Written evidence submitted by the
Department for Science, Innovation and Technology
 

Inquiry into Non-fungible tokens (NFTs) and the blockchain

1.      Non-fungible Tokens (NFTs) are digital tokens which represent an underlying physical or digital asset, such as a piece of art, music, or a game. Like other cryptoassets[1], NFTs use a technology such as blockchain to record and verify ownership. Unlike some other cryptoassets, NFTs are not fungible; each NFT is unique and cannot be substituted for another token.

 

2.      NFTs are one of a number of new applications emerging from blockchain (sometimes referred to as ‘web3’ or ‘decentralised web’) technologies. Collectively these technologies will lead to the development of innovative new products and services. However, the technology also presents risks, particularly to consumers in terms of security vulnerabilities which may be exploited, price fluctuations, money laundering and fraud.

 

Do you think the UK’s light-touch NFT regulation is sufficient?

 

3.      The Government has a range of policy interests across the cryptoasset technology market. Across these, the UK government seeks to strike a balance between driving innovation and growth, and ensuring that new products do not harm citizens or businesses. This approach is laid out in our Plan for Digital Regulation.

 

The Cryptoasset Regime

4.      HMT leads the development of the UK’s cryptoasset financial services regime. Work in this space has included:

    1. The Cryptoasset Taskforce: This Taskforce was established in 2018 and consists of HMT, the Bank of England and the Financial Conduct Authority. The Taskforce’s objectives include exploring the impact of cryptoassets and the potential benefits and challenges of blockchain in financial services; as well as assessing what, if any, regulation is required in response. It continues to monitor ongoing developments in the cryptoasset market, and is taking forward a number of regulatory initiatives to manage risks and support innovation.
    2. Cryptoasset Financial Promotion Legislation: HMT has set out its intention to legislate to bring certain cryptoassets into financial promotion regulations. This will ensure that relevant cryptoasset promotions are held to the same high standards for fairness, clarity and accuracy that exist in the financial services industry. NFTs will not be included in this legislation as they do not typically constitute a financial services product. Fungibility is a characteristic which makes a cryptoasset more closely resemble traditional financial services products and more likely to give rise to consumer protection concerns.
    3. The Future Financial Services Regulatory Regime for Cryptoassets: HMT recently set out intended reforms to the regulation of cryptoassets in financial services. The consultation proposes that financial services activities will be regulated, rather than the assets themselves. All cryptoassets – including NFTs – would have the potential to be included in the future regulatory perimeter if they are used in financial services activities. If an NFT or utility token is not used in such a way, it would not fall into scope of financial services regulation unless – as a result of the particular structure and characteristics of the NFT – it constitutes an already regulated financial services product (a “specified investment”).

 

Intellectual property

5.      The Intellectual Property Office is aware of public uncertainty over the extent to which the purchase of an NFT grants a buyer copyright over the underlying asset. They are working closely with stakeholders to understand the law around cryptoassets and how best to support consumers and raise awareness.

 

Advertising

6.      Government is reviewing the regulatory framework for online advertising as a whole to tackle the lack of transparency and accountability across the online advertising supply chain. Through the Online Advertising Programme (OAP), the government is considering a range of harms in online advertising, including the advertising of illegal products and services and fraudulent advertising. Illegal or fraudulent advertising of cryptoassets would be included in the scope of OAP.

 

7.      The Advertising Standards Authority (ASA) have identified the work they have done on regulating the promotion of cryptoassets in their own evidence submitted to this inquiry. This includes rulings they have published (including 12 relating to crypto asset advertising in 2021 and three relating to NFTs specifically in 2022[2]) and Enforcement Notices issued to companies for non- compliance with the current rules set out in their advertising code. They have also issued a series of additional principles for advertisers on how they can better comply with these rules. They plan to follow-up with monitoring and enforcement work with relevant companies.
 

8.      As with all new and emerging technologies, government will continue to keep cryptoassets and NFTs under review in line with the Plan for Digital Regulation.

 

Do you see any potential harms to vulnerable people due to NFT speculation?

 

9.      Speculation in cryptoassets market can lead to a variety of harms for vulnerable people. This is why government is taking action - including through working with the IPO and the ASA to improve stakeholder understanding and offer support to consumers.

