pdf
We have been advising leading blockchain gaming companies on NFTs and other NFT-related matters since early 2018.
In case you are looking for more information on blockchain games and crypto art, you might find the following two articles interesting.

Blockchain Games and the Japanese Law (November 2018, written in Japanese)
https://innovationlaw.jp/blockchain-games-under-japanese-laws/

Buyer Beware – Digital Art and Non-Fungible Tokens (NFT)
https://innovationlaw.jp/en/buyer-beware-digital-art-and-non-fungible-tokens-nft/

I. The State of the Japanese NFT Market

1. Blockchain Games

Traditionally, items purchased in a game could only be used within the game and not be transferred to other players. This has changed with blockchain games, where game items are represented by NFTs. By allowing players to control the NFTs, they become able to buy, sell, exchange, and lend items represented by NFTs to other players – even outside of the game. According to the JCBA, the use of NFTs further ensures that the game assets do not disappear after the termination of the game. What is most likely meant is that the NFT does not cease to exist. Yet, it may lose its value as the represented asset might not be used anymore due to the termination of the game.
Popular blockchain games on the Japanese market include My Crypto Heroes, Crypto Spells, and Contract Servant.

Traditional online games Blockchain games
  1. In-game items do not exist outside of the game and can generally not be transferred, sold, or lent freely to other players outside the game.
  2. Game assets accumulated over time become unavailable and useless after the game is terminated.
  1. Users may transfer, sell, or lend game assets represented by NFTs to other players of the game (Game Assets).
  2. Third parties can provide services using tokens.
  3. As long as a blockchain exists, NFTs representing digital assets are permanently available.

Source: JCBA Guideline, page 4.

(1) My Crypto Heroes
My Crypto Heroes by double jump.tokyo was released in November 2018. The game is an RPG in which players can gather, build their character, and win items by completing challenges and fighting enemies. Both heroes and items are represented by NFTs and can be freely transferred peer-to-peer or traded on NFT markets.

My Crypto Heroes fast became the world’s number one blockchain game and still has the highest number of (active) users and transactions.

(2) Crypto Spells
Crypto Spells by Crypto Games is a card game in which players use cards represented by NFTs to fight with the computer and other players. There are several ways to acquire new cards, including battles and trading/exchanging them with other players within and outside the game.

(3) Contract Servant
Contract Servant by Axel Mark is a card game in which players have a deck of eight cards (servants). There are two types of servants – common servants and token servants, where the token servant is issued as an NFT. The tokens can then be traded among players through a market function. Players are further able to earn rewards from league battles each week.

(4) Other Notable Games
Other notable blockchain games in Japan are Crypton, Crypton Racing, and Brave Frontier Heroes. Further, double jump.toyko launched MCH+, a blockchain game development program that is based on the knowledge gained from My Crypto Heroes.

2. Crypto Art

In February 2021, Christies sold a Beeple artwork for JPY 7.5 billion. The artwork itself is stored on the InterPlanetary File System (IPFS) and represented by an NFT on the Ethereum blockchain. In Japan, a number of crypto art related services have been launched more recently. The major platforms are nanakusa, NFT Studio, and Token Link.

(1) nanakusa
In March 2021, Smart App released nanakusa – a marketplace for crypto art. nanakusa allows crypto artists to mint NFTs and sell crypto art via the platform. Purchasers of crypto art may further sell artworks – or more precisely, the NFT representing the artwork – via the trading platforms. From the information provided, it seems that royalties are paid to the crypto artists for all secondary sales.

(2) NFT Studio
In March 2021, CryptoGames released NFT studio. The platform allows artists to mint NFTs on Ethereum and Polygon for their crypto art. Similar to nanakusa, NFT studio includes features that allow artists to participate in the price for secondary sales.

(3) TOKEN LINK
In January 2021, Platinum Egg released Token Link, an NFT market for game items. Only a few months later, in April, Platinum Egg implemented an auction mechanism for crypto art.

3. NFT Market

(1) Coincheck NFT Market
In March 2021, Coincheck, the operator of one of the largest crypto exchanges in Japan, launched an NFT market. Currently, the only NFTs listed on the market are from Crypto Spells and The Sandbox. More NFTs will be listed in the future. The company has 2 million active users and hundreds of billions of yen in crypto assets under custody. As such, Coincheck will be an important partner for content providers and a gateway to the Japanese market for foreign projects.

When applying for listing, from our experience, projects must provide Coincheck with information about the blockchain used, the primary sale, IP content, and, where applicable, transaction volumes on other markets. As Coincheck is a member of the JCBA and a head of the NFT committee of the JCBA, it is also valuable to check JCBA guidelines in more detail.

