Must-Read for Entrepreneurs – China’s NFT Digital Collectibles Compliance Operation Guide V2.0

China's NFT Compliance Guide V2.0 for Entrepreneurs

The metaverse is far away, but NFT is close.

NFT digital collectibles, as an important field of the digital economy, have broad market prospects. Guiding NFT digital collectibles to empower entities and promoting the development of “digital collectibles + cultural tourism,” “digital collectibles + cultural creation,” and “digital collectibles + business” is not only an important channel for creating a virtuous closed-loop of “digital collectibles – traditional culture – industry development,” but also a necessary and realistic need to promote the development of the digital economy.

However, at the same time, market chaos such as false advertising, speculative trading, copyright infringement, fictional value, and difficulties in safeguarding rights are increasing day by day. The risks of fraud, money laundering, pyramid schemes, and illegal fundraising cannot be ignored. Supervision, restriction, and compliance guidance are urgently needed.

“Ensuring the legality of Web3.0 in China!” is the industry mission of Lawyer Mankun. In this article, we combine the mainstream business models of the Chinese NFT digital collectibles industry, common collectible gameplay, guidance policies from various departments, and the practical experience of Lawyer Mankun’s team in dealing with market supervision and management bureaus and public security departments in various places, and compile this “China NFT Digital Collectibles Compliance Operation Guide V2.0”. We hope it will be helpful to practitioners in the domestic NFT digital collectibles industry.

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01 Focus on Risk Prevention and Control: Operating Qualifications

10 departments, including the Hainan Provincial Market Supervision and Administration Bureau, issued the “Notice on Strengthening the Risk Supervision of Digital Collectibles” to indicate the qualifications and administrative permits required by digital collectibles companies. Combining relevant laws, regulations, and regulatory documents in China, it is recommended that NFT digital collectibles operators apply for the following qualifications and file records.

(1) ICP Filing

ICP filing is the most basic qualification for website operation. The “Administrative Measures for Internet Information Services” implements the filing system for non-operational internet information services. Non-operational websites can file for free. If a website does not file, it faces the risk of being investigated, punished, and shut down.

(2) ICP License

According to Article 7 of the “Administrative Measures for Internet Information Services,” those engaged in operational internet information services should apply to the provincial, autonomous regional, directly-administered municipal telecommunications management agencies, or the competent departments of the State Council for information industry to handle the license for operating value-added telecommunications services for internet information services.

NFT digital collectible platforms that involve fee-based operations should obtain an ICP license.

(3) EDI License

An EDI license (Electronic Data Interchange), also known as an EDI business license, is a professional qualification certificate for online data processing and transaction processing business needs. It belongs to the scope of Class B21 value-added telecommunications services.

The core criterion for determining whether an EDI license is required is: providing online data processing and transaction processing services for both parties to a transaction through communication networks. This means that if an NFT platform allows third-party merchants to sell or provide transaction services for digital collectibles to users, an EDI license is required. If it is only a self-operated website selling physical products, it is an extension of the distribution channel and does not provide “online data processing and transaction processing” services for both parties to a transaction, so no application is required.

(IV) Public Security Network Security Filing

According to the “Regulations on the Security Protection of Computer Information Systems of the People’s Republic of China” and the “Administrative Measures for the Security Protection of Computer Information Networks International Interconnection”, the Ministry of Public Security is responsible for the security protection of computer information systems nationwide and implements an online filing system. Internet units, access units, legal persons and other organizations using computer information networks for international interconnection should go to the designated acceptance authority to go through the filing procedures.

The company can handle it through the Internet Security Management Service Platform of the Public Security Organ’s website (beian.gov.cn). For specific operation guidelines, please refer to the “National Public Security Organ’s Internet Security Service Platform Filing Manual” published on the website.

(V) Blockchain Information Service Filing

According to the regulations of the “Management Provisions for Blockchain Information Services”, blockchain information service providers should fill in the information such as the name of the service provider, service category, service form, application field, server address, etc. through the National Internet Information Office’s blockchain information service filing management system, and go through the filing procedures.

