non-fungible tokens, or NFTs, are digital blockchain tokens that represent ownership of unique items, whether digital or physical. NFTs can represent real estate, art, music, and even casks of whisky. Since each NFT is unique, they are unlike fungible assets or currencies (eg, Bitcoins or Rupees) where each unit is interchangeable with another.
While the first NFTs actually started in 2012-13, they have shot to mainstream prominence in the last few months with some marquee use-cases like NBA Top Shot, which lets people “own basketball’s greatest moments” by owning NFTs of NBA highlight clips. Indeed, the most popular form of NFT in the last few months appears to be digital images or videos. Another popular use-case is NFTs around items in digital games. F1 Delta Game is a blockchain game licensed by Formula 1, where items like digital car parts can be bought and sold as NFTs for use in the game. The most significant NFT transaction has been the $69-million purchase of an image collection of digital artist Beeple by a fund started by Indian-origin, Singapore-based entrepreneurs. Another headline-grabbing transaction was the auction of Jack Dorsey’s first-ever tweet for $2.9 million.
Other important use-cases of NFTs include viewing or experiencing something (such as exclusive content from a musician) or to represent legal rights (commercialisation rights of a song or image).
A key value proposition of NFTs is that they seek to be authentic and unique. A good analogy to the traditional world is a limited-edition, signed poster by an actor or sportsperson. The value is not in the underlying image alone but in the fact that the celebrity has endorsed the poster and has done so only once, or a few times. NFTs are also a leap forward because they are programmable using smart contracts, which helps automate a variety of hitherto manual transactions.
For instance, artists can automatically get paid a programmed percentage of royalty each time a secondary sale of their work occurs. A real estate NFT could automatically send information to a land registry every time it is transacted. In the traditional world, the artist would have had to go through a lengthy legal process to recover such a royalty, and a real estate transaction would have to be manually registered. Technologically, NFTs also allow their creators to access a global marketplace without high friction in cross-border payments (legal challenges around this in India are discussed below).
Having said that, the current sky-high valuations and excitement around NFTs may be going down a similar path to the dotcom and ICO (Initial Coin Offering) bubbles, both of which presented genuine innovations but also saw unfounded hype. Ultimately, as the market matures, genuine use-cases should survive in the long term.
NFTs are another example of the type of innovation crypto-assets and public blockchains can lead to, in this case, creating a hitherto undiscovered market. Their potential to create a paradigm shift by creating an ‘Internet of Assets’ is yet another reason why the blockchain and crypto-asset ecosystem should be encouraged in India, with suitable guard-rails, as we have proposed separately in our regulatory suggestions to the Indian government.
How do you create, buy and sell NFTs?
NFTs generally reside on public blockchains such as Ethereum, Flow, Algorand, Binance Smart Chain and others. They can either be created by developers using developer tools, or by users through third-party NFT marketplaces such as OpenSea, Rarible or Nifty Gateway. For the layperson, using these marketplaces is a simpler approach to creating and selling NFTs, and resembles listing a product on popular e-commerce marketplaces.
NFTs are typically purchased and sold using crypto-assets such as Ether. Some platforms, such as Nifty Gateway, enable the purchase with credit and debit cards as well. However, those platforms also have to carry out crypto-asset transactions on a blockchain at the backend to enable the transfer of an NFT.
Can I deal with NFTs in India?
There is no general prohibition as of now preventing an Indian resident from buying or selling NFTs. However, some ambiguities arise under the Foreign Exchange Management Act, 1999 (FEMA), which are discussed below. Cutting the clutter, NFTs can be thought of as a digitally signed certificate for the underlying asset, whether it be a real-world or digital item. The treatment under law would depend in large part on how the underlying asset is treated. An NFT representing ownership of a parcel of land, for instance, would be treated differently from one representing ownership of a work of art.
The question arises: are NFTs cryptocurrencies or virtual currencies, and would they be affected by any future law restricting or prohibiting crypto-asset transactions? A sweeping definition of cryptocurrencies or virtual currencies may cover NFTs; however, a nuanced definition should ideally exclude them as they are non-fungible, whereas currencies – both traditional and crypto – are fungible. Unlike crypto-assets like Bitcoin, NFTs – being unique items – also do not act as a means of exchange.