(2) Participation by Major Companies
While Coincheck’s NFT market is the first of its kind in Japan, other major companies, including Mercari[1], LINE[2] and GMO Internet group[3] have announced that they are considering launching their NFT market. The entry of other major players is a clear sign that NFTs are gaining increasing mainstream traction on the Japanese market.

II. NFT Guidelines of Japanese Organizations

Currently, there are no laws and regulations that specifically deal with NFTs. Depending on their design, NFTs may, however, fall under the definition of crypto assets, prepaid payment instruments, or money orders under the Payment Services Act (PSA) or the Banking Act or constitute securities within the meaning of the Financial Instruments and Exchange Act (FIEA). Whether this is the case must be analyzed on a case-by-case basis. The guidelines prepared by the JCBA and the BCA aim to provide some more clarity in this regard.

(1) JCBA guidelines
The JCBA is one of the leading industry associations in Japan. Its members range from crypto-asset exchanges to other crypto asset service providers. The NFT committee of the JCBA issued NFT guidelines on April 26, 2021. The guidelines are meant to provide local and foreign NFT issuers with more clarity when applying for a listing on a Japanese NFT market.

Matters covered by the JCBA guidelines
(1) Use cases of NFTs
(2) Flowchart for determining whether NFTS fall under existing laws and regulations
(3) Profit-sharing arrangements
(4) Settlement
(5) Gambling
(6) Premiums and Representations Act
(7) Anonymity and privacy
(8) Security
(9) User protection
(10) Handling of new NFTs (type of NFT that requires careful handling)

The following chart provides a good overview of the key considerations when determining the legal and regulatory environment for NFTs.

Source: JCBA Guideline page 5.

In the case of blockchain games, it is also necessary to consider gambling laws. According to Japanese criminal law, gambling is a criminal offense. It is defined as a game of chance where players can win monetary prizes, except for small gifts. While the definition is rather blurry, NFT issuers implementing mechanics similar to gatcha should consider gambling regulations carefully.

Blockchain games that include incentives for users, such as the free issuance of NFTs, must further comply with the Premiums and Representations Act. The Premiums and Representations Act regulates the free provision of goods and services by a business which aims to induce potential customers to buy the business’s products or services.

The Premiums and Representations Act stipulates limits for lotteries, competitions, etc. While the total amount differs, the following limits must generally be considered for lotteries and other competitions.

  Description Examples The maximum amount of premiums
Premiums (general) Premiums that are offered to anyone visiting a shop or anyone purchasing goods or services. Gifts to all purchasers, gifts to all visitors, etc. (1) If the transaction price is less than JPY 1,000, the premium must not exceed JPY 200.

(2) If the transaction price is JPY 1,000 or more, the premium must not exceed 2/10 of the total transaction price.
Premiums and prices (game of luck and game of skill) Premiums that are given to users as prices in a game of chance or skill. Lotteries at the store.
Quiz games and other games
(1) If the transaction value is less than JPY 5,000, the maximum amount of the prize must not exceed 20x the transaction value.

(2) If the transaction value is JPY 5,000 or more, the maximum amount of the prize must not exceed JPY 100,000.

※Both are capped at 2% of the total transaction value.

Source: Prepared by our office based on the Consumer Affairs Agency website, etc.

The JCBA guidelines further provide that NFT issuers should implement measures that prevent users from using NFTs for money laundering and terrorist financing; consider security risks for storing NFTs and implement measures to deal with thefts or losses; properly explain to users that there is the risk that the NFT might become worthless if the service is terminated; and consider that NFTs are highly likely to be used for criminal purposes, including money laundering.

(2) BCA guidelines
The BCA was established by SNS and gaming companies and is involved in a number of initiatives aiming at the protection of minors and the elderly when using blockchain applications. On March 24, 2020, the BCA published the BCA guidelines on blockchain content (incl. NFTs) to protect consumers and promote self-regulation. A revised version of the paper was published on December 25, 2020.

Matters covered by the BCA guidelines
(1) Gambling
(2) Premiums and Representations Act
(3) PSA
(4) FIEA
(5) Prevention of scams and other fraudulent practices

The interpretation of the laws and regulations, including the PSA, FIEA, Gambling Laws, and Premiums and Representations Act, is largely in line with the interpretation by the JCBA.

With respect to gambling, the BCA guidelines hold that blockchain games should avoid or at least carefully consider implementing any of the following mechanics: (i) in-game gachas (vending machine type mechanics) that issue NFTs or other in-game items; (ii) collection of fees to participate in rewards.; (iii) randomized creation and burning of NFTs and other in-game items with monetary value; and (iv) collection of fees to participate in competitions where the collected fees are distributed to the participants depending on their ranking.

