Non-fungible tokens (NFTs) are gaining popularity in South Korea. The country's high-tech industry, coupled with its prowess in pop culture products such as K-pop and video games, makes it fertile ground for NFT business. According to Google Trends, as of November 1, 2021, South Korea ranks fourth in the world in terms of interest in buying NFTs.

NFTs surpassed cryptocurrencies in searches by 74% to 26%, underscoring the star status of NFTs in the virtual asset market.

Recent NFT sales also illustrate this huge popularity. Famous Korean artist Jang Koal's digital animation work "Mirage Cat 3" sold for 3.5 BTC, or about 200 million won ($ 168,314 ), and Mr Unknown's "Money Factory" sold for 200 ETH in April , or more than 1.1 billion won.

Despite the popularity of NFTs, the legal status of NFTs under Korean law remains uncertain. While the recently passed amendments to the Reporting and Use of Certain Financial Information Act provide a lot of clarity for cryptocurrency regulation, the application of the Act to NFTs is unclear, primarily as to whether NFTs will be considered by the Act.

Given South Korea's potential as a major player in the NFT market, regulatory developments regarding NFTs deserve close attention.

Popularity of NFTs

Major Korean companies such as Samsung Next and CJ OliveNetworks (the IT arm of CJ Group) have taken significant steps to invest in NFTs and develop NFT-based ticketing solutions.

Established financial institutions such as Ground X (Kakao's blockchain subsidiary), Mirae Asset Securities, Shinhan Bank, and Hanwha Asset Management have all endorsed the idea of ​​integrating NFTs into their products or business models.

South Korea's prowess in pop culture, with globally popular music groups, TV shows and video games, makes the country a fertile ground for the future of NFTs.

South Korea's first NFT marketplace (opening March 31, 2021) includes a "lighter with a 'casano' pattern" featured in the hit Korean drama Vincenzo and sold as an NFT in limited quantities of 100 at 0.13 ETH ($250) each.

Three major K-pop agencies — SM Entertainment, YG Entertainment, and JYP Entertainment — have announced plans to invest in, collaborate with, or distribute NFTs of their artists. BTS, the world's largest music group, also joined the fray. On November 4, 2021, HYBE (BTS' agency) announced that it has entered into a joint venture with blockchain company Dunamu to enter the NFT market.

While K-pop and Korean dramas tend to attract more headlines, the real engine of the Korean pop culture machine is its video game industry.

In 2020, 66.9% of South Korea’s content industry exports were video games, dwarfing K-pop (6.4%) and TV show (4.5%) sales. Major South Korean gaming companies have announced plans to integrate NFTs into their products and platforms.

After the announcement, NCSoft shares rose 30% (the Korean stock market daily limit), and Krafton shares rose 22%. Another player, Kakao Games, announced a partnership with Lion Heart Studio, the developer of this year’s most popular online game, Odin: Rise of Valhalla, to enter the global NFT market.

However, while NFT-integrated games are allowed to be developed, the Korea Game Rating and Governance Council has banned cashable and tradable NFT-integrated games within the country, so these games can only be used outside of Korea.

Regulate virtual assets

According to the amendments, virtual assets are broadly defined as “electronic certificates of economic value that can be traded or transferred electronically,” allowing future developments and innovations to be incorporated into these regulations. Despite the popularity and promise of NFTs, the legal status of NFTs under Korean law is unclear.

At issue is whether NFTs are virtual assets as defined by South Korean law. On March 5, 2020, the National Assembly passed a series of amendments to the Act on Reporting and Use of Specified Financial Information, significantly clarifying regulations for South Korea’s burgeoning cryptocurrency industry.

However, even this broad definition has several exceptions: (1) electronic certificates that cannot be exchanged with money, goods, or services, or certificates that the issuer restricts exchange with money, goods, or services; (2) pre-existing asset classes (3) electronic versions of stocks, promissory notes, or letters of credit; (4) currency and items used in video games.

Virtual asset businesses must register with the Financial Intelligence Unit (FIU) of the Korean Financial Services Commission (FSC), which involves proving that they have adequate information security management systems and conduct banking business under their real names.

Virtual asset businesses must also maintain a statutory level of record-keeping to meet the amended anti-money laundering and know-your-customer requirements. Virtual asset businesses will need to invest in compliance infrastructure in under-regulated industries globally to meet these requirements.

Virtual Asset Framework

Whether NFTs will be included in this umbrella definition remains unanswered, and the Korean government has yet to issue a unified response. Although the country’s financial regulator, the FSC, announced that it might tax NFTs by treating them as virtual assets, the Ministry of Strategy and Finance was more hesitant, saying the status of NFTs as virtual assets has yet to be determined.

South Korean law's broad and inclusive definition of virtual assets provides enough space for NFTs to be considered virtual assets. As mentioned above, a virtual asset is an "electronic document of economic value that can be traded or transferred electronically."

NFTs meet this definition because they have economic value, are traded and transferred electronically, and function as electronic certificates.

The next question is whether NFTs are one of the exceptions to this definition. Electronic credentials that cannot be exchanged for money, goods or services or that restrict such exchange cannot be considered virtual assets.

Under the guidance of the Financial Action Task Force (FATF) on virtual assets - an international organization dedicated to fighting money laundering and terrorist financing - such as airline miles, credit card rewards or similar loyalty program rewards or points.

Since NFTs can be exchanged for money (as we've seen in their high-value sales) and are generally not considered loyalty program rewards, they may not fall into this exception.

A closer question is the video game exception. South Korean law also excludes tangible and intangible items collected from video games from the definition of virtual assets, such as currency and items used in video games, as more specifically defined by the Presidential Decree.

The Presidential Decree prohibits betting or encouraging wagering on items obtained from video games, as well as items obtained illegally (such as hacking).

However, whether NFTs in video games fall into this exception may depend on the characteristics of each NFT. For example, if a particular NFT is more like a digital artwork that the user needs to buy than an in-game currency, or an item obtained through gambling, then such an NFT arguably does not fall into this exception.

Ultimately, factors other than domestic politics may influence the South Korean government's decision. As a member of the FATF, South Korea must comply with its guidelines as an "industry standard for anti-money laundering and counter-terrorism financing obligations". According to the FATF's new guidelines, NFTs are virtual assets.

Earlier this year, the FATF revised their guidelines to define virtual assets as convertible or fungible, replacing the previous definition of virtual assets as fungible. On October 28, the FATF proposed that NFTs be included in the definition of virtual assets and thus be regulated by virtual assets. South Korea may follow the FATF and treat NFTs as virtual assets. Doing so has practical benefits, such as taxation and preventing NFTs from being used for money laundering and other criminal purposes.

If South Korea decides to treat NFTs as virtual assets, further legal clarification is required. For example, a virtual asset business must be registered. Individuals operating unregistered virtual asset businesses could face up to five years in prison or a fine of up to 50 million won.

Will the registration requirements be extended to individual artists offering NFTs for their digital artworks on a peer-to-peer basis for relatively low amounts? The exact tax category also remains an issue. The FSC said NFT transactions should be taxed as other income, but income from the sale of art is generally considered a capital gain.

If South Korea begins to treat NFTs as virtual assets, market participants should familiarize themselves with regulations regarding virtual assets and virtual asset businesses, especially those regarding certification and anti-money laundering security requirements.