The regulatory shoe has finally dropped.

 

 

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This article is an original article of Mankun Law Firm and represents only the personal views of the author. It does not constitute legal consultation or legal advice on any specific matter. If the article is to be reproduced, please contact Mankun Law Firm staff: MankunLawFirm.

Recently, several NFT digital collectibles entrepreneurs registered in Hainan communicated with Lawyer Honglin, saying that their companies were preparing to deregister or relocate to other cities.

The reason is a notice issued by the local Hainan market supervision administration together with other departments. The content of the notice is very clear: enterprises operating NFT digital collectibles business within the jurisdiction are required to submit their operating qualifications within a specified period; otherwise, "the relevant responsibility shall be borne by the enterprises themselves."

In principle, government regulation of industry development is a good thing, but the matter is obviously not that simple.

Lawyer Honglin reviewed the full text of the notice, and the overall impression is that the local government's qualification requirements for the NFT digital collectibles industry are purportedly for the need to promote the healthy development of the digital collectibles industry, but are in reality a one-size-fits-all and lazy administrative action by the local government.

It is time for the NFT digital collectibles industry to say goodbye to Hainan (the involuntary kind).

According to the requirements of the local market supervision administration, operating NFT digital collectibles locally in Hainan requires the following qualifications:

(1) Internet Information Services Business License (ICP).

(2) Value-Added Telecommunications Business License (EDI).

(3) Art Business Filing (Note: Article 5 of the Measures for the Administration of Art Business provides that an operating entity established to engage in art business activities shall apply to the administrative department for industry and commerce of the people's government at or above the county level in the place of its domicile for a business license, and shall, within 15 days from the date of receipt of the business license, file with the cultural administrative department of the people's government at or above the county level in the place of its domicile).

(4) Blockchain filing.

(5) Online culture business permit.

(6) Online publishing service permit.

(7) Auction permit (Note: Article 11 of the Auction Law of the People's Republic of China: An enterprise must obtain approval from the department responsible for administering the auction industry under the people's government of the province, autonomous region, or municipality directly under the Central Government in the place where it is located in order to obtain a permit to engage in auction business. An auction enterprise may be established in a city with districts).

(8) Classified protection of cybersecurity Level 2 or Level 3 filing.

(9) Trading market establishment permit (Note: Article 2 of the Interim Measures for the Administration of Trading Venues of Hainan Province: Trading venues referred to in these Measures mean trading venues established with the approval of the provincial government in accordance with the provisions of the State Council within the administrative jurisdiction of this province, engaging in equity-type transactions, bulk commodity transactions, and other standardized contract transactions, including trading venues whose names do not use the words "exchange," but excluding trading venues engaging in financial product transactions that perform daily regulatory duties under the financial management department of the State Council.

Which digital collectible enterprises are required to obtain the above nine qualifications? The local government has adopted a one-size-fits-all approach.

The wording in the notice document is "If an enterprise engages in digital collectible business, in particular opening a secondary market to conduct transactions, it shall possess the above qualifications.If it does not possess the above qualifications and carries out business without authorization, and is suspected of illegal or non-compliant conduct, the relevant industry competent department shall impose administrative penalties; if a crime is constituted, criminal liability shall be pursued in accordance with law."

This means that whether it is a digital collectible platform that, as understood by industry practitioners, only has primary market issuance activities, or one that opens secondary functions allowing users to exchange collectibles, all are required to obtain the above qualifications.

Is such a compliance requirement of the local government really reasonable and lawful? I do not know what others think, but at least my personal view is:Both legality and reasonableness are questionable.

As we know, there are broadly two business models for mainstream NFT digital collectibles in China. One is to sell NFT digital collectibles only, without supporting transfers between users; a well-known industry example is Jingtan. Under this business model, the issuer merely sells digital collectibles as virtual goods. Regardless of the rights and interests to which the digital collectibles sold are bound, they are legally typical goods, except that these goods are virtual goods of the digital age. In this scenario, the issuer earns sales fees for the goods, and the platform earns fees for technical services, which is fully legal and compliant. In this case, for operators of digital collectibles, their business model and scope of business present nothing special compared with current mainstream e-commerce websites, and naturally there is nothing special about their qualification compliance requirements.