The BCA guidelines further include self-regulation for member companies that include (i) the prohibition of loss compensation, (ii) the prohibition of insider trading, (iii) the monitoring and prevention of market manipulation, and (iv) the obligation to disclose material information to all users.
In addition, the guidelines hold that the issuance of NFTs may involve scams and other fraudulent practices, such as the termination of services shortly after selling the NFTs. To prevent fraudulent practices, member organizations are advised to (i) provide all material information to their users, (ii) secure the necessary funds and resources to ensure that the content shown to the users is actually delivered, and (iii) conduct test sales of NFTs and extensive beta-testing to enable users to understand the content of the services and NFTs prior to the actual launch.

III. Future Issues

Given the fact that NFTs are a relatively new phenomenon that is still evolving, many issues are yet solved. The following explanations are meant to provide some guidance for matters not included in the BCA and JCBA guidelines but relevant for the industry.

(1) NFTs and External Services
In most cases, the data represented by NFTs is stored off-chain. This raises the question of how consumers can be protected from later changes to the service and what companies can do to avoid claims for damages. In the case of blockchain games, NFTs typically represent assets that are stored on the servers of the blockchain game company. If the company now decides to change its terms of use or to terminate its services, this may ultimately render the NFT worthless and, in some cases, non-functional. To ensure that the game company does not face any claims for damage, this scenario must sufficiently be covered in terms of use. The same applies to crypto art, where the artworks are stored on the servers of a marketplace. If the data is stored and subsequently deleted on the InterPlanetary File System (IPFS), the situation is much more unclear and requires further consideration.

(2) NFTs and IP
For NFTs that are used for crypto art or in blockchain games, it is necessary to consider the relationship between the content provider and the holder of the NFT carefully. Two aspects are of utmost importance. First, the rights that are represented by the NFT should be clearly stipulated in the sales documentation of the initial sale. This also includes the question of how the rights represented by the NFT are transferred. Second, the relationship between the off-chain data and the NFT, as well as the retention of the off-chain data, should be considered carefully to avoid potential actions for damages. In cases where the content provider participates in all further sales, this should be clearly indicated in the contract as well. In the future, it is possible to discuss what rights should be granted as best practices.

(3) Issues concerning the trading of NFTs
If not explicitly provided in the contract, it is unclear under Japanese laws whether the rights represented by an NFT – i.e., the economic substance – are transferred (i) if both parties agree to the transfer and the transfer is recorded on the blockchain or (i) by mere agreement. To increase legal certainty and to ensure that the data recorded on the blockchain accurately reflects reality, the terms of sale should clearly stipulate that transfers only become effective if it is recorded on the blockchain. While there is no legal precedent, we believe that this solution is most practical and reflects the parties’ intentions.

(4) Taxation of NFTs
The taxation of NFTs another issue to be considered. In February 2019, the Japan Cryptocurrency Tax Association (JCTA) found that the taxation of income from the sale of NFTs is “an issue that has not been clarified in tax law.” The document finds, however, that “NFTs have an independent value, and if income is generated from the sale or exchange of NFTs, it will generally be taxed as miscellaneous income.”

(5) Secondary distribution of NFTs and rewards for creators
For many projects, content creators are rewarded when a secondary sale takes place. Examples are the above-mentioned nanakusa and NFT Studio, who both pay royalties to the content creator for secondary sales. In other cases, the content creator might want to transfer all his IPs to achieve higher prices for the initial sale. It is likely that both models will exist side by side in the future, but best practices still have to evolve. Further discussions are necessary in that regard.

Disclaimer
The content of this article has not been confirmed by the relevant authorities or organizations mentioned in the article but merely reflects a reasonable interpretation of their statements. The interpretation of the laws and regulations reflects our current understanding and may therefore change in the future. This article does not recommend the use of or investment in NFTs. This article provides merely a summary for discussion purposes. If you need legal advice on a specific topic, please feel free to contact us.

EOD


[1] On April 2, 2021, Mercari announced that it established a new company to plan and develop blockchain-related services, including NFTs.

[2] LINE tweeted recently that it is building an NFT platform. The tweet states that it intends to build services that make it easy to mint, buy, sell, and exchange NFTs.

[3] GMO announced developing a marketplace that allows users to buy and sell NFTs representing digital art and music from famous artists.

On March 19, 2021, the Financial Action Task Force (FATF) announced that it is updating its guidance for a risk-based approach to virtual assets and virtual asset service providers. The update is open for comments until April 20, 2021, and, if implemented as is, will have far-reaching implications for the DeFi space.