You can log in to the blockchain information service filing system website (https://bcbeian.ifcert.cn/) for real-name registration and follow the website prompts to go through the filing procedures.

(VI) Art Business Unit Filing

According to the “Administrative Measures for Art Business” of the Ministry of Culture and Tourism, art business units engaged in art business activities through information networks should apply for a business license and go through the filing procedures with the cultural administrative department at or above the county level of their place of residence within 15 days from the date of obtaining the business license.

Therefore, it is recommended to go through the art business filing procedures with the relevant local authorities.

(VII) Internet Culture Operation License

According to Articles 3 and 4 of the “Administrative Measures for Internet Information Services”, Internet information services are divided into two categories: for-profit and non-for-profit. The state implements a licensing system for for-profit Internet information services; and a filing system for non-for-profit Internet information services. Without obtaining a license or going through the filing procedures, no one is allowed to engage in Internet information services.

Digital collectibles are non-fungible digital works, artworks, and commodities that are based on their own collection value and copyright value, and use blockchain encryption technology for unique identification to confirm ownership rights and achieve traceability. Therefore, the network service activities of selling digital collectibles to users on the Shu Cang platform fall within the scope of for-profit Internet information services. It is recommended to obtain the “Internet Culture Operation License” in accordance with the regulations.

(VIII) Auction Business Approval Certificate

According to the “People’s Republic of China Auction Law”, enterprises engaged in auction business need to obtain an auction business approval certificate. This provision applies to auction activities conducted by enterprises within the territory of the People’s Republic of China, regardless of whether the auction activities are conducted online or offline.

Therefore, if the Shu Cang platform sells digital collectibles in the form of auctions, it is advisable to apply for the auction business approval certificate according to the above regulations, or consider cooperating with auction companies that have obtained the corresponding licenses.

02 Focus on risk prevention and control: Financial

(I) Illegal Fundraising Risks

The supervision of virtual currencies by Chinese regulatory agencies has been strengthened. On September 15, 2021, the People’s Bank of China and ten other departments issued the “Notice on Further Preventing and Handling Risks of Virtual Currency Trading Speculation,” which clearly stated that Bitcoin and other homogeneous tokens belong to virtual currencies, and related business activities of virtual currencies are illegal financial activities. On March 1, 2022, the “Interpretation of the Supreme People’s Court on Several Issues Concerning the Specific Application of Laws in the Trial of Criminal Cases of Illegal Fundraising” also included the behavior of absorbing virtual currencies into the model of illegal absorption of public deposits.

There are four characteristics of illegal fundraising: illegality, publicity, sociality, and attractiveness. Currently, in the digital asset industry, platforms develop more aggressive and attractive activities to guarantee user stickiness and activity, which may be recognized by judicial authorities as being attractive. For example, in order to increase sales, some platforms promise regular repurchases at the time of sale; some platforms develop activities such as “holding certain digital assets, earning points every day, and exchanging points for prizes” to increase user holdings; and some platforms even promise users high returns in the future directly in their communities before the sale.

Therefore, domestic digital asset platforms can only use the Chinese yuan as the pricing and settlement currency, and in the marketing and promotion of platforms, avoid using similar expressions such as “promise to repay principal and interest” (for example, when selling digital assets, claiming that the platform will repurchase assets from users at prices lower than specific prices).

(II) Payment and Settlement System

According to current laws and regulations, the establishment of a digital asset trading platform or the sale of digital assets does not violate prohibitive provisions of laws and regulations. The criminal risk of illegal operation that digital asset platforms may be involved in mainly lies in the platform’s fund settlement methods.

Regulations such as the “Measures for the Administration of Non-Financial Institution Payment Services” stipulate that non-financial institutions providing part or all of the currency fund transfer services as intermediary institutions between payers and payees should obtain a “Payment Business License”.

