NFTs: a modern-day “tulip mania” or a true asset class? – comment

introduction

In the art world, the non-fungible token (NFT) has a better defined niche than in the financial services sector. Previously, it could be described as a digital or computer-generated artistic expression using blockchain technology (or distributed ledger technology) as its backbone, enabling ownership to be identified and attributed to a specific person. However, from a banking and economic perspective, the role of NFTs is still evolving, and there are open questions. Specifically, the question is whether an NFT is a real asset (and thus can serve as a security), or whether it is a modern-day throwback to the so-called “tulip mania” of the 17th century, i.e. the phenomenon of a financial bubble rising The value of the asset is largely due to perception and not due to its intrinsic value.

There are some interesting similarities between how NFTs work and the tulip mania event:

• Both have passionate and visible supporters and advocates that have hogged the limelight and led to a massive increase in interest among audiences and thus in their values.
• Neither of them has any tangible value that appears on the surface.
• Both appear to have been accompanied by mass hysteria that precipitated adoption of the system (e.g., purchases), and each was accompanied by a sudden drop in value.
• Neither of them seems able to shake off the speculative assumptions surrounding them.

Issues and solutions

Notably, financial sector experts will point to the lack of a widely accepted valuation mechanism for NFTs and potential regulatory moves to classify NFTs as “unregistered securities” as key factors hindering the acceptance of NFTs as an asset class. Unlike other asset classes, the inability to restrict the transfer of NFTs also detracts from their acceptability as collateral for loans via traditional forms of security, such as a mortgage or lien. Even among participants in the specialized financial sector that provide information and lend against the security of works of art, there do not appear to be any reports in the public domain of loans provided by traditional financial institutions against the security of NFTs.

However, there appear to be some online marketplaces and platforms that provide decentralized financing solutions through a peer-to-peer lending model where an NFT creator or owner can offer it as collateral to raise funding.

Financial sector participants are now increasingly subject to data privacy and protection regulations, which require them to put in place robust technological measures to prevent data breaches and leaks. Some of these data protection mechanisms could also be compatible with protecting or locking digital assets, which would enable them to have similar features to traditional asset classes – and this would make it possible for NFTs to be provided as collateral for loans from traditional financial institutions as well.

Having regulations that recognize NFTs as an asset class (and not as an exchange-traded security or commodity) would also be a good start to boosting their acceptance as a financial asset. This must be accompanied by clarity from a valuation and tax perspective. Any regulation on NFT-based lending would need to consider the risks involved in execution and calling or selling collateral in the event of any default.

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Aside from their unfortunate commonality with the occurrence of lavender mania, and despite the criticism they have received due to environmental concerns due to energy use by blockchain networks that support NFTs, NFTs appear to provide a real technological solution for the financial market sector. It is beneficial to promote its development through appropriate regulation rather than dismissing it as a speculative instrument that should be kept away from stakeholders in financial markets.

For more information on this topic please contact Aditya BhargavaMithila Bhatti or Sristy Yadav At Phoenix Legal by phone (+91 22 4340 8500) or email ((email protected), (email protected) or (email protected)). Phoenix Legal’s website can be accessed at www.phoenixlegal.in.