The Updates

The updates include the following areas and are meant to provide the public and private sector with more clarity:

  1. definition of virtual assets (VA) and virtual asset service providers (VASP)
  2. guidance on the implementation of the ‘travel rule’
  3. guidance on the risks and potential risk mitigants to P2P transactions
  4. guidance on the licensing and registration of VASP
  5. guidance on the application of the standards to stablecoins
  6. principles of information-sharing and cooperation amongst VASP supervisors

The focus of this post will be on item 1. The other areas will be covered in a separate post in the future.

The definition of VA and VASP

Virtual Assets

“A virtual asset is a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes. Virtual assets do not include digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the FATF Recommendations.”

Source: Glossary of the FATF Recommendations

In the updated guidance, the FATF highlights that no asset should entirely fall outside the FATF standards. At the same time, no asset should be considered both a VA and a traditional financial asset. In cases where it is difficult to characterize an asset as a VA or a traditional financial asset, jurisdictions are required to decide which designation suits best to mitigate and manage the risk of the product. 

So what is a VA according to the FATF?

A VA is not a traditional financial asset. The digital representation of fiat currencies, securities or other financial assets are therefore not covered by the definition. For an asset to be considered a VA, the asset must further be digitally traded or transferred and used for payment or investment purposes. The otherwise denied inherent value of cryptocurrencies is seen as a defining feature of VA.

While it is easy to see that cryptocurrencies, utility tokens and governance tokens are covered by the definition it is not clear whether non-fungible tokens (NFTs) are included as well. Given the fact that they have a similar risk profile with respect to cross-border transfers, their increasing popularity, and pseudonymity, it is however likely that the FATF wants to see these assets covered by the definition as well.

“Assets should not be deemed uncovered by the FATF Recommendations because of the format in which they are offered and no asset should be interpreted as falling entirely outside the FATF Standards.“

Source: Draft updated Guidance for a risk-based approach to virtual assets and VASPs, para 40

To include NFTs representing digital art, collectibles or in-game items would however constitute a departure from the principle of financial markets regulation. After all other unique assets such as traditional arts, real estate, etc. are not covered by the definition of traditional financial assets as well which are fungible by definition – or in other words interchangeable with each other.

Virtual Asset Service Providers

“Virtual asset service provider means any natural or legal person who is not covered elsewhere under the Recommendations, and as a business conducts one or more of the following activities or operations for or on behalf of another natural or legal person:

i. exchange between virtual assets and fiat currencies;
ii. exchange between one or more forms of virtual assets;
iii. transfer of virtual assets;
iv. safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and
v. participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.”


Source: Glossary of the FATF Recommendations

As with the definition of VA, the FATF highlights that the definition of VASP must be interpreted broadly. Without going into the details of what services are covered by item (i) to (iv), the focus of this post is on the question to which extent DeFi protocols are covered. The updated guidance provides more clarity on this which does, however, not necessarily mean that you will like it.

In short, it can be summarized as follows:

Software developers do not fall under the definition of VASP. But – according to the FATF there are hardly any cases where someone only provides a software solution.

So, let’s look at this in some more detail.

In the guidance, the FATF reiterates that it does not intend to regulate technology. The target of regulation are always natural or legal persons – in other words, individuals and legal entities. This point is important as it allows projects to assess whether they fall within the scope of VASP and, where necessary, make changes to their setup. As can be seen from the following statement, this will become increasingly difficult – yet not impossible – in the future.

“The FATF takes an expansive view of the definitions of VA and VASP and considers most arrangements currently in operation, even if they self-categorize as P2P platforms, may have at least some party involved at some stage of the product’s development and launch that constitutes a VASP. Automating a process that has been designed to provide covered services does not relieve the controlling party of obligations.”

Source: Draft updated Guidance for a risk-based approach to virtual assets and VASPs, para 75

According to the FATF, the expansive view is a conscious choice. Despite its commitment to innovation and not regulating software developers, this could still be the ultimate result. Similar to blockchain companies that were not meant to be excluded from traditional finance on a wholesale basis but still have a hard time opening bank accounts, the regulation of software developers might just be another collateral damage, and as such a conscious choice by the FATF.

So, if the regulatory environment was as strict as we claim here, how is it possible that projects like Uniswap allow users to exchange millions worth of dollars daily without being regulated?

First, the new guidance has not been finalized yet.

Second, the guidance has not been implemented into national law yet.

Third, even if it was implemented as is, law enforcement is still a different issue altogether.

The fact that the FATF intends to update its guidance on VAs and VASPs shows that the success of DeFi has not gone unnoticed. From the request for public comments, it is also clear that the overall direction is set – more regulation rather than less. The request only aims at removing potential ambiguities that could give countries room for interpretation and offer loopholes for DeFi projects and other innovations.