If a “platform internal user asset circulation channel” is established, the platform should use a third-party payment institution holding a “Payment Business License” to provide a payment and settlement system, and the funds should be paid and held through the third-party payment institution. This can avoid the platform from collecting funds through accounts it controls, forming a fund pool, and thereby prevent the criminal risk of illegal operation.

(III) Anti-Money Laundering Mechanism

The establishment of a “platform internal user asset circulation channel” will greatly increase the market circulation rate of digital assets. Combined with the natural characteristics of virtual assets, this may make digital assets a tool for money laundering by criminals. The “Initiative to Prevent Financial Risks Related to NFTs” proposes, “authenticate the issuers, sellers, and buyers, properly preserve customer identity information and transaction records, and actively cooperate with anti-money laundering work.”

Therefore, the digital asset platform should establish a sound anti-money laundering mechanism, fulfill regulatory review obligations, prevent the platform from being used as a tool for crime, and thus prevent criminal risks of concealing, concealing, and assisting cybercrime.

The digital asset platform should strictly implement real-name identification of customer identities. In the case of large or suspicious transactions, the customer’s identity should be verified in a timely manner, relevant information should be reviewed, the business relationship and purpose and nature of the transaction should be understood, and the transaction behavior of the relevant account should be monitored and restricted. If there is a possibility of violation or crime, it should be promptly reported and dealt with in accordance with laws and regulations. Strengthen system security to prevent network data leakage, theft, or tampering, strengthen the ownership certificates of digital assets, and strengthen the platform’s technical security and defense against network attacks. In addition, the digital asset platform has a high confidentiality obligation for personal information security, and must avoid disclosing personal information, and strictly prohibit the illegal acquisition, provision, and sale of personal information.

(IV) Speculation and trading risks

On April 13, 2022, the China Internet Finance Association, the China Banking Association, and the China Securities Association jointly issued the “Initiative to Prevent Financial Risks Related to NFTs”, which mentioned: “Do not provide centralized trading (centralized bidding, electronic matching, anonymous trading, market makers, etc.), continuous listing trading, standardized contract trading, and other services for NFT transactions, and do not establish trading venues in violation of regulations.” The establishment of the “platform internal user asset circulation channel” (consignment market) on digital asset platforms is often strongly associated with speculation. After opening the consignment market, speculation and high-priced resales are prone to occur, blurring the boundary between digital assets and financial products.

Therefore, digital asset platforms should actively guide users to correctly understand the nature and purpose of asset ownership and transactions, and avoid attributing financial attributes to digital assets. Otherwise, it will bring significant uncertainties to the platform’s continued operations. In this regard:

(1) Asset prices should be within a reasonable limit. That is, the price limit of assets should be determined based on factors such as asset characteristics, platform size, and market conditions, in order to establish a reasonable price range. Avoid the price limit measures for reducing financial risks from being superficial and ineffective.

(2) Set restrictions on asset circulation. For example, set a longer protection period for asset circulation, requiring a certain holding period before assets can be circulated, restrict the trading cycle of digital assets to prevent immediate re-trading, limit the trading frequency, and set a maximum number of total asset circulations for a single asset.

(3) After the consignment market is opened, some platforms may choose to cooperate with third-party digital asset market platforms, such as “Ding Chain” and “Zhi Tan”, to display real-time market value quotations. In this regard, due to the traceability of blockchain, it is necessary to avoid falsifying market data from third-party markets.

03 Key Risk Prevention: Fraud

After opening the “platform internal user collection circulation channel”, it is very easy to see speculation or high-priced reselling, making the boundary between digital collectibles and financial products unclear. The risk warning on “preventing illegal fundraising in the name of the metaverse” also specifically prohibits “speculating on metaverse real estate to raise funds, creating a buying frenzy, and enticing people to hoard and trade”.

