Hong Kong extends regulatory rules to NFT-based collective investment schemes, warning investors to be mindful of risks

·3-min read

Hong Kong’s securities watchdog for the first time said that some non-fungible tokens (NFTs) that constitute investment products have to be regulated, and warned investors of the risks involved with investing in such tokens.

Some NFTs are fractionalised or structured in a way similar to securities or interests in a “collective investment scheme” (CIS) as defined in the city’s Securities and Futures Ordinance (SFO), the Securities and Futures Commission (SFC) said in a statement on Monday.

Parties that provide those tokens in Hong Kong or target Hong Kong investors need to obtain a licence from the SFC, and certain authorisation requirements could also be triggered, the SFC said.

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Under the ordinance, a CIS generally includes projects that enable participants to receive profits, income or other returns, especially if participants do not have day-to-day control over the management of the assets.

“As with other virtual assets, NFTs are exposed to heightened risks including illiquid secondary markets, volatility, opaque pricing, hacking and fraud,” the SFC said. “Investors should be mindful of these risks, and if they cannot fully understand them and bear the potential losses, they should not invest in NFTs.”

Hong Kong regulators have been moving towards regulating cryptocurrencies, having proposed a regulatory framework governing virtual asset service providers with a licensing regime and restricting them to only servicing professional investors.

In January, the Hong Kong Monetary Authority also launched a consultation seeking public feedback on regulating stablecoins, which it said could become a widely accepted means of payment. The SFC’s latest statement, though, is the first specific reminder about NFTs falling within the ambit of the regulator by being considered a security or a CIS.

“This is a timely and well warranted warning given the vast amount of new NFT projects being marketed towards the General public in Hong Kong, via both online and offline methods, including numerous billboards in the subway and on buses,” said Charles To, a partner at law firm Ellalan in Hong Kong.

Since NFTs exploded into mainstream consciousness globally last year, enthusiasts in Hong Kong have launched numerous projects selling cartoon avatars, artworks, and fractional ownership of digital or physical assets as NFTs.

The SFC’s warning, though, comes at a time when fervour for the tokens has cooled down globally amid what is dubbed as another “crypto winter”, where a wide range of popular tokens, including bitcoin and ether, have plunged in market value.

The daily number of global NFT sales in November sat at between 160,000 and 200,000, while this week it lingered at around 20,000, according to data from Nonfungible.com. Active market wallets have also fallen from more than 90,000 in November to around 17,000 this week.

The SFC did note, however, that most NFTs are intended to “represent a unique copy of an underlying asset such as a digital image, artwork, music or video”, and that activities involving those NFTs do not fall within the SFC’s regulatory remit.

But more details and concrete guidelines are still needed from the regulator regarding how an NFT could be considered a security, so that project creators can better design a project without fear of contravening the law by accident, To said.

“If the rules are kept too vague, there is a risk that it could kill off the industry in Hong Kong completely,” To said.

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