More and more NFT platforms are no longer limited to issuing and consigning, but have also launched NFT/NFT collateral mining mechanisms, which have activated the NFT market. Recently, many NFT platforms have successively launched collateral mining activities. Let’s take a look at what the NFT collateral mining is all about. Is it a legitimate and good business?
Note: The difference between NFT and NFT will not be discussed in this article.
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01 Transaction Mode
NFT collateral mining (referred to as “digital collection mining” hereinafter) is a way to use digital collections as “collateral” to participate in mining activities.
In NFT collateral mining, users “pledge” their own digital collections to the mining platform as proof of participation in mining. By “pledging” the digital collections, users can receive corresponding mining rewards, such as platform tokens, digital collections, etc.
Therefore, NFT collateral mining is a new way to earn passive income in the cryptocurrency field. Holders can lock their digital collections in a smart contract to earn rewards, all without selling their digital collections.
This way, it can continuously incentivize users to hold and trade digital collections, improve user retention and platform activity. Users can also use their digital collections to earn additional income and participate in the development of the digital collection market, increasing its market value.
02 Basic Gameplay
After evaluation, different digital collection platforms have different rules and requirements, but the basic mechanism of collateral mining is generally the same.
According to the market situation, the platform will release a certain number of mining machines at a certain time, and there are certain digital collection requirements for user investment and participation. The mining machine has a certain validity period (lock-up period);
Participation method: Register a platform account, purchase or hold the digital collections required for the mining farm activities, and participate in the lock-up mining channel at the start time;
Destruction mechanism: Until the end of the validity period, the “pledged” digital collections will be unlocked and a part of the digital collections will be destroyed as fuel consumption for the mining machine;
Reward distribution: By participating in mining activities, you can obtain mining rewards. These rewards may include platform tokens, digital collections, or other forms of income.
03 Compliance Evaluation
(I) Civil Legal Risks
Is “pledging” digital collectibles a real pledge?
Before exploring whether the pledge of digital collectibles belongs to the pledge in the sense of civil law in China, let’s review the rights of purchasers of digital collectibles. According to the current mainstream practice in the industry, consumers do not have ownership of NFT digital assets in the sense of civil law, and consumers cannot prohibit others from accessing, copying, or disseminating the digital assets mapped by NFT. What consumers have is only the exclusive right to prevent others from unauthorized alteration of the ownership of NFT recorded on the blockchain.
Chinese law has strict regulations on pledged property. The Civil Code stipulates two types of security rights, namely, chattel security rights and rights security rights. Although digital collectibles cannot be included in either chattel security or rights security, they lack a legal basis as pledged property and are not protected by the law. At the same time, the pledged digital collectibles are locked during the period, and users cannot trade the digital collectibles during this period.
Is there a contractual risk in “pledging” digital collectibles?
Usually, users do not sign contracts or agreements with platforms/mining providers before participating in the pledge mining of digital collectibles. In other words, when disputes and controversies arise, there is no contract or agreement to clarify the rights and responsibilities of both parties, and users can only consult customer service to handle their issues.
However, there is also another dilemma. Even if there is a contract between users and the platform, it is still difficult to determine the validity of the contract in Chinese judicial practice.
In the process of “pledging” digital collectibles, due to technical reasons or other reasons, if the digital collectibles are damaged or lost or users do not obtain the promised output rights, the risk of users’ failure to safeguard their rights will greatly increase, and they may resort to complaint methods or even gather large-scale complaints.
(II) Administrative Supervision Risk
According to the “Notice on Further Preventing and Dealing with the Risks of Virtual Currency Trading Speculation” issued by 10 departments including the People’s Bank of China and the Cyberspace Administration of China on September 15, 2021, it is pointed out that “virtual currency-related business activities are illegal financial activities. Conducting legal tender and virtual currency exchange business, exchange business between virtual currencies, buying and selling virtual currencies as central counterparties, providing information intermediaries and pricing services for virtual currency transactions, token issuance and financing, and virtual currency derivative transactions and other virtual currency-related business activities are suspected of illegal issuance of token tickets, unauthorized public issuance of securities, illegal operation of futures business, illegal fundraising, and other illegal financial activities, which are strictly prohibited and will be strictly banned in accordance with the law. For those who engage in related illegal financial activities constituting crimes, they shall be held criminally liable in accordance with the law.”