Getting back to Uniswap which was initially funded by venture capital, there is indeed the risk that it falls under the definition of VASP. The fact that the governance of Uniswap was largely distributed to the community by an airdrop last year, does not necessarily lead to a different result if other elements of the VASP definition remain in place.

Where the initiators of a protocol, for example, control the admin keys of the exchange’s smart contracts, the initiators may be considered a VASP. If transaction fees, on the other hand, are not distributed to the initiators of the protocol but the liquidity providers, this may lead to different results as the VASP – if existent – is not provided as a business.

Since there is no bright line test, there is always the possibility that DeFi protocols or the teams behind them are considered VASP. As the FATF wants its recommendations to be as broad as possible, it is highly likely that the teams behind DeFi protocols will initially be considered VASP unless active measures are taken, and proper structures implemented are implemented to further mitigate this risk.

Conclusion

The updated guidance shows that the FATF has been monitoring the DeFi space closely. If implemented as is, most projects will be covered as VASP under the new guidance. The growing regulatory burden has the potential to slow down innovation in the DeFi space. More likely than not, the industry will however find an appropriate answer which either includes increasing decentralization or the implementation of new solutions such as DeFi Compli from CipherTrace.

Besides all the criticism, the new regulations should also be considered as an opportunity for CeFi as it will most likely allow registered exchanges to implement DeFi solutions much more easily.

In 2019, Andreessen Horowitz predicted that in the not-too-distant future every company will be a FinTech company. Fast-forward to today, and most large companies embed financial services into their products to streamline the customer journey and increase their lifetime value.

Embedded finance typically covers the following services:

Generally speaking, there are three different types of entities involved in embedded finance – brands, enablers, and license holders.

BrandsNon-financial services companies that embed financial services into their platforms and applications to improve the user experience and increase their lifetime value.
EnablersCompanies acting as the middle layer between brands and license holders.
License HoldersFinancial services companies that are registered with or licensed by the Financial Services Agency (FSA)

Historically, enablers and license holders have been largely identical in Japan. Yet, there is no particular reason why this should not change. In particular, the amended Act on the Provision of Financial Services is likely to bring new momentum to the FinTech industry as it allows financial intermediaries to provide services across different sectors with a single registration.

For brands the upcoming changes mean that they will be able to embed different types of financial services much easier, which in turn will drive demand for enablers connecting them smoothly with different license holders.

What type of license should the license holder hold?

The type of license depends on the kind of services the license holder intends to provide. In most cases one of the following licenses is required:

One example that might be different from other jurisdictions is to the provision of lending services in online shops. Depending on the type of lending services different licenses are needed. A careful analysis is therefore necessary.

If the license holder, for example, makes the payment on behalf of the buyer by granting an instalment loan, this is considered an ‘instalment sale’ which falls under the supervision of the Ministry of Economy, Trade and Industry. If the license holder, however, lends the money to the buyer, and the buyer uses that money to pay the shop, lending regulations apply, and the license holder falls under the supervision of the Financial Services Agency.

What type of license does a brand need?

A brand only needs a license if it acts as an intermediary for financial services. ‘Intermediation’ under Japanese laws is understood broadly and covers any act that furthers the execution of financial contracts. If a brand’s application, for example, seamlessly integrates financial products, this is generally considered an intermediation of financial services.

On the contrary, the introduction of financial products does generally not require a license. If a user is forwarded to the license holder’s website to purchase financial products, for example, the brand is not regulated.

Until this year, the intermediation of different kinds of financial services required different licenses. The intermediation of banking services required a banking agent license, the intermediation of securities services required an intermediation of financial instrument license and so on. For the intermediation of different types of financial products, the brand therefore needed different licenses. From mid of this year, this will change however, and a single license will be sufficient.

What type of license does an enabler need?

If an enabler provides intermediary service as described in the previous section, it has to apply for an intermediation license.

If an enabler, however, only provides a software solution connecting the brand with the license holder a license is not required.

Overview

Depending on the exact service, companies may or may not be subject to license requirements in Japan. At a very high level the regulatory environment is as follows:

A more detailed overview can be found in the following section.

Detailed overview of what licenses are necessary

As mentioned above, the license requirements differ considerably depending on what kind of service is carried out. A careful case-by-case analysis is therefore necessary.

