Foreign NFT marketplaces and platforms: Do they need to comply with Ukrainian virtual assets law?

Virtual assets blue ocean is becoming more regulated. With the Law of Ukraine “On Virtual Assets” No. 2074-IX of 17 February 2022 (the “Virtual Assets Law”), many popular services in the digital realm involved in circulation of virtual assets may be subject to an additional regulatory burden.

Marketplaces for non-fungible tokens (the “NFTs“) are not an exception. Most of the well-known NFT marketplaces are based abroad in jurisdictions that offer them suitable and preferential conditions. In this newsletter we discuss whether the already existing NFT platforms which operate outside Ukraine need to comply with the Virtual Assets Law.

NFTs as secured and unsecured virtual assets

In our last newsletter we discussed the regulation of NFTs in Ukraine and how they can be interpreted under the Virtual Assets Law. In sum, NFTs would likely fall within the meaning of secured virtual assets as they usually certify proprietary rights to a digital asset (digital photo, video, tweet or other digital content) or tangible asset (an image or video of fine art, sculptures, monuments, luxury goods etc.).

It remains disputable but it may also be that NFT is also classified as unsecured virtual asset. In such case, the NFT does not certify any proprietary rights (e.g., a photo of a person uploaded from the Internet and further tokenised without securing any rights to use such photo for tokenisation). One of the obligations of the virtual assets market participants under the Virtual Assets Law is to conduct transactions with virtual assets in good faith and at their own risk. Therefore, in terms of the Virtual Assets Law, those NFTs which qualify for unsecured virtual assets still remain a legitimate asset (though more speculative).

The regulated virtual assets services (activities) which we will further discuss generally apply to both secured and unsecured virtual assets (NFTs) without any specific segmentation between different types of virtual assets.

Regulated virtual assets services

Depending on the business model of the NFT marketplace, at least three types of marketplaces are known: open marketplaces, curated marketplaces and proprietary marketplaces. Other variations of NFT marketplaces do exist and, without doubt, new business models will likely emerge as a result of further development of the virtual assets industry. From a regulatory perspective, the extent of the marketplace’s involvement in the NFT transactions is a decisive factor to consider whether the marketplace is subject to licensing in Ukraine.

The marketplace usually seeks a contract to be directly between the buyer and the seller taking the position that it is administrative only and merely facilitates transactions between buyers and sellers. Still, considering complex new regulation of the virtual assets under the Virtual Assets Law, it is important for NFT marketplaces to analyse if they (entirely and some of their functions) and/or third-party service providers which they engage for supporting the marketplace operation fall within the scope of the regulated services under the said law:

• custody or administration of virtual assets and/or virtual asset keys

This regulated activity involves storage of virtual assets, or keys of virtual assets, with the ability for the custodian to independently move such virtual assets in the interests and on behalf of third parties.

Service provider transfers virtual assets only if such transfer is carried out under instructions of the owner of the virtual asset and it is expressly stated in a storage or administration agreement with owner of the virtual assets.

• exchange of virtual assets

This regulated activity involves exchanges of virtual assets exclusively to other virtual assets or to Ukrainian Hryvnia (UAH), and, when allowed by the National Bank of Ukraine, to other currencies.

This regulated activity shall be carried out for third parties and/or under instructions and in the interests of third parties.

• transfer of virtual assets

This regulated activity involves transfer of virtual assets in the interests of third parties between the wallets of third parties. Any ancillary activity where a service provider cannot directly influence, make decisions or control the transfer of virtual assets, is out of the scope of this regulated activity.

• intermediate services associated with virtual assets

This regulated activity involves conducting virtual assets transactions, including public offerings, in the interest of third parties. Service provider can provide the intermediary services in its name and on behalf of third parties, under instructions of third parties and at their expense. From a Ukrainian law perspective, it virtually means conclusion of two types of agreements: (i) commission agreement where service provider shall conduct one or several transactions on behalf of its client and at the expense of the client; (ii) agency agreement where a service provider shall conduct one or several transactions in its name but under instructions of the client and at the expense of the client.

Licensing requirements to providers of regulated services

The Virtual Assets Law provides the framework requirements for service providers, which at the very least cover perfect business reputation of C-level management, founders, major stake holders and ultimate beneficiary owners, transparency of corporate structure, money laundering law compliance etc.

There is also a requirement set for the minimum amount of statutory capital for foreign service providers. The amount varies depending on the type of the regulated activity — approx. EUR 193,000 for custody and administration services and approx. EUR 97,000 for other regulated activities (as of the date of this newsletter).

What if foreign NFT marketplace does not comply?

The Virtual Assets Law provides that carrying out the regulated activity without obtaining a proper license can lead to a fine of approx. EUR 1,100 – 3,800 (as of the date of this newsletter).

There is also a risk of blocking access to online resource. Failure to obtain a license may not be the only ground for blocking. For example, granting a website blocking injunction in the criminal proceedings regarding money laundering can also be one of the grounds.

Due to the lack of sufficient statutory regulation, the current practice of blocking access to online resources is mainly based on the court practice. However, both the court practice and statutory regulation is constantly evolving concerning this issue, so the risk of blocking the NFT platform in Ukraine requires regular re-assessment.

Tax considerations and Diia city regime: can NFT marketplace benefit?

In our last newsletter we also highlighted that the Virtual Assets Law will be enacted after the Tax Code of Ukraine will be amended to stipulate taxation of transactions with the virtual assets for individuals and legal entities.

Draft Law No. 7150, dated 13 March 2022 can shed some light on the expected tax issues. According to the Draft Law, only capital gains from sale-purchase of virtual assets and profit from regulated virtual asset services are proposed to be taxed. Considering that the NFT marketplaces do not usually own NFTs, they are unlikely to be taxed under the upcoming special rules. However, the marketplaces may be taxed under general rules for intermediary service providers where commission profit is taxed.

Finally, NFT marketplace can benefit from the Diia City regime only if it has a local company in Ukraine and carries out one of the regulated virtual assets activities or other types of IT / tech industry activities which are eligible for the Diia City residency. Otherwise, foreign NFT marketplace is not eligible.

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.

Oleg Klymchuk, Ivan Chopyk