A regulatory horizon for non-fungible tokens under newly adopted Ukrainian virtual assets law
On 15 March 2022, the President of Ukraine has signed the Law of Ukraine “On Virtual Assets” No. 2074-IX of 17 February 2022 (the “Virtual Assets Law”). In this overview we summarise what’s in store for those involved in circulation of non-fungible tokens (“NFTs” or “NFT”).
NFTs under the Virtual Assets Law
The Virtual Assets Law defines the “virtual assets” as intangible benefits expressed as a dataset in the electronic form, that have certain value. Virtual assets are divided into secured and unsecured. Secured virtual assets certify proprietary rights, in particular, the right to claim other objects of civil rights. For regulatory clarity, the Virtual Assets Law expressly states that securing virtual assets should not be treated as a security interest. In its turn, unsecured virtual assets do not represent any rights or assets. The Virtual Assets Law also introduces the concept of financial virtual assets. The Virtual Assets Law neither provides an NFT definition, nor specifically regulates circulation of such digital assets type.
In light of the above classification, the NFT would likely fall within the meaning of secured virtual assets as it usually certifies the proprietary rights to a unique digital version of an underlying digital asset (e.g., digital photograph, video, tweet or other digital content) or physical asset (e.g., an image or video of fine art, sculptures, monuments, luxury goods or other tangible assets).
As NFTs uniqueness and ownership can be demonstrated and verified using distributed ledger technology, it helps to create value for NFTs. Value is also an essential element for NFTs to be qualified as a virtual asset under the Virtual Assets Law. On a related note, under the Virtual Assets Law, a virtual assets market participant has, among others, the right to define a monetary value of the virtual asset at his or her discretion. In our opinion, this right also extends to smart contract arrangements.
Notably, in order to ensure compliance of virtual assets with the classification of the virtual assets under the Virtual Assets Law, one of the regulators of the virtual assets market National Securities and Stock Market Commission (the “Commission”) will also have the authority to issue official virtual asset classification conclusions.
Scope of the Virtual Assets Law
The Virtual Assets Law is broad in scope. Its applicability is not limited to the NFTs minted outside Ukraine. Moreover, the Virtual Assets Law will likely be applicable to the transactions between residents and non-residents of Ukraine. Legally speaking, it will apply to the relations which arise:
- in case of providing services which are related to circulation of virtual assets, if participants of such relations have registered location or permanent representative office in Ukraine;
- in connection with entering into an agreement the subject matter of which is a virtual asset, if the parties have agreed that Ukrainian law should apply either to the entire agreement or a part thereof;
- in connection with entering into an agreement the subject matter of which is a virtual asset if both parties are residents of Ukraine;
- in connection with entering into an agreement the subject matter of which is a virtual asset if a person that carries out operations with virtual assets in its own interests (purchaser of virtual asset) is a resident of Ukraine.
If, either by operation of law or under an agreement between the parties, Ukrainian law applies to a transaction on disposal of an object of civil rights that secures a virtual asset, the Ukrainian law also applies to the relations with regard to circulation of such virtual asset. It virtually means that if Ukrainian law applies to disposal of a digital asset (e.g., a digital photograph created by a Ukraine-based photographer in Ukraine) or a physical asset (a monument in Kyiv), Ukrainian law will also apply to circulation of a unique digital version of an underlying ‘tokenised’ digital asset or physical asset.
It is also expected that both regulators of the virtual assets market, the Commission and the National Bank of Ukraine (for virtual assets backed by currency assets), will be issuing guidance on the applicability of the Virtual Assets Law to various practical situations with virtual assets, including the NFTs.
Circulation of the NFTs under the Virtual Assets Law
The Virtual Assets Law per se does not provide for extensive specific regulation on NFTs transactions, including specific requirements to the essential terms and form of the respective agreements. Nevertheless, basic virtual assets regulation under the Virtual Assets Law as well as other applicable laws shed some light on what to expect from the Ukrainian law perspective:
- an agreement on NFT creation (known as minting) shall define an object of civil rights that secures the virtual asset. Such agreement may also contain provisions on replacement of the initial object of civil right that secures the NFT in case it ceases to exist (no longer valid) or was removed from civil use for whatever reasons. The Virtual Assets Law stipulates that similar replacement provision can also be included in an NFT purchase agreement.