EMBEDDED PAYMENTS

Instruction by brand

brandenablerlicense holder
service providedbrand instructs user’s bank to transmit money to brand’s account for purchasing goods or servicesprovides API for instructionmoney transfer
applicable lawsnot regulatednot regulatedBanking Act (BA) or Payment Services Act (PSA)
license/registration requirementnot regulatednot regulated  banking license under BA or money transmitter license under PSA

Instruction by third party

brandenablerlicense holder
service providedinstructs user’s bank to transmit money to brand’s accountmoney transfer
applicable lawsBA or not regulatedBA or PSA
license/registration requirementregistration as electronic payment services provider under BA if instruction is given to bank   not regulated if instruction is given to money transmitter  banking license under BA or money transmitter license under PSA

Payment by third party (performance by user at the time enabler receives payment)

brandenablerlicense holder
service providedentrusting the collection of payment to the enablerreceiving payment from user and making payment to brand   (performance by user under the agreement with brand at the time enabler receives payment)
applicable lawsnot regulated
license/registration requirementnot regulated  

Money transmission (not related to the purchase of goods or services)

brandenablerlicense holder
service providedbrand instructs user’s bank to transmit money to another person’s accountmoney transfer
applicable lawsBA or not regulatedBA or PSA
license/registration requirementregistration as electronic payment services provider under BA if instruction is given to bank   not regulated if instruction is given to money transmitter.  banking license under BA or money transmitter license under PSA

EMBEDDED LENDING

Inhouse instalments

brandenablerlicense holder
service providedbrand provides installment loan to user to finance purchases
applicable lawsInstallment Sales Act
license/registration requirementnot regulated

Credit purchase brokerage

brandenablerlicense holder
service providedbrand intermediates advance payment and installment payment from license holderslicense holder makes advance payments to brand and receives installment payments from user
applicable lawsnot regulated-Installment Sales Act
license/registration requirementnot regulatedregistration as credit purchase brokerage business and in cases where the amount is less than JPY 100,000 registration as small-amount credit brokerage business

Loan affiliated sales

brandenablerlicense holder
service providedbrand intermediates loan and then jointly and severally guarantees the loan paymentlicense holder provides loan to user to finance purchase in brand’s online shop
applicable lawsInstallment Sales Act, BA or Money Lending Business Act (MLBA) or Financial Services ActBA or MLBA
license/registration requirementbrands must comply with some duties under the Installment Sales Act (no license/registration)   intermediaries of loans must obtain a bank agency business license under BA or register as money lending business under the MLBA or as financial services intermediary under Financial Services Actbanking license under BA or registration as money lending business under MLBA  

Affiliated loan

brandenablerlicense holder
service providedprovides access to loan products in its online storelicense holders provides loan to user to finance purchase in brand’s online shop
applicable lawsBA or MLBA or Financial Services Act BA or MLBA
license/registration requirementintermediaries of loans must obtain a bank agency business license under BA or register as money lending business under the MLBA or as financial services intermediary under Financial Services Actbanking license under BA or registration as money lending business under MLBA

EMBEDDED INVESTMENTS

brandenablerlicense holder
service providedprovides interface for investments in securities through appinvestment into securities
applicable lawsFinancial Instruments and Exchange Act (FIEA)FIEA
license/registration requirementif brand is a financial institution, it must be registered as a financial institution engaging in the investment advisory and agency business; it is not allowed to use a financial services intermediary under the FIEA   if the brand is not a financial institution, it can act under the investment advisory business or as a financial instruments intermediary business under the FIEA or a financial services intermediary business under the Financial Services Actinvestment business under the FIEA

EMBEDDED INSURANCE

brandenablerlicense holder
service providedprovides access to insurance products in its online storeprovides insurance products
applicable lawsInsurance Business Act or Financial Services ActInsurance Business Act
license/registration requirementregistration as insurance agent under Insurance Business Act or financial services intermediary under Financial Services Actinsurance business license or small insurance business license

EMBEDDED BANKING

brandenablerlicense holder
service providedprovision of withdrawals and deposits through the appdeposit
applicable lawsBA or Financial Services ActBA
license/registration requirementpermission for banking agency business under BA or registration as financial services intermediary business under Financial Services Actbanking license

EMBEDDED CARD PAYMENTS

Debit cards issued by large companies

brandenablerlicense holder
service providedissuance of debit cards linked to bank accountsdeposits
applicable lawsBA or Financial Services ActBA
license/registration requirementpermission for banking agency business under BA or registration as financial services intermediary business under Financial Services Actbanking license

Debit cards issued by money transmitters

brandenablerlicense holder
service providedissuance debit cards linked to money transmitterstransfers
applicable lawsPSAPSA
license/registration requirementnot regulatedregistration as money transmitter under PSA

EOD

Photo by Ashwin Vaswani on Unsplash

Non-fungible tokens (NFTs) have become increasingly popular more recently. Starting with small blockchain games such as Crypto Kitties in 2017, they have entered public awareness with NBA Top Shot and the Christie’s auction raising USD 70 million for a digital art piece.

