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Legal Aspects of Non-Fungible Tokens in Malaysia

Introduction

Since 2021, transactions involving Non-Fungible Tokens (“NFT”) have seen a rise in popularity. NFT is the flavour of the month and people have taken full advantage of this so called NFT-bubble with people starting to venture, trade and deal in NFTs to a point that there are specific marketplaces dedicated to NFTs. In Malaysia alone, there are 6 exclusive NFT marketplace currently.

 

What are NFTs?

An NFT is a digital certificate representing ownership of, or rights to a unique digital asset, ownership of which is recorded on a non-centralized blockchain (a digital ledger of transactions which is not owned by the state or authoritative bodies). A piece of NFT usually consists of digital art or artistic works, including photos, videos, audio files, and collectibles, and may extend to game items, tickets, and other digital assets. NFTs may even include social media posts such as Facebook or Instagram posts and YouTube videos.

 

Are NFTs Regulated in Malaysia?

As at the date of this article, there is no specific law governing NFTs yet in Malaysia (as with most parts of the world). The closest related regulation is the Capital Markets and Services (Prescription of Securities) (Digital Currency and Digital Token) Order 2019 (“Prescription Order”), which governs digital assets.1 Under Section 2 of the Prescription Order, a “digital token” (which is a category of digital assets) is defined as a digital representation which is recorded on a distributed digital ledger, whether cryptographically secured or otherwise.

Further, Section 3 recognizes digital assets as securities (and accordingly, all the securities law will be applicable to such digital assets), only if all the following conditions are fulfilled:

(a) The digital token represents a right or interest of a person in any arrangement made for the purpose of providing facilities for the person;

(b) the person receives the digital token in exchange for a valuable consideration;

(c) the consideration or contribution from the person, and the income or returns, are pooled;

(d) the income or returns of the arrangement are generated from the acquisition, holding, management or disposal of any property or assets or business activities;

(e) the person does not have day-to-day control over the management of the property, assets or business of the arrangement;

(f) the person expects a return in any form from the trading, conversion or redemption of the digital token or the increase in its value; and

(g) the digital token is not issued or guaranteed by any government body or central banks of any country as may be specified by the Securities Commission (“SC”).

As of to date, there has been no issuance of NFT yet in Malaysia which meets all the conditions in the Prescription Order above or are eligible to be legally traded as securities. According to a statement by the Chairman of the Securities Commission (“SC”) dated 28 March 2022, the SC will approach the regulation of NFT issuance on a case-by-case basis, subject to the nature of the token and the NFT projects, as well as the activities carried out at the NFT marketplace2.

This is because the SC observed that in the current Malaysian NFT marketplace, the underlying assets of most NFT are non-security products and involve more of collectable items. Hence, they do not yet come within the purview of the SC (unlike cryptocurrency, whereby there are currently 4 registered market operators/ digital asset exchanges for cryptocurrency trading)3.

Besides that, the SC Guidelines on Digital Assets (“DAS Guidelines”)4 are applicable to any fundraising activity made through digital token offering (not personal or individual transactions involving NFTs). The DAS Guidelines is applicable to the following:

(a) all issuers seeking to raise funds through digital token offering;

(b) all persons intending to operate an initial exchange offering platform (offering of digital tokens by an issuer through an electronic platform); and

(c) persons intending to provide the services of safekeeping, storing, holding.

Any person intending to carry out the above activities will need to comply with the provisions of the DAS Guidelines, such as issuance of white paper, reporting and audit requirement, and guidelines on utilisation of the issuance proceeds.

 

Potential Legal Issues from Transactions Involving NFT

(a) Are Transactions Involving NFT Recognised Under the Contracts Act 1950?

Since the Malaysian Contracts Act was passed in 1950, there are no indications on whether it applies to transactions involving digital assets, including NFTs. As at the date hereof, NFT-related disputes have also not reached the Malaysian courts yet. However, there is a Malaysian decided case involving cryptocurrencies, Robert Ong Thien Cheng v Luno Pte Ltd & Anor (unreported), whereby the Respondents filed an action against the Appellant to claim for a return of 11.3 Bitcoins (amounting to approximately RM300,000.00) which was transferred by mistake to the Appellant.

The Malaysian High Court decided that whilst they are intangible and only exist virtually, cryptocurrency is a form of commodity as “real money” is used to purchase them and hence, there is value attached to the said Bitcoins in the same way value is attached to shares. As such, transactions involving Bitcoins fall well within the ambit of the Contracts Act 1950. The Court accordingly allowed the Respondent’s appeal for a return of the said Bitcoins.

Should any disputes arise later on involving NFTs in Malaysia, it is likely that the courts may recognize NFTs to be a commodity and governed under the established contractual principles embodied in the Contracts Act 1950, by applying the same reasoning as cryptocurrencies above.

