NFTs, sport and the law

Non-Fungible Tokens (NFTs) are digital assets created on a blockchain using unique identification codes and metadata to distinguish them from one another.  Once created NFTs can be sold on digital platforms.

Unlike cryptocurrency, an NFT cannot be directly traded or exchanged in equivalence because of its unique and irreplaceable properties.  One NFT is not worth the same as another NFT, and so they are unsuitable for use as currency.  The uniqueness of an NFT means that they can be used as digital representations of assets.  They have been likened to digital passports, because each token contains a unique, non-transferable identity to distinguish it from other tokens.

NFTs have been introduced in sport initially through the sale of collectibles, such as limited edition virtual memorabilia, unique trading cards, or even through the sale of video clips or virtual highlights of a game. As an example, in the NBA the ‘Top Shots’ series allows an owner to own the NFT ‘Moment’ of a particular on-field event.

More recently, in November Cristiano Ronaldo launched his own range of NFTs through the Cryptocurrency exchange platform Binance.  Fans will now be able to ‘own’ seven of the superstars most iconic moments. Additional benefits from owning the NFTs include a virtual greeting from Ronaldo, a signed NFT statue and signed Ronaldo shirt and an entry into future giveaways to win Ronaldo merchandise.

The use of NFTs has expanded to the point where they are now being used to give fans a say in key decisions on how their favourite team is run. In April 2022 Crawley Town FC were taken over by WAGMI United, a group who aim to fund the club through sales of NFTs that entitle those purchasing them to make decisions on certain aspects of club ownership. In July the club signed a player following a vote amongst season ticket holders and NFT holders on which on-field position most needed strengthening.

To some, NFTs represent a new opportunity for athletes, clubs, and brands by creating new methods to reach new audiences, increase fan engagement and connect with younger generations. To others, they signal another step into the murky and unregulated world of cryptocurrency, and could lead to further exploitation of consumers.

Here, we consider the key issues around NFTs, and offer some advice about the legal steps that can be taken to avoid the pitfalls associated with an NFT platform.

Regulatory Considerations

In rare circumstances, some NFTs may be regulated by the Financial Conduct Authority (‘FCA’). However this will only be the case if they meet the definition of a ‘Security Token’ (similar to traditional securities such as share or debentures) or ‘E-Money tokens’ (electronic currency). These are seen as ‘specified investments’ and therefore dealing with these tokens will be deemed to be a regulated activity that would require regulatory approvals. An NFT will not typically constitute an E-Money token, but it’s foreseeable that they could.  NFTs that represent actual ownership of a sports club could fall under the definition of a ‘security token’, for example.

Almost all other NFTs fall under the ‘Exchange Tokens’ (owner only has the right to hold, buy or sell a token) or ‘Utility Tokens’ (owner has the right to obtain goods or services) categories. Examples of these include NFTs used to validate tickets for sports matches or events, or those used for digital collectibles. Currently there are no specific laws or regulations which cover these NFTs; however certain aspects, such as the advertising and marketing of the tokens, may be caught by non-specific regimes.

The Advertising Code (CAP code) applies to cryptoassets which are not regulated products, and therefore covers most NFTs. The code sets out detailed rules which must be followed when advertising NFTs.  This includes making it clear that cryptoassets are unregulated and that the value can go up or down, including all material information and making it clear that past performance is not a guide for future performance.

In December 2021 Arsenal Football Club saw two of its promotions for ‘fan tokens’ banned by the Advertising Standards Agency (‘ASA’) for failing to comply with the CAP code. The ASA found that Arsenal were ‘taking advantage of consumer’s inexperience or credulity’ and were ‘misleading consumers over the risk of the investment, as it was not clear the “token” was a crypto asset’. In light of this it is important for those promoting any NFT products to seek legal advice for the full details of the CAP rules and requirements.

It is also important to consider Anti-Money Laundering Regulations which apply to the issuing and exchanging of crypto assets, including to NFTs. In order to remain compliant, sports clubs and individuals who intend to deal with NFTs by way of a business from within the UK will need to register with the FCA under its anti-money laundering rules.  They will then need to comply with anti-money laundering requirements, including client due diligence checks and transaction monitoring.

In July the Law Commission issued a consultation paper setting out a number of proposals around the reform of the law of digital assets. This included explicitly recognising a distinct category of personal property ‘data objects’ which would allow the law to better accommodate the unique aspect of digital assets, as well as clarifying the law around ownership, control, transfers and transactions of digital assets. The commission is seeking responses to the consultation by 4 November 2022.