Given the recent success and increasing interest of mainstream media, it is time to take a closer look the mechanics and legal classification of NFTs. In many cases it is still unclear what NFTs legally represent, and poor technical implementation may render them worthless despite the buyer spending millions of dollars.

Definition

NFTs are commonly said to represent something unique. It may therefore come as a surprise that the content represented by the NFT can often be downloaded by anyone and duplicated freely. Take ‘Everydays: The First 5000 Days’ which was auctioned off by Christie’s recently. While you cannot simply download the high-resolution picture from Christie’s website directly, it is recorded on the Inter Planetary File System (IPFS) where it can be accessed and downloaded by anyone. The file stored on IPFS is the same file the buyer of the digital artwork will eventually receive.

https://ipfsgateway.makersplace.com/ipfs/QmZ15eQX8FPjfrtdX3QYbrhZxJpbLpvDpsgb2p3VEH8Bqq

Beeple (b. 1981), Everydays: The First 5000 Days – Sold for USD 69,346,250 by Christie’s

The high-resolution file is recorded on IPFS and can be accessed and downloaded by anyone. The size file is 326MB. It might therefore take some time to download.

So, if the content is not unique, what is it, then? In fact, it is the token itself. NFTs, unlike other tokens, are not interchangeable. Each NFT has unique features and given these features, a different economic value. While you can easily interchange ten ERC-20 tokens with ten ERC-20 tokens of the same kind, you cannot do this with NFTs as you will end up with tokens that have different features and a different economic value.

Implemented properly, NFTs inextricably link to the content which they represent. Depending on the design, they may represent digital ownership or some other rights and make the otherwise easily duplicable content scarce.

Common use cases

Common use cases of NFTs include digital art, digital collectibles, in-game items and worlds, domain names, event tickets, and fan tokens. The focus of this post will be on digital art.

The anatomy of NFTs and related problems

When dealing with NFTs it is important to understand why an NFT is unique, but more importantly, how it links to the content represented by it and where the content is stored.

On Ethereum, there are different token standards for NFTs – ERC-721 and ERC-1155. In the case of ERC-721, the NFT contains a mapping of unique identifiers with each identifier representing a single asset/content. In addition, it allows to track the owner of the token easily and creates a public trail of ownership. In the case of ERC-1155, the identifiers do not represent single assets but groups of assets. Tracking the provenance of single tokens is only possible if an ERC-721 superset is implemented. Given the possibility to track provenance, digital art typically uses the ERC-721 standard.

The metadata, which makes a token unique may either be on-chain or off-chain. Because of the costs for storing something on-chain, it is typically stored off-chain. In these cases, the NFT only contains a pointer to an external source which is typically an URL.

Once minted the data on the token becomes immutable and cannot be changed.[1] Depending on how the external content is stored the same is not necessarily true for the content. If the pointer in the NFT points to a URL that is controlled by a central entity or the artist himself, the artist may decide to replace the picture stored under the URL or to delete it completely. In addition, the link itself may be removed resulting in the NFT pointing to a 404 website.

Ultimately, this would leave the owner of the NFT in a very bad position as he still owns the NFT pointing to the URL where the digital art was originally stored. To draw attention to this issue, neitherconfirm replaced digital art with pictures showing rugs more recently.

To avoid this from happening and to ensure the data lives on forever, more recent projects including Beeple’s artwork on Christie’s use IPFS. Unlike current URLs, the IPFS creates unique URLs for files stored on the IPFS in a decentralized manner. If the file is changed, a new URL will be produced, meaning that the original file will always sit at the URL referenced in the NFT. Stated differently, the content and the token will become inextricably linked.

Legal issues

As important as the technical implementation is the question of what NFTs legally represent. This is important as it may limit what the creator or the buyer of an artwork can do, which again affects the price – both for primary and secondary sales. Other issues include the legal classification of NFTs under the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA), their custody, and consumer protection laws.

Copyright and Ownership

Art, in general, involves a number of complex questions revolving around ownership and copyright. When creating an artwork, the creator generally becomes the first copyright owner. Registration at the copyright office is not necessary but may be advisable in some cases as it establishes a record of copyright ownership. For digital artworks, the same result can be achieved by signing the picture digitally, recording the corresponding NFT on the blockchain, and storing the high-resolution file on the IPFS.

But what does the NFT exactly represent? Digital ownership? Copyright? Or both?

This really depends on the artist as well as the platform the artist uses to sell his artworks. At an absolute minimum, an NFT represents digital ownership. The ownership of a digital artwork is transferred when transferring the NFT itself. The copyright, however, remains with the creator unless explicitly agreed otherwise.

