Non-fungible tokens - legal issues

Posted: 27/09/2021

Since the first non-fungible token (NFT) was created (or “minted”) in 2014, interest in NFTs has been steadily rising, starting with the crypto community and exploding into mainstream in 2021. Quantum, an octagon-shaped animation by artist Kevin McCoy, was the first work to be associated with an NFT-type certificate of ownership and was sold this year by Sotheby’s for $1.4 million. This not only indicates the increase in public demand for NFTs but also that traditional institutions such as Sotheby’s are taking note.

This rise in popularity has not only seen NFT-based artwork being sold at an increasing rate but has creators utilising NFTs to commercially exploit other types of assets in many different fields such as music, sport and fashion.

For example, the National Basketball Association has released Top Shot, an online platform where fans can purchase NFTs representing highlights of NBA sporting history which can be traded much like physical sports trading cards. The band The Kings of Leon released its new album as a limited edition NFT, with some NFTs offering front row seats to its shows for life, as well as exclusive audio-visual art. An NFT representing Tim Berners-Lee’s original source code for the world wide web was recently sold for $5.4 million. The founder and CEO of Twitter, Jack Dorsey, sold an NFT representing his first Tweet, which read “just setting up my twttr” for $2.9 million. Finally, Shakira recently announced her first NFT collection in collaboration with artist Bosslogic, a portion of the proceeds of which will support her charitable foundation.

What is a non-fungible token? 

An NFT is a cryptoasset or “token” that represents or points to a physical or digital asset such as art, videos or even land.

These tokens are described as “non-fungible” meaning they are not interchangeable for other items because they have unique properties (unlike fungible items which can be exchanged because their value defines them rather than their unique properties, for example cryptocurrency). An NFT is unique and is not divisible and this is where an NFT derives its value.

NFTs give the ability to transfer or claim ownership of any unique asset which it represents, trackable using a suitable blockchain, usually Ethereum.

Each NFT is composed of code stored in the form of a smart contract that conforms with a standard, such as ERC-721 or ERC-1155, which is minted into a token stored on a blockchain. Ownership of the NFT is managed through the unique ID and metadata that no other token can replicate. Once minted, an NFT cannot be edited or deleted. It can be viewed publicly and can be traded with verifiable ownership (including the history of its ownership), originality and authenticity.

An NFT and the asset it represents are usually stored separately. The NFT is stored on a blockchain and contains information on where the asset is located (for digital assets this is usually by way a link), with the digital asset being hosted on a website.

Ownership and copyright

When a purchaser buys an NFT, the purchaser owns the NFT itself which is a record of ownership of the unique digital version of the underlying asset. In other words, it grants to the purchaser ownership of the specific copy or version of the work that the NFT represents. When the NFT is transferred to another person, ownership of the digital version of the underlying asset is transferred with it.

Purchasing ownership of an NFT representing a work in which copyright subsists does not, unless stated otherwise, grant the new owner of the NFT ownership of the copyright in the underlying work.

It is possible to vary this position by contract. Copyright to the underlying asset (or property rights where the underlying asset is a physical asset) can be transferred if specifically agreed (and validly transferred). Smart contracts, which govern the NFT, can be coded to specify that certain proprietary rights, including copyright, are transferred on sale of the NFT. In addition, standard terms and conditions, contracts for sale, deeds of assignment or licences, expressly setting out how rights to the underlying asset are dealt with, can apply to the sale of an NFT.

Some NFTs are governed by smart contracts that specify and automate certain rights and obligations of the purchaser and the seller. For example, they could allow for the distribution of funds for the payment of royalties each time the NFT is resold.    

The potential challenges

NFTs present exciting opportunities for creators in various fields due to the ability of an NFT to prove ownership and authenticity of the asset that it represents (which is where the commercial value of an NFT lies). However, NFTs are not without their legal issues.

For example, a person could mint an NFT of a public domain work and falsely claim to own the copyright in the underlying asset as an original work. Alternatively, a person could infringe copyright and moral rights in a work by misrepresenting that they are the author or copyright owner of the underlying work represented by the NFT.

There could also be data protection issues. Some data protection laws allow individuals “the right to be forgotten” and/or the right to rectify inaccuracies in their personal data. Blockchain technology and its immutable nature might mean it is impossible for a data controller to comply with such rights and thereby breach data protection law.

As the popularity of NFTs quickly increases, the legal and regulatory issues connected to NFT transactions are bound to increase and, as always, the law will take a while to catch up.

This article has been co-written by Tom Perkins, trainee - IP, IT and commercial. 

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