Additionally, on 3 November the Department for Culture, Media and Sport launched a public inquiry into the operation, risks and benefits of NFTs. This comes on the back of a vote by the House of Commons in October in favour of adding cryptocurrency to the scope of activities which should be regulated via the proposed Financial Services and Markets Bill.

Taxation of NFTs

For individuals, transactions involving NFTs are likely to be subject to income tax if these are associated with trading activity. Therefore, any athletes selling their own collectable NFTs would likely be subject to income tax on the profits.

HMRC also regards cryptocurrency, and therefore NFTs as an intangible asset. If an NFT is bought, and subsequently sold, any realised gain will be subject to Capital Gains Tax. This may also be chargeable if cryptocurrency is used to purchase NFTs, as the cryptocurrency is an asset that will have been disposed of.

For companies, and therefore any sports teams, brands or organisations, any activity involving NFTs will be deemed to be trading activity and any profits will be subject to corporation tax. Profits from a trade involving NFTs should be calculated in accordance with Generally Accepted Accounting Practice (GAAP).

On top of this, if a company acquires an NFT as an investment, its value will need to be reflected on the company’s balance sheet as an intangible asset. Therefore, any disposal of this may fall within the Corporation Tax Intangible Asset Regime.

With regards to VAT, unlike with Bitcoins (where it has been established that VAT does not apply) the sale of NFTs is less clear. Due to the unique nature of the tokens, common practices do not apply, and they are being assessed on a case by case basis. However, it may be the case that if the sale is considered final, they will be treated in a similar way to the supply of digital services, where the supplier will be liable to pay VAT in the country where the customer is based.

Intellectual Property and Smart Contracts

A key issue with sports NFTs is there can be significant uncertainty around whether the issuer of the NFT has the right to commercialise an athlete’s image, and if so, what rights are being sold or licensed, and whether the terms of any license align with existing contracts that are currently in place (such as between an athlete and the relevant club, organisation or brand).

Smart Contracts (which self-execute once a pre-defined set of requirements are fulfilled) can help circumnavigate this issue. These can be written into NFTs to prove authorship or ownership, which allows the relevant IP rights to be licensed in a clear and transparent manner. They can also be used to provide that once an NFT is resold, the original rights holder receives a royalty as a percentage of this sale.

Other key provisions such as the date of payment, value of the NFT, the relevant currency to be used, limitation of liability and governing law can also be addressed in Smart Contracts. Encouragingly, the Law Commission recently concluded that Smart Contracts are compatible with existing English Law and are capable of being legally binding.

Analysing a potential NFT project

Given the uncertainty and broadly unregulated nature of NFTs, it is important to take a considered approach and undertake a detailed due diligence exercise before beginning a NFT project to set up a new platform. There are 4 key issues, and multiple questions which need to be asked at this stage.

• The People.  Who are the people behind the platform? Due to the decentralisation of crypto currency platforms, it is common for those behind a project to be anonymous. If this is the case, a more detailed due diligence exercise will be needed. If the key individuals are known, what is their past history in relation to NFTS? What is their reputation in the field? Have they run any successful projects, or have there been any major issues?
• Project Plan.  Does the platform have a business plan? Is this realistic in relation to the financial resources at play, and is the team in its current form able to achieve this?
• The Technology. Which ecosystems are blockchains based on and how are established are the blockchains? Do the blockchains have key investors behind them? How does the platform deal with and protect its customer’s assets? Does it have an effective disaster recovery plan? What is its approach toward cyber security and business operations?
• The Community. Does what the platform is offering, correlate with those who are likely to engage with it on the relevant social media platforms?

The use of NFTs in sport is likely to become more commonplace, and it may well be that we see a shift away from the use of NFTs as collectibles, to the approach used by Crawley Town FC  to give fans an immersive experience in the day to day running of their favourite teams. It is therefore important that all athletes, clubs, brands and organisations have an understanding of the key legal and regulatory issues which can arise.

For more information on this, please contact Ted Powell or Douglas Kitchen.

To some, NFTs represent a new opportunity for athletes, clubs, and brands by creating new methods to reach new audiences, increase fan engagement and connect with younger generations. To others, they signal another step into the murky and unregulated world of cryptocurrency, and could lead to further exploitation of consumers.”