Disputes and challenges involving NFTs and digital assets

Introduction
Are NFTs property?
Other dispute fora
Regulatory environment for NFTs
Comment

Introduction

Non-fungible tokens (NFTs) are digital assets that can provide digital ownership rights representing anything from digital art to sports memorabilia. Holders of certain NFTs even carry with them unique benefits, such as membership of a community or enrolment to special events. Because of the novel, distinctive and fluid nature of NFTs, and the increasing value of digital assets generally, NFTs have gained popularity in recent years. However, their increasing popularity and value alongside, perhaps, a tendency not to scrutinise the rights and terms associated with NFTs have caused them to become more susceptible to commercial disputes, while also attracting the attention of some regulators. This article provides a snapshot of some early trends for NFT disputes in Hong Kong, in what is an evolving market requiring care and attention by investors and contracting parties.

Are NFTs property?

In Hong Kong, the courts have made clear that they recognise digital assets as property. However, there has so far been no authoritative legal determination that NFTs are recognised as property.

In June 2023, the Court of First Instance held that cryptocurrencies are property in a landmark ruling in Re Gatecoin Ltd (in liquidation).(1) Cryptocurrencies and NFTs have some similar characteristics (for example, both are categorised at a high level as digital assets and rely on blockchain technology). However, different types of digital assets carry different ownership and contractual rights. It is, therefore, likely that (as things stand) the Hong Kong courts should extend the same reasoning in Re Gatecoin to NFTs, finding as a general principle that NFTs can constitute property – while scrutinising the specific NFTs and how they have been bought and sold in order to consider exactly what rights are at stake in a specific dispute.

In Re Gatecoin, the joint and several liquidators of Gatecoin applied for directions on whether cryptocurrencies satisfied the requirements of property and could be the subject of a trust.

In finding that cryptocurrencies are a form of property that could be held on trust, the Court examined the traditional position on common law property,(2) relying on the following reasoning:

  • Cryptocurrency is definable as the public key allocated to a cryptocurrency wallet and is readily identifiable, sufficiently distinct and capable of being allocated uniquely to individual account holders.
  • Cryptocurrency is identifiable by third parties in that only the holder of a private key can access and transfer the cryptocurrency from one wallet to another.
  • Cryptocurrency is capable of assumption by third parties in that cryptocurrency can be and is the subject of active trading markets, where:
    • the rights of the owner are respected; and
    • it is potentially desirable to third parties such that they want to obtain ownership.
  • Cryptocurrency has some degree of permanence or stability as the entire life history of a cryptocurrency is available in the blockchain.

The Hong Kong courts can be expected to follow the same reasoning to treat other novel kinds of intangible assets as property. Accordingly, to the extent that NFTs are definable, identifiable and capable of assumption by third parties with some degree of permanence, they should (in principle) be regarded as property. However, any assessment of NFTs as property will need to involve an examination of the specific tokens, the rights attached to them, and how the holder came to acquire the tokens.

There is already case law in other common law jurisdictions, including Singapore(3) and England and Wales,(4) recognising NFTs as property. The Hong Kong courts have followed the trend in other principal common law jurisdictions of recognising cryptocurrencies as assets, and all things being equal, one would expect future decisions of the Hong Kong courts regarding NFTs to be consistent with these common law precedents.

Other dispute fora

One reason that there have been few, if any, reported court cases in Hong Kong determining parties’ rival claims to outright ownership of NFTs is the use of other dispute resolution fora (such as arbitration) to resolve claims concerning digital assets.(5)

Given the relatively unconventional, and token-specific, nature of NFTs, in contrast to more traditional financial assets, several factors encourage parties (particularly, cryptocurrency exchanges) to opt for other, non-court, means of dispute resolution, such as arbitration. These include, in particular, the privacy and confidentiality. That non-parties to arbitration cannot lawfully receive evidence filed in the arbitration is a strong reason for parties with stronger bargaining power (such as cryptocurrency exchanges) to choose arbitration as the dispute resolution forum in their terms of business. High-profile parties “minting” NFTs (such as artists) may also wish to keep any disputes confidential.

Other disputes fora such as arbitration also carry the twin advantages of:

  • parties being able to choose their decision maker to ensure that they have at least an understanding of the high-level nature of NFTs and related technical concepts; and
  • being more easily enforceable in multiple jurisdictions under the New York Convention.