If the digital platform artificially inflates prices to boost popularity and increase sales, creating an illusion of scarcity, it is highly likely to be deemed by judicial authorities to have the subjective intention of illegal possession, thus constituting fraud. Several domestic digital platforms have already been investigated and filed by judicial authorities for “fraud” or “fundraising fraud”.

The risks of the digital platform opening the “platform internal user collection circulation channel” often come from the lack of regulation on insider trading and price manipulation, as well as the absence of mandatory information disclosure requirements. Therefore, after opening the “platform internal user collection circulation channel”, it is necessary to eliminate behaviors that artificially influence and manipulate prices, constrain internal personnel of the platform, and prevent private buying and selling or tampering with data in the background. At the same time, the digital platform should rigorously review the commitments made to users to ensure that they can fulfill these commitments within the legal scope; establish a sound pricing and evaluation mechanism for collectibles to avoid artificially high prices. The final selling price should be determined based on the security of digital collectibles, the reputation of the artwork content, and market potential from multiple perspectives; and appropriately limit the number of collectibles for sale to avoid weakening their non-fungible characteristics and reducing the attributes of digital collectibles.

04 Key Risk Prevention: Gambling-related Risks

In the digital collectibles industry, many platforms have set up a points mall, and in order to increase platform activity and the circulation of collectibles, the points mall is often used in conjunction with activities such as “guessing” and “lottery”. However, in the process of designing these activities, if the behavior follows the pattern of “paying to participate – random gameplay – reward output – reclaiming rewards”, there is a risk of being suspected of establishing a gambling venue.

(1) Paying to participate: Payment includes cash, virtual currency obtained through payment, and game props obtained through virtual currency exchange, etc.

(2) Random gameplay: If the minimum or maximum value of the output greatly exceeds the amount paid, it has a certain “high risk, high return” nature.

(3) Reward output: Cash or physical rewards given directly or indirectly.

Therefore, if the platform launches activities such as “guessing” and “lottery” later on, do not directly bet with fiat currency, do not use fiat currency to directly purchase/exchange props for betting, and increase the channels for obtaining betting props or the ways to use them.

Secondly, the circulation or recycling channels of rewards are strictly prohibited. The platform must ensure that users cannot trade or circulate rewards within the platform, or exchange rewards for fiat currency, virtual currency, or transferrable vouchers within the platform. Do not provide circulation or recycling channels for exchanging rewards on the platform, and do not open any circulation or recycling channels on other platforms (such as WeChat) by the official. It is strictly forbidden to engage in the practice of converting physical rewards into cash before the user receives them.

Lastly, in lottery activities, manipulation by the background is strictly prohibited. Changing the extraction results through background manipulation, arbitrarily adjusting the extraction probability, and other means of inducing consumption is not allowed. The platform should retain complete records of the extraction probability setting and result extraction, establish a tracking record system, and ensure that the goods extracted by users are delivered properly. The retention period for relevant records is generally not less than 3 years. At the same time, it is recommended that the platform guide users to consume rationally by setting extraction time, upper limits on extraction amounts and frequencies, and other methods.

05 Key Risk Control: Copyright Risk

The copyright holder of a work enjoys multiple rights, including the right of reproduction, distribution, public performance, and information network dissemination. If the Digitized Collectibles platform sets up a “platform-internal user collectible circulation channel,” the platform is required to obtain the corresponding authorization from the copyright holder. Otherwise, there may be a risk of copyright infringement, which may constitute a crime and involve criminal risks. Due to the immutability and publicity of digital collectibles after being uploaded to the blockchain, once infringing works are uploaded to the platform, the entire work can only be deleted and destroyed, with no room for modification. Therefore, it is necessary for the Digitized Collectibles platform to avoid copyright-related risks.

In terms of ownership examination of works, it is recommended that the Digitized Collectibles platform sign a commitment letter with the authorized party of the work and provide corresponding evidence of ownership (such as the manuscript of the work, copyright registration certificate, etc.), and establish a reporting mechanism afterwards. If there is any infringement, timely measures such as delisting should be taken.