The second model builds on the first: the platform supports transfers of collectibles between users, such as consignment sales or purchase requests, similar to the "transfer behavior" on second-hand platforms like Xianyu. Because of the sensitivity of the term Token in the Chinese context and the need to prevent financialization risks, transactional transfers between users have become a compliance focus in the digital collectibles industry. Companies such as major internet platforms are more cautious and often do not support paid transfers between users, and they impose multi-dimensional restrictions on users' transfer functions to avoid speculation; users can only trade through private arrangements or third-party software.

This time, the local government authorities in Hainan, disregarding differences in business models, have set qualification-based thresholds for digital collectibles operations by issuing documents, requiring, in addition to the value-added telecommunications licenses (ICP, EDI) and online culture operation licenses that already satisfy the compliance foundation for internet enterprise operations, additional qualifications unrelated to the business model, such as auction permits and permits to open trading markets. This is somewhat forcing people to do what is beyond their capacity.

For example, the local government requires platforms operating digital collectibles to have an online publishing license, which is somewhat unreliable. Whether NFT digital collectibles constitute online publications is itself a question. Take the relatively common NFT tickets or membership-rights NFTs that combine virtual and physical elements in the digital collectibles industry as an example: as the seller, issuing NFTs is either to attract traffic and promote consumption or purely for brand marketing and publicity. Is a mere image or painting an online publication? Without examining the substance of the business, imposing a one-size-fits-all requirement to obtain certificates clearly ignores how much money entrepreneurs must spend to obtain such certificates and whether they can obtain them at all.

In fact, the restrictions on the NFT digital collectibles industry are still a minor matter, but often small matters reveal larger ones. The introduction of the relevant restrictive policies in Hainan shows that over the past year or more, the relevant local government authorities have been plagued by customer rights-protection complaints and petitions concerning the digital collectibles industry, and so simply banned it outright. But this lazy government action clearly does not conform to the current national policy of promoting the development of private enterprises.

To look no further than recent events, consider the State Council's "31 Measures to Promote the Private Economy" issued on July 19 this year. The central government's first requirement for local governments is:Continuously break down market access barriers.

Article 1 of the Opinions:No region or department may set, or set in disguised form, market access obstacles in the form of filing, registration, annual inspection, recognition, certification, designation, or requiring the establishment of branch offices.Clean up and standardize the preconditions and approval standards for government service matters such as administrative approval, licensing, and filing; government service matters may not be converted into intermediary service matters; and absent a legal or regulatory basis, enterprises may not be required, before government services are provided, to conduct their own testing, inspection, certification, appraisal, or notarization, or to provide certificates, and so on..."

Under these circumstances, the local authorities in Hainan, for the convenience and ease of managing enterprises, have established barriers to market access contrary to the policy's encouragement, which is somewhat contrary to national policy.

In early 2022, when the NFT digital collectibles industry was booming, Lawyer Honglin was talking with a local NFT entrepreneur in Hangzhou. I asked him: so many companies in the industry register their place of incorporation in Hainan—qualifications are easier to apply for and there are more tax incentives—so why do you stay in Hangzhou? He said: Hainan appears permissive, but it will take some time for it to accept new things.

It seems that Hainan's "some time" amounted to just one year.

This article is not meant to suggest that entrepreneur friends registered in Hainan should take a hard line against the government, because there really is no need to do so. A gentleman does not stand beneath a crumbling wall, and a wise bird chooses the tree on which to perch. A good entrepreneur does not fight local government—you will not win anyway. Since the local government has already made clear that it does not welcome them, the best response for entrepreneurs is to go with the flow and say goodbye to Hainan quickly and with dignity: those who should deregister their companies should deregister them, and those who should change their registered addresses should change them. After all, beyond Hainan, there are places more friendly to internet and new-economy entrepreneurship, such as Hangzhou, Shenzhen and Chengdu.

The only hope is this: when local entrepreneurs in Hainan deregister or relocate their companies, the counter staff handling business at the Market Supervision Administration should not raise another threshold by saying:"Someone has filed a complaint against your company, so we cannot handle this industrial and commercial registration change."


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