Although the definition of virtual currency in the article is slightly different from digital collectibles, according to the technical characteristics of digital collectibles and the increasing trend of the Chinese regulatory authorities towards “substantive determination,” in specific circumstances, digital collectibles that are detached from real business scenarios, lack commodity attributes, and are only used as speculative objects or even financing tools may still be recognized as “virtual currency”.
In addition, the trading of digital collectibles through pledge mining is a typical financial investment project, which carries a great risk of being deemed illegal financial activity and therefore subject to regulation.
So, will the overseas expansion of digital collectible platforms to Hong Kong avoid the above-mentioned regulatory risks? The article also believes that “overseas virtual currency exchanges providing services to residents within China through the internet are also considered illegal financial activities.” For the domestic employees of these overseas virtual currency exchanges who are aware of or should be aware of their engagement in virtual currency-related business, legal entities, non-legal entities, and individuals who continue to provide marketing, payment settlement, technical support, and other services shall be held accountable according to the law.
Many digital collectible platforms actively embrace the favorable policies of Hong Kong and expand to Hong Kong to build NFT trading platforms. However, they also attract a large number of users from mainland China, with mainland Chinese users accounting for the vast majority of active users. Therefore, even if the platform expands to Hong Kong, as long as mainland Chinese users engage in NFT pledge mining activities on the platform, they will still be subject to strict supervision by relevant departments in China.
(III) Criminal Legal Risks
1. Digital collectible pledge mining projects may involve pyramid scheme crimes
Based on Article 224(1) of the Criminal Law of China and the criteria for determining pyramid scheme behaviors specified in Articles 2 and 7 of the Regulations on Prohibition of Pyramid Selling, combined with the basic transaction mechanism of digital collectible pledge mining projects, we can cautiously conclude that there is a certain similarity in form between the requirement of holding specific digital collectibles for pledge mining and the entrance fee for pyramid scheme crimes. This provides a disguise for illegal activities. Therefore, if the project adopts some multi-level marketing designs, hoping that investors will recommend other investors and the referrers will receive relevant rewards, rather than purely pledge storage mining, then these projects often face charges of constituting pyramid scheme behaviors.
2. Digital collectible pledge mining projects may involve fraud crimes
We can see that pledge mining projects will offer certain profits as rewards for users’ mining activities. If the digital collectible pledge mining project attracts investors through false advertising, exaggerated profits, and other means, and there is actual fraud involved, the responsible individuals or platforms may face charges and penalties for fraud.
3. The digital collectible pledging and mining project may involve money laundering crimes
Based on our past evaluation experience, offshore digital collectible platforms usually use hot wallets as a payment method. However, if the platform does not conduct “KYC” authentication on user transactions, and the digital collectible pledging and mining project transactions are used for money laundering activities, such as using digital asset transactions and transfers to conceal the illegal source and flow of funds, the individuals involved may be suspected of money laundering and face criminal prosecution.
Anti-money laundering is one of the important means for the international community to combat crime and terrorism. Its core regulatory measure is to strictly review the real-name system of transaction accounts. However, the operational mechanisms and characteristics of decentralized, confidential, and cross-border circulation of digital assets under blockchain technology have brought new challenges to the current anti-money laundering system. However, China still maintains strict regulations on money laundering activities. Therefore, platform operators need to promptly face certain “KYC” regulatory requirements and improve their anti-money laundering mechanisms.
Digital collectible pledging and mining is a way to securitize digital collectible assets and can provide users with additional income opportunities. We can foresee that digital collectible pledging will bring new opportunities, but platform operators still face a series of civil risks, administrative regulatory risks, and criminal risks.
In particular, the current laws and regulations in China do not yet recognize the existence of this trading mechanism, and users’ investment behavior may not be protected by law, which may lead to large-scale disputes over rights protection. In such cases, platform operators often face significant criminal liability risks.