How will cross-border transactions work under Indian law?
As of now, the well-known NFT marketplaces are operated by entities established outside India. While FEMA governs cross-border economic transactions in India, there are no guidelines from the RBI around crypto-assets or NFTs. Extrapolating existing provisions under FEMA, crypto-assets and NFTs could be treated as intangible assets like software and intellectual property under FEMA. However, determining the location of an NFT is an open question. Blockchains are global ledgers and the Supreme Court has recognised that crypto-assets “cannot be stored anywhere”.
Internet and Mobile Association of India v. Reserve Bank of India, (2020) 10 SCC 274 (the Court observed that what is actually stored is only the private key to the blockchain wallet (this is roughly analogous to the password to an email account)).
However, based on case law in other contexts, it could be said that the location of the NFT – an intangible asset – is where its owner resides. This principle may change, however, where the NFT is tied to a physical asset, in which case the location of the physical asset may be determinative.
Since NFT marketplaces and many buyers and sellers are located outside India, Indian participants in the NFT ecosystem could be seen as making cross-border transfers of NFTs. This would raise questions under FEMA, such as whether there is an export or import of an intangible asset. If so, the transaction has to have a corresponding remittance of fiat currency done through authorised banking channels. Crypto-crypto NFT transactions are hence in an ambiguous position. Indian parties may choose to transact in NFTs through fiat currencies, duly reported to their authorised dealer banks, for a more risk-averse (though restrictive) approach.
Indian entrepreneurs may consider establishing an NFT marketplace for Indian residents to avoid ambiguities under FEMA.
Are NFTs securities?
Since NFTs are merely a digital representation of title to an underlying asset, whether an NFT is a security will largely be governed by whether the underlying asset is a security. For instance, an NFT representing a company share is likely to be a security subject to Indian securities law, whereas an NFT representing a piece of digital art would just act as certificate of title to that piece of art.
It is worth clarifying, however, that merely owning an NFT representing an asset does not automatically imply legal ownership of that underlying asset. For instance, anyone can create an NFT purportedly representing the Mona Lisa; unless that NFT is suitably validated by French government authorities as a proof of title, ownership of the NFT does not create any ownership interest in the Mona Lisa itself.
What intellectual property issues arise with NFTs?
Taking the signed-poster analogy further, an NFT generally does not transfer the copyright ownership to the holder (unless, of course, it is contractually agreed). Rather, just like the buyer of a signed poster owns the poster itself, but not the underlying copyright, the buyer of an art NFT would own that digital item, but generally would not get the right to reproduce the artwork.
With the booming market for NFTs, combined with vast troves of digital art available on platforms such as Instagram, a danger arises that malicious actors may misappropriate the work of unsuspecting creators, and commercialise their work without their knowledge on NFT marketplaces. Such instances have already been reported, and artists have had to clarify that they were not involved with a particular NFT. Artists in such cases may have claims for copyright infringement and should obtain advice on their potential legal recourse. Similarly, if an NFT representing a public figure is created and sold without their approval, the public figure may have a claim under the right to publicity, which gives a person the right to control commercial use of their identity.
How should NFTs be taxed?
Typically, the tax treatment of NFTs should generally follow from the nature of the underlying asset. For instance, a digital art NFT could be treated as an intangible asset or good for income tax and Goods and Services Tax (GST) purposes. Taxes should be declared and paid accordingly.
However, the cross-border and digital nature of transacting in NFTs is likely to raise other tax issues. For instance, sales of NFTs by offshore sellers through an offshore NFT marketplace to Indian buyers could be subject to a 2% equalisation levy on the gross value of the NFT and the income of the marketplace from Indian customers. Further, sales of NFTs by Indian resident sellers through a foreign platform may get excluded from the equalisation levy. However, whether the platform’s income or commission is also excluded in such a case is not without doubt.
Additionally, domestic and foreign platforms may face challenges under the withholding tax or tax-collection-at-source provisions under income tax and GST laws, respectively. Sales by onshore and offshore sellers will have to be tracked and tax-deducted by NFT platform operators as applicable under those laws. Tracking such transactions can be a complex effort since where resident sellers are involved, withholding under income tax would apply, whereas GST is likely to apply to all sellers on the platform.
The authors are Leaders at Nishith Desai Associates.