Whether or not disputes related to NFTs continue to be heard in other disputes fora, the Hong Kong courts should soon be required to grapple with the concepts of ownership and rights attached to NFTs.

Regulatory environment for NFTs

Digital assets generally, and recently NFTs in particular, have been the focus of financial regulators around the world.(6) Depending on the nature and characteristics of the NFTs, in Hong Kong parties minting and dealing with NFTs may fall under the regulatory supervision of the Securities and Futures Commission (SFC). According to a statement published by the SFC on 6 June 2022,(7) where NFTs are a genuine digital representation of a collectible, the activities related to NFTs generally do not fall within the SFC’s regulatory remit. The SFC has also made clear that it will not treat digital assets as high-risk investments solely because they are digital in nature.

Securities and CIS
NFT investors should ensure regulatory compliance where their NFTs are structured in a form similar to “securities”, or as interests in a “collective investment scheme” (CIS), both as defined in and regulated by the Securities and Futures Ordinance (SFO).

Dealing, marketing or distributing NFTs akin to securities or interests in a CIS may constitute a “regulated activity” as defined in the SFO. Parties carrying on a regulated activity, whether in Hong Kong or targeting Hong Kong investors, generally require a licence from the SFC – such as type 1 (dealing in securities), type 4 (advising on securities) or type 9 (asset management). Further, where NFTs representing interests in a CIS are offered to the Hong Kong public, relevant parties will need to meet the authorisation requirements under the SFO.

VATP licence
Effective on 1 June 2023, all virtual asset trading platforms (VATPs) carrying on their businesses in Hong Kong, or actively marketing their services to Hong Kong investors, must be licensed by the SFC – subject to a grace period of one year for pre-existing VATPs. While this licensing regime mainly targets cryptocurrency transactions, trading NFTs on a platform may also be subject to licensing requirements depending on the nature of the NFTs. For example, where the characteristics of a specific NFT go beyond that of collectible, such as vesting in holders a right to vote on the arrangement (such as a fractionalised investment in an asset using an NFT), VATPs offering trading of such NFTs are likely to require a licence from the SFC.

Comment

Despite the recent downturn in digital asset values, and high-profile issues with specific NFTs, NFT markets generally are still on the ascendency around the globe. Given the novelty of NFTs, the regulatory environment is at a relatively early stage of development. Various key legal issues deriving from NFTs (such as their characterisation as property, ownership of underlying AI-generated artwork and the contractual rights attached to the NFTs) remain for now to be authoritatively tested before Hong Kong courts.

Bearing in mind that the legal landscape for digital assets is evolving, it is important for NFT holders and investors to keep up to date with market and legal developments; not only in Hong Kong, but also in other jurisdictions – particularly, those with a close connection with Hong Kong. Parties who are unsure of their legal rights or regulatory obligations should consider seeking advice from locally qualified lawyers.

For further information on this topic please contact Jonathan Crompton, Flora Leung or Armani Cheng at RPC by telephone (+852 2216 7000) or email ([email protected], [email protected] or [email protected]). The RPC website can be accessed at www.rpc.co.uk.

Endnotes

(1) [2023] HKCFI 914, [2023] 2 HKLRD 1079. On the facts, trust ownership was not established.

(2) National Provincial Bank v Ainsworth [1965] AC 1175, Ruscoe v Cryptopia Ltd (in liq) [2020] NZHC 728.

(3) Janesh s/o Rajkumar v Unknown Person (“CHEFPIERRE”) [2022] SGHC 264.

(4) Lavinia Deborah Osbourne v (1) Persons Unknown and (2) Ozone Networks Inc trading as OpenSea [2022] EWHC 1021 (Comm).

(5) There has been a multitude of HKIAC arbitrations against cryptocurrency exchanges and traders for disputes arising out of cryptocurrency transactions. For example, in 2021, Liti Capital represented traders against Binance for damages arising from an outage. In 2022, CoinFLEX commenced arbitration against one of its users for an unpaid margin call. In 2023, a user commenced arbitration for damages arising from an unauthorised ledger adjustment.

(6) For example, “SEC charges LA-based media and entertainment company ‘Impact Theory’ for unregistered offering of NFTs”, 28 August 2023 (also see dissenting statement: “NFTs & the SEC: Statement on Impact Theory, LLC”, 28 August 2023).

(7) “SFC reminds investors of the risks associated with non-fungible tokens”, 6 June 2022, available here.

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