Game-changer? Regulatory implications for NFTs in sport

There has long been a market for sports memorabilia and collectibles and so it is no surprise that sport is at the forefront of their digital equivalent: non-fungible tokens (NFTs). But as sports NFTs become more popular, questions arise about how they differ from conventional (regulated) forms of trading and investment and the regulations that apply to them. 

What are NFTs and how are they being used in the sports sector?

Non-fungible tokens are generally unique cryptographic tokens. Their unique nature derives from the fact that each NFT is a distinctly constructed digital representation. For example, X Evolutions is a unique digital luxury sneaker created by RTFKT (recently acquired by Nike).

NFTs therefore generally differ from cryptocurrencies which are “fungible” or interchangeable. For example, each Bitcoin has the same value and is indistinguishable from another Bitcoin.

NFTs are increasingly being monetised, traded and promoted in the sports sector, from sports trading cards and limited-edition video clips of sporting moments to luxury sneakers. Football clubs, including Premier League champions Manchester City, and superstar players such as Lionel Messi (Messiverse), have marketed individual digital NFT artworks. It is predicted that NFTs for sports media will generate more than US$2 billion in transactions in 2022.

Given they are distributed over the internet, access to NFTs can be global. Accordingly, several distinct areas of law, across many jurisdictions, including securities laws, intellectual property and tax, may apply. This article focuses on the potential UK financial regulation consequences for sports NFTs.

Do I need a licence to trade sports NFTs in the UK?

In most cases, activities relating to the minting, buying and selling of sports NFTs in the UK do not require a licence under currently applicable financial services legislation.

The regulatory analysis of any asset depends on its specific characteristics, and NFTs are no different. Most sports NFTs do not exhibit characteristics of regulated e-money tokens (since they do not have electronically stored monetary value) or of regulated security tokens (since they generally do not qualify as investments like shares, bonds or units in a fund) under the Financial Conduct Authority's (FCA) categorisation (see our Fintechlinks blog here). Sports NFTs are also unlikely to be considered as “cryptocurrency derivatives”, although specialist advice should be sought if the NFT exhibits characteristics of a derivative such as a future, contract for differences or an option. 

This means that, unlike trading platforms and businesses which trade or facilitate the trading of regulated financial products, sports NFT trading platforms and businesses will most likely be able to operate in the UK without a regulatory licence.

Do money laundering controls apply to sports NFT service providers?

Sports NFT trading platforms and businesses facilitating the exchange of NFTs could be subject to the UK’s anti-money laundering regime if the NFTs being traded are deemed to be cryptoassets.

The UK’s money laundering regulations (MLRs) apply to cryptoasset exchanges and custodian wallet providers conducting business in the UK. These crypto businesses must apply for registration with the FCA. The MLRs require crypto businesses to carry out due diligence on customers to assess their money laundering risk and to monitor transactions.

The question is whether sports NFTs, and the businesses providing services in relation to them, fall within the scope of the relevant definitions in the MLRs.

• The MLRs define a cryptoasset as “a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically”. 

• Cryptoasset exchange providers include firms which provide services of “exchanging, or arranging or making arrangements with a view to the exchange of, cryptoassets for money or money for cryptoassets”.
• Custodian wallet providers are defined as firms which provide services to “safeguard, or to safeguard and administer, cryptoassets on behalf of customers, or private cryptographic keys on behalf of customers in order to hold, store and transfer cryptoassets”.

The definition of cryptoasset is evidently broad and arguably capable of capturing NFTs. A regulatory analysis will likely hinge on whether any given NFT represents a “digital representation of value” (e.g. a virtual currency or store of value) or “contractual rights”, although there is currently little guidance in respect of what this means in practice. If sports NFTs fall into either of these categories, service providers involved in trading them may consequently fall within the definition of either a cryptoasset exchange provider and/or a custodian wallet provider, depending on the specific services they provide and where they are providing them.

Many providers of NFTs could, however, argue that they are not conducting business “in the UK”. Current guidance suggests that a key factor is whether the firm has a physical presence in the UK through which business is conducted. The location of the business’s offices or software/hardware will be relevant considerations. Where the business has no UK office or other activity in the UK, beyond simply having clients in the UK, the FCA is likely to consider that the firm is not carrying on UK business. For example, if a cryptoasset exchange, registered in a jurisdiction other than the UK, and which has no offices or agents in the UK but nevertheless permits UK customers to open trading accounts, the FCA would not automatically consider that as business being carried on in the UK.

