NFTs in Germany: Proof of Ownership Via Blockchain

Similar to cryptocurrencies, NFTs are also based on blockchain technology. This is a continuously expandable chain of datasets (blocks). Unlike datasets in a cloud, these are stored decentrally on many different computers and each contains its own value (hash), the value of the previous block. If the hash of a block in the chain were to be changed, the chain would thus break. Since the chain is stored on many different computers, an altered chain would be noticed as manipulation. This approach makes the blockchain tamper-resistant. It is therefore particularly suitable for storing data in a tamper-proof manner.

A distinction is made between fungible tokens and non-fungible tokens (NFTs). Fungible tokens all have the same asset value, so it is then irrelevant to the holder which token is actually assigned to them. The best known application for this is cryptocurrencies. As with banknotes, it does not matter to the cryptocurrency user which token they own, as all other tokens of this type also have the same value. In that respect, from the user's point of view, they are interchangeable.

NFTs, on the other hand, are tokens that are marked with unique information. These are then not found on any other token in the blockchain. This allows the ownership of a particular asset - whether physical or digital - to be linked to an NFT and assigned to a certain individual. These tokens are not arbitrarily interchangeable with other tokens. Rather, it is precisely the individual token that matters, as it is unique. NFTs exist only once within the blockchain and cannot be split into smaller individual parts.

Currently, NFTs are mainly used in

• digital trading cards,
• game characters,
• virtual lands in virtual worlds or in
• crypto art.

By storing the information about the original file in an NFT, a digitally unique unit is created. If the purchaser receives the NFT as well as the original file, they can prove that they are the owner of the original. This resolves a problem that has long hampered lucrative trading in digital assets. Whereas, for example, physically existing original works of art can usually be proven beyond doubt to be such, virtual assets could previously be copied and distributed without any problems. It was difficult for the owner of the original file to prove its originality.

Although the use of NFTs does not prevent the original files from still being copied at will, "tokenization" now makes it possible to prove their originality beyond doubt and, as a result, they become a significant factor in increasing the value of a file. Because of its provability, the value of a file is no longer undermined by identical copies. This guarantee of uniqueness ultimately grants virtual assets a quality that they previously lacked in comparison to analog works of art. Consequently, they become serious digital commodities and investments, which their creators, in turn, benefit from as it generates a secure source of revenue.

Many of these transactions are processed using smart contracts which are also based on blockchain technology. Although, to date, NFTs have primarily been used for digital art and collectibles, their potential range of application goes far beyond that. For example, NFTs could also serve as the basis for digital identification documents.

As with blockchain technology in general, NFTs raise numerous legal issues that may have a significant impact on their users. However, these concerns have not yet been conclusively resolved. This is reason enough to obtain a brief overview. Our NFT lawyers are happy to assist you.

The consequence of this classification is that the corresponding economic dealings with NFTs are subject to the licensing requirements of § 32 (1) of the German Banking Act. Particularly important in this context is the permission to act as an investment broker (§ 1 (1a) Clause 2 No. 1 of the Banking Act), but proprietary trading or the custody of NFTs are then also subject to permission.

If there is a prospectus requirement, an appropriate prospectus must be published the first time a security is offered to the public that provides investors with transparent information on the content and risks. Whether the creator of an NFT must also publish such a prospectus again depends on the legal classification of the NFTs. In addition to being an investment object, these would also have to be securities in order to prompt a prospectus requirement under the prospectus regulation (VO 2017/1129). According to Art. 2 lit. a of the prospectus regulation in conjunction with Art. 4 (1) No. 44 of the Directive 2014/65/EU (MiFID II), securities within the meaning of the prospectus regulation can be traded on the capital market. According to the German Federal Financial Supervisory Authority (BaFin), tradability requires a minimum degree of standardization that makes the securities comparable in the sense of a class.

Even if the assessment from the BaFin does not seem to apply to the individualized NFTs, it must be taken into account that the individual NFTs can certainly be transferred, are thus tradable and could be covered by the wording of the prospectus regulation. However, NFTs do not fit the securities examples cited in Art. 4 (1) No. 44 of the Directive 2014/65/EU (MiFID II), so their classification as securities has not been conclusively clarified. Nevertheless, there are good arguments against this. Moreover, a prospectus requirement is cancelled in each instance when an NFT is offered for not less than EUR 100,000 (Art. 1 Para. 4 lit. c, d of the German Prospectus Regulation).