 

(b) Copyrights and NFT

A potential legal issue which would arise from sale and purchase of NFTs would be copyrights to the NFT, especially NFTs involving artistic works such as drawings, music etc. Under Section 7 of the Copyrights act 1987 (“Act”), the authors of literary works, musical works, artistic works, films, sound recordings and broadcasts which have been written down, recorded or otherwise reduced to material form are eligible for copyright, irrespective of the quality and purpose such work was created. According to Section 13(1) of the Act, the copyright shall include the exclusive right to control of the reproduction and distribution of copies of the work in Malaysia.

Hence, a person may possess, sell, buy and transact in NFT, but he does not automatically own the copyright to such NFT (which will only be owned by the author).

However, since NFT assets are very new, there has been no guidelines issued for registration of the same with the Malaysian Intellectual Property Corporation (“MyIPO”), or any indication as to whether copyrights of NFTs are accepted for registration.

Besides that, since NFT related transactions occur online, breaches of copyright of the author may occur more easily as compared to sale of physical artistic works. For instance, if one owns or buys an NFT of an image or video of a certain sports game, one can’t prevent others who have the same picture or video to upload or use it anywhere else on the internet.  However, since this is a fairly new area of law, it remains to be seen what remedies are available in case of breaches of copyrights involving NFT.

 

(c) Are Taxation Laws Applicable to NFT-Related Transactions?

According to Section 4 of the Income Tax Act 1967 (“ITA”), gains or profits from a business, for whatever period of time carried on is a taxable income. According to the Inland Revenue Board’s Guidelines on Digital Business, trading in cryptocurrencies (including trading, selling and mining) is subject to income tax5. However, as at the date hereof, there is no guideline yet issued by the Inland Revenue Board as to whether NFT-related transactions are subject to income tax.

 

Legal Treatment of NFTs in Other Jurisdictions

In the USA (where NFTs first originated) and generally all around the world, legislations regulating NFTs are still in the research and draft stage. Similar to the current position in Malaysia, the question whether NFTs qualify as a security under the USA Securities Act 1933 and Securities Exchange Act 1934 (and fall into the regulatory purview of the USA Securities and Exchange Commission) is still unclear and will be analysed on a case-to case basis.6 Interestingly, there have been cases involving NFTs decided in the UK and Singapore respectively in 2022. In the UK High Court case of Lavinia Deborah Osbourne v (1) Persons Unknown (2) Ozone Networks Inc (Trading as Opensea), the Plaintiff filed a suit against an NFT marketplace operator to recover NFTs stolen from her e-wallet. The English High Court held that the NFT assets were “property” and thus able to have access to legal protection. Consequently, an injunction was granted against the Defendant to freeze the stolen NFT and to compel the Defendant to disclose information about the e-wallet account holders who were involved in the theft.7 8

Closer to home, the High Court of Singapore on 13 May 2022 had granted an injunction to an individual to stop any potential sale and ownership transfer of a NFT that was previously owned by him. The Plaintiff sought to repossess a NFT which he had used as a collateral for a loan from an online persona named “chefpierre” (the NFT was wrongfully seized by Chefpeire following some disputes regarding the loan).

This injunction is said to be the first in Asia issued in relation to NFTs.9 This is a notable development as it paves the way for a certain extent of legal protection for NFT related transactions in an otherwise unregulated sphere of business.

 

Conclusion

Whilst NFT related transactions are unchartered territories, it is likely that such transactions are protected under the law of contracts in Malaysia. However, since the NFT industry is fast expanding, there is a need for direct regulation on the same to avoid potential legal issues, especially those involving frauds, scams and hacks.

In view of the various legal issues surrounding NFT-related transactions which may pose a liability if not adequately addressed, potential market participants are advised to seek proper legal consultation before tapping into the NFT market.

 

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  1. https://www.sc.com.my/api/documentms/download.ashx?id=8c8bc467-c750-466e-9a86-98c12fec4a77.
  2. https://www.nst.com.my/business/2022/03/783971/sc-will-approach-nft-projects-case-case-basis.
  3. https://www.sc.com.my/regulation/guidelines/recognizedmarkets/list-of-registered-digitalasset-exchanges.
  4. https://www.sc.com.my/api/documentms/download.ashx?id=aeb10f62-944b-4d83-8aa0-4ed492dc1109.
  5. https://www.hasil.gov.my/en/company/digitalbusiness/.
  6. https://www.globallegalinsights.com/practiceareas/fintech-laws-and-regulations/2-the-regulation-of-non-fungible-tokens-in-the-united-states.
  7. https://news.artnet.com/market/uk-highrecognizes-nfts-as-property-2108605.
  8. https://cointelegraph.com/news/uk-courtrecognizes-nfts-as-private-property-what-now.
  9. https://www.straitstimes.com/tech/tech-news/singapore-high-court-blocks-potential-sale-and-transfer-of-rare-nft

 

Written by:

Muhammad Inamul Hassan Shah (Partner) hassanshah@azmilaw.com

Fairuz Hanim Abdul Latiff (general@azmilaw.com)

 

30 July 2022