As the first copyright owner, the artist has the exclusive right to make copies, sell and distribute the copies, prepare derivative works based on the copyrighted artworks and publicly display the artworks. In case you have been wondering how it is possible that some of the pictures in Beeple’s ‘Everydays: The First 5000 Days’had been sold in other auctions before but are still shown in his latest piece – this is the reason.

Beeple (b. 1981), Everydays: The First 5000 Days with one of the artworks sold earlier on Nifty Gateway

The copyright gives creators the following rights/protection:

Compared to copyright, ownership rights are rather limited and, broadly speaking, restricted to non-commercial use.

If a creator wants to grant the owner the right to use the artwork for commercial purposes (merchandize, display, etc.), he may either transfer the copyright or grant the owner a license to use the artwork commercially.

It should be noted that some platforms require creators to give the platform a license to use the artwork for commercial and non-commercial purposes. In the case of Open Sea, for example, the creator grants the platform a worldwide, non-exclusive, royalty-free license to use the uploaded artworks for non-commercial and commercial purposes.

“By submitting, posting or displaying Content on or through the Services, you grant us a worldwide, non-exclusive, royalty-free license (with the right to sublicense) to use, copy, reproduce, process, adapt, modify, publish, transmit, display and distribute such Content in any and all media or distribution methods (now known or later developed). This license authorizes us to make your Content available to the rest of the world and to let others do the same. You agree that this license includes the right for OpenSea to provide, promote, and improve the Services and to make Content submitted to or through the Services available to other companies, organizations or individuals for the distribution, promotion or publication of such Content on other media and services. Such additional uses by OpenSea, or other companies, organizations or individuals, may be made with no compensation paid to you with respect to the Content that you submit, post, transmit or otherwise make available through the Services.” OpenSea, Section 9 Terms of Service

When selling digital artworks to users, the creator must therefore consider which rights he has already granted to the platform to avoid potential conflicts. If a creator has given the platform a non-exclusive license to use the artwork for commercial purposes, he cannot grant an exclusive license to the buyer anymore.

Hashmasks clearly distinguished between ownership and copyright as well. In its terms and conditions, Hashmasks states that the buyer of the NFT does not only become the owner of the artworks but also that he is granted an unlimited worldwide, exclusive license to use, copy and display the purchased art.

You Own the NFT. Each Hashmask is a NFT on the Ethereum blockchain. When you purchase a NFT, you own the underlying Hashmask, the Art, completely. Ownership of the NFT is mediated entirely by the Smart Contract and the Ethereum Network”Hashmask, Section 3.A.i. of the Terms and Conditions
Subject to your continued compliance with these Terms, The Company grants you an unlimited, worldwide, exclusive, license to use, copy, and display the purchased Art for the purpose of creating derivative works based upon the Art (“Commercial Use”). Examples of such Commercial Use would e.g. be the use of the Art to produce and sell merchandise products (T-Shirts etc.) displaying copies of the Art.” Hashmask, Section 3.A.iii. of the Terms and Conditions

Even where the creator and the buyer explicitly agree on the transfer of the copyright or the granting of a license, the token does not necessarily reflect the exact terms. Written in natural language, the terms do not become part of the code. To ensure that all parties are always fully aware of the rights represented by the NFT, it is advisable that the NFT points to the respective terms and to store the terms on the IPFS. In this case, the NFT would not only serve as a track record of ownership but also bring more clarity with respect to the rights represented by it.

Crypto regulations and custody

According to the Japanese Financial Services Agency (FSA), NFTs are generally not considered securities or crypto assets. Trading, intermediary services for the trading, as well as the provision of custody services is therefore not regulated and may be performed without a license.

If a platform accepts BTC, ETH, or some other crypto asset as payment and manages the funds on behalf of the artist, the platform would however have to register as a crypto asset service provider with the FSA as it would engage in regulated activities – here the provision of custodian services.

BTC, ETH, etc. can be used for payment. There are no legal or regulatory limitations.

Consumer protection

Consumer protection laws only apply if the artist sells his artworks as a business. This must be assessed on a case-by-case basis. Where the pictures are sold by a platform, consumer protection laws generally apply.

AML/CFT Regulations

Since art dealers are not regulated, they do not have to comply with AML/CFT regulations.

Tax

Gains from the sale of NFTs are classified as miscellaneous income under Japanese tax law. As such they are subject to a progressive tax rate of up to 45% plus a fixed local inhabitants’ tax of 10%.


[1] In many cases, it is still possible to change the metadata in the smart contract. It is therefore advisable to analyze each smart contract carefully.