The world of Non-Fungible Tokens (NFTs) has seen a whirlwind of activity, with several notable events that have captured global attention. Their origins can be traced back to 2012 when cryptographer Meni Rosenfeld, also former President of the Israeli Bitcoin Association, published a seminal paper introducing the idea of Colored Coins. These tokens could be used to represent “ownership of physical assets such as cars and cellphones” (Rosenfeld, Overview of Colored Coins). However, the first NFT as we know it today, named "Quantum" ("Token ID: 0”), was minted by Kevin McCoy on the 2nd May 2014 (Sotheby’s, Quantum).
NFTs began to gain significant traction in the games and art world beginning 2018, following the introduction of Ethereum's ERC-721 standard (Entriken; Shirley; Evans; Sachs, RC-721: Non-Fungible Token Standard). This innovation paved the way for groundbreaking projects such as CryptoPunks and CryptoKitties. CryptoPunks, a collection of 10,000 algorithmically generated 24x24 pixel character images, drew inspiration from the burgeoning CryptoArt movement (LarvaLabs, CryptoPunks). Similarly, CryptoKitties, an Ethereum blockchain-based game centred around digital and collectible cats that can be bought, sold, and bred, leveraged the potential of NFTs (CryptoKitties, White Pa-purr).
The success of CryptoKitties was later echoed by Axie Infinity, a metaverse-style game that enables players to battle, breed, collect, and trade creatures (Axies) on an open marketplace (Axie Infinity, Axie Infinity?). These tokenised creatures are stored on the Ethereum blockchain, under the form of an NFT. Axie Infinity once had millions of monthly active players, with a peak of 2.8 million players in January 2022 (CoinTelegraph, Axie Infinity player count; NBC, Axie Infinity’s $615 million crypto hack; Yahoo Finance, Top NFT game Axie Infinity).
However, it was perhaps the sale of Beeple's digital artwork, "Everydays: The First 5000 Days”, which fetched an astounding $69.3 million at Christie's auction house on 11 March 2021, that has garnered global attention to NFTs (Christie’s, Everydays: The First 5000 Days). This digital collage, devoid of any physical paint, was sold as an NFT representing a compilation of 5,000 digital pictures, created daily by Beeple (real name Mike Winkelmann), between Day 1 (1 May 2007) and Day 5,000 (7 January 2021) (Christie’s, Lot Essay). This sale not only ranked the artwork among the top most expensive pieces sold in 2021 but also underscored the growing significance of NFTs in the art market (ArtNet, The 10 Most Expensive NFT Artworks; ArtPrice, Le Marché de l’Art en 2021, 58).
Nevertheless, an artwork created by the anonymous artist Pak, named "Merge", may probably be considered as even more valuable and as the most expensive NFT artwork of all time according to some measures (Crypto, The Most Expensive NFTs Ever Sold; CoinDesk, The Top 10 Most Expensive NFTs of All Time). It was released on 3 December 2021 and has, to this day, been sold in 29,000 editions to 22,000 different buyers, for a total of $100 million (Nifty Gateway, Merge by Pak).
These significant sales mentioned above propelled NFTs to the forefront of the art world in 2021, generating a volume nearly equivalent to that of traditional art (Financial Times, How NFTs became a $40bn market in 2021).
Artists and market participants alike have embraced NFTs, leveraging them to promote and sell their creations, including digital art and collectibles (Recital (10) MiCA).
In 2020, the NFT market was valued at $338 million (Forbes, What is an NFT and Should You Buy One?), before exploding in popularity to an estimated worth of $41 billion in 2021 (Bloomberg, NFT Market Surpassed $40 Billion in 2021), and $25 billion in 2022 (Finance Yahoo, NFT Sales in 2022). Some predict an NFT market of $231 billion by 2030 (CoinTelegraph, NFT Market Worth $231B by 2030?).
However, the high prices fetched by such non-physical items, some of which freely accessible on the internet, may seem irrational at first glance. This phenomenon may however be better understood when considering the dynamics of the art market. This market often measures the social value attributed to a specific artwork rather than merely rewarding creativity. It can also have psychological reasons surrounding it (e.g., being the only person having access and owning an unique item) or reflect interest or cultural trends, leading to intense speculation. In this context, the NFT market does nothing else than mirroring the traditional art market.
Nevertheless, the NFT market currently lacks regulation, posing substantial risks to investors due to its partially speculative character, and potentially creating loopholes for unlawful activities such as money laundering. They generally do not fall within MiCA’s application scope (Article 2-3 MiCA; Recital (10) MiCA), except in some circumstances indicating fungibility – for example, tokens designated as “non-fungible tokens” minted in large series or collections (Recital (11) MiCA; EP, Remaining regulatory Challenges, 101).
One potential solution to better regulate this market could involve classifying certain NFTs as financial instruments whenever they fulfil the conditions of such instruments. According to a study by the European Parliament, the current perimeter of regulation is such that crypto-assets, particularly NFTs, may be treated as financial instruments, depending on their characteristics (EP, Remaining regulatory Challenges, 100, 102 and 118). This would thereby subject them to relevant rules and regulations.
Yet, the definition of "financial instruments" provided by the markets in financial instruments directive (MiFID II), which determines the scope and applicability of most EU financial services laws, was not written with crypto-assets in mind. Therefore, its provisions require further interpretation to determine whether they may apply to crypto-asset schemes, particularly to NFTs. This “six parts” article will explore the possibility of categorising an NFT as a financial instrument, providing a preliminary answer to this question.