 

10. The most obvious risk to vulnerable users who speculate in crypto markets is financial harm. This can occur in a number of ways, including:

    1. Market volatility: Volatility in crypto markets is routine, with regular ‘mini-crashes’, recoveries, booms and corrections.[3] This volatility is seen in all crypto markets[4] and there is evidence to suggest that some UK investors do not understand the risks of investing in these assets, and that some are borrowing to fund their investments.[5]
    2. Misleading information: Misleading information about the potential gains to be made from investing in crypto markets is rife, and there is evidence to suggest that some harms are being exacerbated by advertisers and influencers who make misleading claims.[6] Vulnerable people may be particularly likely to be exploited by businesses and individuals who take advantage of their lack of knowledge or experience.
    3. Scams: The FCA have received a number of reports about cryptoasset investment scams, often targeting consumers searching for investments online. Scammers offer high returns to tempt people into making investments and then manipulate software to distort prices, suddenly close accounts or refuse to transfer funds.[7]

 

11. Fungibility and transferability are two characteristics which make a cryptoasset more closely resemble traditional financial services products and more likely to give rise to consumer protection concerns. The non-fungibility of NFTs mean they do not resemble traditional financial services products as closely, and are less likely to share the same financial services consumer protection concerns. Unlike fungible assets which can generally be sold more easily and quickly, the sale of non-fungible tokens typically depends on the utility or unique value it gives the holder and may be more akin to a digital collector item than a financial services product.

 

Do you have any views on the security risks of the use of blockchain for British investors?

 

12. Blockchain implementations can contain vulnerabilities which may be exploited by bad actors. Such security issues offer new ways of committing existing types of fraud, such as market manipulation and investment scams. Billions of dollars’ worth of cryptoassets are stolen every year,[8] much of which is used to fund illicit activities and crime;[9] British investors should be aware of these risks - and ensure robust security protocols are in place - when making their investment decisions.

Do you see any potential benefits to individuals and society of NFT speculation?

 

13. Government believes that cryptoasset technologies can have a profound impact across financial services. By capitalising on the potential benefits offered by cryptoassets we can strengthen our position as a world-leader in fintech, unlock growth and boost innovation.[10]

 

14. The NFT market is nascent, evolving rapidly and at an early stage of development. There are promising and innovative potential applications of the technology, including opportunities for sporting brands to increase revenues and fan engagement; the possibility for artists to express themselves and secure income from second-hand sales of their products; and the chance to develop digital services related to the metaverse.

 

15. The Government will continue to monitor these and other emerging technology markets and work to drive growth across the digital sector, while being aware of the risks highlighted above.

 

 

March 2023

 


[1] A cryptoasset is a cryptographically secured digital representation of value or contractual rights that uses some type of Distributed Ledger Technology and can be transferred, stored or traded electronically. Examples of cryptoassets include Bitcoin and Litecoin (and other ‘cryptocurrencies’), and those issued through the Initial Coin Offering (ICO) process, often referred to as ‘tokens’.

 

[2] ASA Ruling on Turtle United NFT, ASA Ruling on Foris DAX Global Ltd t/a Crypto.com, ASA Ruling on FC Barcelona

 

[3] https://www.statista.com/chart/27577/cryptocurrency-volatility-dmo/

[4] https://www.wsj.com/articles/nft-sales-are-flatlining-11651552616

[5] https://www.fca.org.uk/publications/research/research-note-cryptoasset-consumer-research-2021

[6] https://www.asa.org.uk/news/asa-enforcement-notice-continues-clampdown-on-misleading-and-irresponsible-crypto-ads.html

[7] https://www.fca.org.uk/scamsmart/cryptoasset-investment-scams

 

[8] https://www.reuters.com/markets/us/crypto-crime-hit-record-14-billion-2021-research-shows-2022-01-06/

[9] https://www.reuters.com/business/finance/crypto-crime-hits-record-20-bln-2022-report-says-2023-01-12/

[10] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1133404/TR_Privacy_ edits_Future_financial_services_regulatory_regime_for_cryptoassets_vP.pdf