Chris Haywood writes for The Oath on the impact of Dubai's new Virtual Asset Law on NFTs and the metaverse

Chris Haywood, Senior Associate, examines the impact of Dubai’s new Virtual Asset Law on NFTs and the Metaverse and takes a closer look at the market for The Oath. Read the full article below:

On March 9, 2022, Dubai Law No.4 of 2022 (“VAL”) established the Dubai Virtual Asset Regulatory Authority (“VARA”). It has been tasked with regulating in Dubai the issuance and release, exchange, custody, and manipulation of any virtual asset or virtual token in Dubai (although excluding the DIFC).

The impact of the VAL is likely to be felt across a number of industries with established digital asset strategies. This article will look into the approaches that we have seen on the market, particularly in relation to NFTs and the Metaverse, and how the arrival of a new law and regulator might affect them.

NFTS

NFT offerings have diversified significantly over recent months. The opportunities presented by an asset class that (theoretically at least) cannot be corrupted, and that indelibly records each interaction, have been thoroughly explored. Within our own client base and further afield we have seen NFTs applied in a number of interesting ways, including:

• As tokens of financial interests or stakeholdings – from currency-type assets to shares in the ownership of a particular project such as a film (NFTs with this quality as a medium of exchange are normally referred to as security tokens);
• As redeemable coupons for certain experiences or opportunities - a digital ticket for access to openings, events etc. (utility tokens);
• To record the fractional ownership of assets (sometimes known as FNFTs - fractional NFTs);
• As a means of storing and accessing authenticity, condition, and provenance information, often in combination with QR codes or other physical tags;
• As options for future acquisitions. For example, Damien Hirst’s offering of NFT options to acquire physical prints of his limited-edition Empresses series. This is particularly interesting as the number of prints was limited to the number of NFT purchases and presumably, as NFTs are tradeable, it allowed for an “en primeur” type pre-release market to evolve. It may also have led to royalty income (which is next);
• As “on chain” royalty mechanisms attached to particular transactions
  through the use of smart contracts that automatically return a share of any purchase price to the minter of an NFT;
• Game tokens, metaverse tokens, and unique in-game/in-‘verse items that can be traded within a particular ecosystem; and
• As a unique form of transactional communication. This was reported in the Law Society Gazette on July 13, 2022. The English High Court allowed a claimant to serve proceedings on an unknown defendant by dropping an NFT containing the relevant documents into the defendant’s
  wallet. Service would have otherwise been difficult or impossible in the absence of a physical or digital address.

Depending on how the regulatory landscape changes, in the future we could conceivably see NFTs deployed for more formal record keeping in relation to transactions relating to shares in companies, or even as real estate deeds.

THE METAVERSE

In its current incarnation the metaverse is not quite the that of Neal Stephenson’s Snow Crash. Rather than the digital echo of the physical universe, within which one unified and singular reality is barely distinguishable from another, we have a number of compartmentalised software offerings. The lack of interconnectivity between these offerings has led to CNET2 predicting that the metaverse will only ever be a “multi-platform mess”. Even so, businesses are taking their first steps into digitally offering their services via the various platforms on offer. VARA itself has set up in Sandbox. In the course of establishing a presence in the metaverse, most businesses will generate or interact with digital assets.

Digital assets in this context can of course be NFTs. These can either be developed using the metaverse in question’s own platform, or via one of the existing thirdparty platforms. Outside of NFTs there may also be fungible assets that are developed for and recorded within the metaverse itself, on or off the blockchain. An example might be a standard-issue avatar that comes as part of the package when a customer signs up to the service. It is an asset within the game, it may or may not be traded within or outside of the game’s environment.

Some assets may not conform comfortably to any category, which makes things complicated from a regulatory perspective. Legislative language and enforcement practice may struggle to cope with both the sheer variety on offer and the speed of technological evolution.

VAL AND VARA

Arguably, the explosion in value and diversity of digital assets has been facilitated by the absence of significant regulation across the globe. The introduction of the VAL may present a minor threat on this basis. However to offset the chilling effect of increased regulation, the establishment of VARA’s oversight is intended to lead to more predictable market behaviour, and to act as a safety net for investors into new digital assets. From a purely practical perspective, neither VARA nor the DWTC have any interest in stymying growth in this sector given Dubai’s ambitions to be the global leader. With that said, it is still essential that businesses with digital interests pay attention to the changes that the VAL brings.

The VAL regulates virtual assets and virtual tokens. Virtual assets are broadly defined under the law as any “digital representation of value that may be digitally traded, transferred, or used as an exchange or payment tool, or for investment purposes. This includes virtual tokens, and any digital representation of any other value as determined by VARA”. Virtual tokens (a subset of virtual assets) are even more broadly defined as “a digital representation of a set of rights that can be digitally offered and traded through a Virtual Asset Platform”.

A digital representation of value could be anything from an in-game reward to a unique username. Both have value in their uniqueness or effect. The VAL does not say what kind of value is needed. It does not appear to be limited to financial value. The law is even less prescriptive when it comes to virtual tokens. There is no clear guidance as to what a digitised set of rights might be. It would not be unreasonable to consider that it would include game progress data, user information, or any other unique digital information belonging to anyone anywhere. Importantly, it is generally accepted that NFTs would fall within at least one of these two definitions, regardless
of their specific purpose.

VARA is tasked with ensuring that certain activities in relation to these virtual assets and virtual tokens are carried out only under licence - notably the provision of a virtual asset platform, the exchange of virtual assets, the management of virtual assets, and offering or trading in virtual tokens.

A virtual asset platform could be almost anything that produces, stores, transfers, interacts with, manipulates, or generates them. Almost any activity in relation to them on or off of that platform requires a licence.

The likelihood is that the law will not extend to individual users or third parties generating assets via existing platforms – for example minting an NFT on a local platform such as NIFTY Souq. In this situation it would make sense that it is the platform itself that is responsible for the mechanism of provision/exchange/management/trade, rather than the user of that platform. There will likely be grey areas. A security token offering based entirely on a thirdparty platform may nevertheless be the responsibility of the offeror.

In addition to potential uncertainty as to whether or not certain digital assets require licensing by VARA, there is an additional uncertainty as to whether or not VARA would be the only relevant regulator for businesses to seek a licence from.

The Securities and Commodities Authority (SCA) is already responsible for its own virtual asset licensing and regulatory regime in onshore UAE under Decision No. 23 of 2020 Concerning Crypto Assets Activities Regulation. This particular regulation relates to the governance of “crypto assets” which as a category has a significant overlap with virtual assets and virtual tokens. It is reasonably likely that the present definition encompasses all NFTs, not just security tokens as one might expect from a securities regulator.

It is not clear how this overlap will be dealt with in practice yet.

A CHANGE IN APPROACH TO NFTS AND THE METAVERSE?

The bottom line is that any business engaged in producing a significant number of digital assets should be aware of the potential exposure to the licensing regimes offered not only by the new VARA, but also by the SCA. This of course will be the case if a business establishes a platform, storage or management service, or an exchange of any sort in relation to NFTs or any other form of crypto or digital asset. However, the boundaries of licensed activities and assets are still unclear, as is the division of responsibility between the two regulators.

If there is any doubt as to whether a particular activity might be regulated, then there is no harm in contacting VARA and/or the SCA for clarity. We expect to be in regular contact with them both, and to work with them to ensure that our clients will operate with certainty in what we hope will be the global centre for digital business in the future.

The full article was first published in The Oath (subscription required).