Guidelines on Criteria for NFT Categorization as Virtual Assets

On June 10, 2024, the Financial Services Commission (“FSC”), the Korea Financial Intelligence Unit (“KoFIU”), and the Financial Supervisory Service (“FSS”) announced the “Guidelines on Criteria for NFT Categorization as Virtual Assets” (the “Guidelines”).

Non-Fungible Token (“NFT”) is a token that contains unique information and therefore, is non-fungible. The Enforcement Decree and the Supervisory Regulations of the Virtual Asset User Protection Act (the “Act”), which is set to take effect on July 19, 2024, will exclude NFTs that meet certain requirements from the scope of “virtual assets.” The Guidelines have been established to clarify the criteria for determining whether an NFT is categorized as a virtual asset.

Key Details

A person who intends to issue, distribute, or handle an NFT is required to (i) examine whether the NFT constitutes a security under the Financial Investment Services and Capital Markets Act (the “FSCMA”), and (ii) if it is not a security, examine whether it constitutes a virtual asset under the Act.

Categorization as Security

Whether a right to be acquired by an investor constitutes a security under the FSCMA is determined based on the actual substance of such right, irrespective of the method and form of such right, whether certain technologies have been adopted, or the name of such technologies. The “Security Token Guidelines” included in the “plan to overhaul the regulatory framework around the issuance and distribution of security tokens” announced by the FSC and other regulators on February 6, 2023 may serve as a reference to determine whether an NFT would constitute a security. For such purpose, it is necessary to review and determine whether such NFT may constitute an investment contract security based on the totality of circumstances, in addition to whether such NFT may fall under a conventional type of security. For more details, please refer to our previous newsletter titled “Overhaul of the Regulatory Regime Regarding Issuance and Distribution of Security Tokens in Korea” (Link).

Categorization as Virtual Asset

If an NFT does not constitute a security, whether it constitutes a virtual asset should be separately reviewed. The Proposed Enforcement Decree and Supervisory Regulation of the Act defines an NFT, excluded from the scope of virtual assets, as “a digital certificate primarily for collection and digital certificate only for the purpose of confirming transactions between the parties to the transaction, or any other digital certificate which exists in a single unit and is non-fungible with other digital certificates, but excludes digital certificates that can be used as a means of payment for certain goods or services.”

Therefore, a digital certificate lacking uniqueness (existence as one of its kind) and non-fungibility is unlikely to fall under such definition and, as a result, would constitute a virtual asset. The Guidelines determine that if an NFT falls under any of the following cases, it is highly likely to be considered a virtual asset as its uniqueness and non-fungibility are impaired.

(1)

Case where it is issued in large volume or large-scale series and is highly likely to be fungible

The case where a large number of identical or similar NFTs have been issued to the extent that it is difficult to recognize their uniqueness based on social norms.
The case where a market price is set based on the same or similar NFT, and a transaction is conducted mainly to gain profits from the market price of the same or similar-type NFT, not the price of an individual NFT.
However, whether an NFT constitutes a virtual asset shall be determined by taking into account all specific circumstances on a case-by-case basis (i.e., the total number of the NFTs issued, whether NFTs of the same or similar type are issued, the number of such NFTs, the price, transaction patterns such as frequency of transaction of the NFT), and shall not be determined simply based on issuance volume.

(2)

Case where its uniqueness is significantly weakened due to divisibility

The case where one NFT is split-able, or if one NFT is split and then issued or sold.

(3)

Case where it can be used as a direct or indirect means of payment for certain goods or services

(4)

Case where it can be used as a direct or indirect means of payment for certain goods or services

The case where an NFT is issued only for the purpose of exchange for another virtual asset.
The case where an NFT can be exchanged with other virtual assets between unspecified persons.
The case where an NFT is used to receive goods or services with prices, etc., indicated by other virtual assets.
However, the Guidelines are intended to regulate the cases where NFTs are issued to circumvent regulations applicable to virtual assets, but not to prohibit purchasing NFTs using virtual assets at marketplaces where NFTs are currently traded.

Separately, the Guidelines consider that a digital certificate with any of the following characteristics is highly likely to be deemed an NFT, not a virtual asset.

(1)

Case where it is for any value or utility other than economic value

The case where it is used only for proof of identity or qualifications or proof (receipt) of assets or transactions.

(2)

Case where its economic function is insignificant in terms of place of use and purpose

The case where performance tickets, etc., are issued in a limited volume and used only for exhibition or viewing.

(3)

Case where it is difficult to be deemed as a digital certificate that can be traded or transferred

The case where trading thereof on secondary market is not possible.

Implications

As the Guidelines are now publicly available, the criteria for determining whether an NFT constitutes a virtual asset under the Act have been specified more. A business operator intending to issue, distribute and handle an NFT needs to comply with virtual asset-related laws and regulations, including the Act and the Act on Reporting and Using Specified Financial Transaction Information (the “Specified Financial Information Act”) if the NFT constitutes a virtual asset based on the results of the review under the Guidelines.

In particular, please note that (i) if an NFT that a business operator distributes or handles is a virtual asset, and (ii) if the business operator engages in “sale or purchase, exchange, transfer, custody and management, and brokerage, intermediation and agency of sale and exchange” (see Article 2 (1) (n) of the Specified Financial Information Act) of such NFT, such business operator constitutes a virtual asset service provider under the Specified Financial Information Act, and thus, must file a report as virtual asset service provider. Failure to do so may result in certain criminal punishment (imprisonment of up to five years or a fine of up to KRW 50 million).

As a business operator is responsible for reviewing and determining whether its NFT is a virtual asset and complying with the relevant regulations, it would be crucial for any person intending to issue, distribute, or handle an NFT to accurately and carefully review the legal nature of NFTs in accordance with the Guidelines and comply with the relevant laws and regulations accordingly.

[Korean Version]

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