On a related note, in case an object of the civil rights that secures the NFT is encumbered or is removed from civil use, the sale of such NFT is prohibited. Any purchase of the NFT with underlying encumbered asset shall be treated as null and void.
- since copyright to some specific work will be a likely object of the civil rights that secures the NFT as a virtual asset, a copyright license will be required, so that the purchaser of the NFT will be able to legitimately use the unique digital version of the work. In this regard, the Virtual Assets Law requires that proprietary rights to the object of civil rights which secure a virtual asset should be assigned to a person that acquires rights to such virtual asset. It means that copyright to the unique digital version of the work should be assignable to a new owner (purchaser), i.e., the copyright license should also include the right to resell that copy of the work.
Notably, the Ukrainian copyright law requires that a copyright license agreement must be in writing. In some cases, electronic form of the copyright license agreement can also be treated as written form.
- the Virtual Assets Law provides for basic regulation for smart contracts (an agreement written in computer code with automated performance). Where relevant, smart contract terms should be defined in the agreement on creation (minting) of the NFT.
- the Virtual Assets Law sets detailed requirement to the content of public offer of virtual assets, including its posting, as well as the language requirements.
- agreements on custody/administration of virtual assets or keys of virtual assets shall be governed by the respective provisions of the Civil Code of Ukraine with regard to the storage agreements taking into account the provisions of the Virtual Assets Law.
Under the Virtual Assets Law, an owner of a virtual asset key is deemed to be the owner of such virtual asset (virtual asset key is a Ukrainian analogue of the ‘token’ definition), unless:
- the virtual asset key or the virtual asset is stored by a third party in accordance with the terms of the transaction between the custodian and the owner of such virtual asset;
- the virtual asset is transferred for storage to any person in accordance with the Virtual Assets law or a court decision that has entered into force; or
- the virtual asset key was acquired by a person illegally.
Furthermore, in order to ensure lawfulness of the transactions with the NFTs as virtual assets under the Virtual Assets Law, it is important that it is conducted with the engagement of the relevant Ukrainian or non-Ukrainian legal entity that has obtained proper permit to provide the virtual assets services. The local permit is required for:
- custody or administration of virtual assets and/or virtual asset keys;
- exchange of virtual assets;
- transfer of virtual assets; and
- intermediary services associated with virtual assets.
Finally, the Virtual Assets Law allows owners of virtual assets to open bank accounts for transactions with such assets. Another important legislative upgrade is the regulation on declaring virtual assets (submitting electronic declarations) by individuals under the Law on Prevention of Corruption.
Protection of rights to the NFTs
Under the Virtual Assets Law, the virtual assets market participants have, among other, the following rights:
- judicial and other legal means of protecting the rights to their virtual assets; and
- the right to protect their personal data in accordance with the Law of Ukraine “On Personal Data Protection”.
When the Virtual Assets Law becomes effective?
The Virtual Assets Law shall become effective upon adoption of the amendments to the Tax Code of Ukraine governing tax reporting and taxation of transactions with the virtual assets for individuals and legal entities. On 13 March 2022, draft law No. 7150 for amending the Tax Code of Ukraine was registered with the Ukrainian Parliament, so it is only at the beginning of the lawmaking process. In the best-case scenario, tax part of the virtual assets legal framework will be adopted by the end of 2022 and will enter into force as of 1 January 2023.
The Virtual Assets Law also establishes a six month transition period for both regulators of the virtual assets market for amending the relevant secondary legislation.
The Diia City legal framework is in effect as of 15 February 2022, but currently, the virtual assets service providers are not eligible to become the Diia City residents. Delaying with the entering of the Virtual Assets Law into force delays the applicability of the Diia City legal framework to the virtual assets service providers. In particular, according to the Final and Transitional Provisions of the Diia City Law, virtual assets service providers will be eligible to become the Diia City residents in six months after the Virtual Assets Law effective date.
Information contained in this overview is for general information purposes only, does not constitute legal or other professional advice, and should not be relied upon as a substitute for specific professional advice tailored to particular circumstances.