In terms of the ownership of intellectual property rights for digital collectibles, it is necessary to clearly specify that the intellectual property rights of digital collectibles are owned by the issuer or other rights holders, and the above-mentioned rights are not transferred or shared through the act of purchasing digital collectibles. Without the written consent of the platform or the relevant rights holder, buyers are not allowed to independently or license any third party to implement, utilize, or transfer the aforementioned intellectual property rights for any commercial or non-commercial purposes. For example, the “Whale Exploration” platform clearly states in the purchase notice, “The copyright of the digital collectibles is owned by the issuer or the author. Without the written consent of the copyright owner obtained separately, users are not allowed to use the digital collectibles for any commercial purposes.”

In summary, currently, there are no specific regulations in China that classify the opening of collectible circulation channels between users on digital collectibles platforms as illegal or non-compliant. In this context, the Digitized Collectibles platform should adhere to the principle of de-financialization of collectibles, leverage the cultural attributes of collectibles themselves, guard against various risks, and establish a sound compliance mechanism.

06 Key Risk Control: Personal Information and Data Compliance

Issuance and trading activities related to digital collectibles are considered data processing activities and should comply with the requirements of the Data Security Law. At the same time, digital collectible trading platforms that are built, operated, maintained, and used domestically need to comply with the compliance requirements of the Cybersecurity Law. During the casting and issuance process of digital collectibles, a large amount of personal information may also be involved, which needs to comply with the relevant provisions of the Personal Information Protection Law.

From the construction of the digital collectibles platform to various stages such as casting and issuance, a large amount of data and personal information is inevitably involved. Therefore, the platform should also pay attention to the compliance of personal information and data. It is recommended that the platform take the following measures:

(1) The digital collectibles platform should implement a strict real-name authentication mechanism for the issuers and buyers of digital collectibles.

(2) The hardware devices, servers, databases, and related cloud services (or proprietary devices) deployed by the digital collectibles platform must be within China.

(3) In the data collection stage, the “notice-consent” rule should be implemented, and the collection of personal information should be limited to the minimum scope necessary to achieve the processing purpose. The platform’s handling of personal information should follow the principles of legality, legitimacy, necessity, and good faith, and should also comply with the requirements of full disclosure, voluntary consent, explicit authorization, notification of changes and obtaining consent again, and allowing withdrawal of consent.

(4) In the data storage stage, the digital collectibles platform should record and store user login history (time, IP address, etc.), asset transfer records (inbound and outbound details), etc., strictly protect and save customer privacy information, and the backup records should be kept for no less than six months.

(5) In the data usage stage, personal information should not be provided to others without the consent of the data subject; when using personal information for automated decision-making, transparency and fairness of the decision should be ensured; in cases where data involves third-party interactions, the qualifications and cooperation content of the third-party data partners should be strictly reviewed.

(6) In terms of data content, the content and activities published by the platform should be strictly reviewed, and the blockchain information service should not be used for activities that are prohibited by laws, regulations, and administrative regulations, such as endangering national security, disrupting social order, and infringing upon the legitimate rights and interests of others. The production, reproduction, publication, and dissemination of prohibited information content using blockchain information services are prohibited.

07 Final Words

Over the past year, the Manquan Law Firm team, including Lawyer Honglin, has written hundreds of popular legal articles related to NFT digital collectibles, which are real problems encountered by industry friends and cases handled by Manquan Law Firm. We continue to pay attention to the industry and output legal popularization content, hoping to help entrepreneurs avoid pitfalls and prevent NFT digital collectible buyers from falling into traps.

The blockchain industry in China needs more peers who recognize and adhere to compliant development concepts. Only by being compliant can we go further! If you encounter legal confusion and problems on your journey of entrepreneurship in Web3.0, blockchain, and NFT digital collectibles, please feel free to contact Lawyer Honglin for communication.

We will continue to update Blocking; if you have any questions or suggestions, please contact us!