To date, the vast majority of cryptocurrency businesses which have applied for AML registration have either withdrawn their applications or had them turned down by the FCA for not meeting their standards. As a result, these businesses are restricted from providing certain services in the UK. However, the application of the MLRs to NFT providers remains unclear and it also remains to be seen whether – or, more likely, when – the FCA will cater specifically for NFTs. 

Separately, businesses operating in the sports NFT space are advised to consider whether they may be considered an “art market participant” under the MLRs and whether any underlying NFTs fall within scope of a “work of art”. “Art market participants” are currently interpreted to include art dealers, art galleries, auction houses and artists who sell and deal in artwork. “Works of art” are interpreted to refer to physical paintings, original engravings, lithographs, prints, sculptures, tapestries, ceramics and photographs. It is likely that NFTs are outside scope, but NFT providers should continue to monitor this space. Classification as an “art market participant” would not fall within scope of FCA registration but money laundering risk and control requirements in the MLRs would still apply.

What are the rules on promoting sports NFTs?

Sports NFTs may fall outside the UK’s restriction on financial promotions but other constraints on advertising will apply.

The UK generally restricts the marketing of specified financial products to promotions made or approved by regulated firms. There are plans to extend this financial promotions restriction to further financial products, including cryptoassets (see our FintechLinks blogpost on the proposals). The provisional definition of “qualifying cryptoassets” for this purpose includes any cryptographically secured digital representation of value or contractual rights which is fungible and transferable. Those providing these qualifying cryptoassets would need to have their promotion communications approved by a regulated financial services firm (unless they are authorised themselves). These communications would also need to comply with FCA rules. For example, they must be fair, clear and not misleading.

At first glance, it seems NFTs would not be affected: by definition, they are non-fungible. The Treasury has also confirmed that NFTs are generally intended to be outside the scope of the regime given the absence of fungibility. However, some “wrapped” sports NFTs could present key characteristics of fungibility, particularly in circumstances where they allow for a 1:1 swap with another NFT in the same project. Whether wrapped tokens would be captured under the financial promotions regime will vary on a case-by-case basis. Those involved in the promotion of wrapped NFTs must therefore closely monitor the expansion of the financial promotions regime.

Those marketing sports NFTs should also bear in mind broader law and standards. For example, the UK Advertising Standards Authority (ASA) recently ruled against Arsenal F.C. for promoting crypto-based fan tokens in breach of its advertising rules. While the ASA acknowledged that Arsenal’s fan tokens were not subject to the FCA’s financial promotions rules, it held that the advertisements in question trivialised investment in cryptoassets. Further, the advertising took advantage of consumers’ inexperience or credulity by neglecting to reference the volatile nature of such unregulated investments and by failing to make clear that there are tax implications from profits on the tokens. 

This ruling is part of a wider clampdown on crypto promotions and is as clear a signal as any that we should expect closer regulatory scrutiny of sports NFT marketing. 

The ASA has also since confirmed that it will continue to retain oversight of the advertising of cryptoassets following the extension of the FCA’s financial promotions regime and, in particular, that adverts for non-fungible tokens, which will generally not be caught by the FCA’s regime, will remain under the remit of the ASA.

What are the risks associated with sports NFTs?

As they gain popularity, NFTs are being used in the creation of new markets and as potential forms of investment. They are also an attractive source of income for sports rightsholders, particularly in the wake of economic challenges posed by Covid-19. But, as with conventional forms of trading and investment, concerns arise around financial misconduct and consumer harm. For example, the recent liquidation of IQONIQ – one of the biggest brands in the sports-crypto space, which reportedly had agreements with Spain’s La Liga, the McLaren Formula One team and a number of major football clubs in Europe – reportedly rendered millions of IQONIQ tokens worth almost nothing and led to calls for greater regulation.

In the short term, AML supervision represents the most likely avenue for regulatory intervention in NFT markets. Sports NFT trading platforms and businesses operating in the UK should consider if the scope of their activities could trigger a requirement to register under the MLRs, and monitor FCA guidance in this respect.

In the longer term, given that the sports NFT market is likely to be driven by advertising, stakeholders in the NFT space should review the UK financial promotions regime as it extends to cover cryptoassets and factor in how any regulatory changes impact their marketing. This should go hand-in-hand with an ongoing assessment of the sports NFTs they trade – if or when such products may be characterised as FCA regulated financial products, authorisation will be required.

Increased regulation is coming – and those operating in the sports NFTs sphere will need to keep abreast of developments. 

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