Very rarely has a technological concept risen from relative obscurity to boardroom discussion mainstay in the way non-fungible tokens (NFTs) rose to prominence in 2020 and 2021. For major brands and other businesses looking for ways to digitise their product offerings in the midst of the global Covid-19 pandemic, the promise of NFTs was that they could be associated with any form of digital image, video clip, piece of audio or other digital asset and used to demonstrate authenticity and proof of ownership, therefore creating a scarce and valuable new asset class.
When an NFT associated with Mike Winkelmann’s “Everydays: the First 5000 Days” was sold for $69.3 million in March 2021 it became the sixth most expensive art work by an artist living at the time of the sale. It also helped to legitimise and give credence to the idea of NFTs carrying scarcity value, even though the digital asset they are associated with can often be viewed by anyone, for no cost.
As a relatively new technological idea which is bound up with fundamental legal concepts of contractual rights and ownership, GCs and other senior lawyers within businesses have a key role to play in any project involving NFTs. In this article we have set out five of the key technical considerations to bear in mind, and how these interact with the law.
1. No standard terms
When a person creates an NFT and sells it for the first time, they will often provide certain legal terms which establish the rights which the owner of the NFT has in the related digital asset. These terms, including any licence rights, are typically not embedded in the NFT, but are hosted in the traditional way, if at all.
The rights could include copyright in the digital asset, or a licence to use a trade mark which forms part of the digital asset. Some of the rights might be assigned to the first and any subsequent owner of an NFT, and some might be only licensed to the first owner of an NFT. An NFT might also refer to a digital asset that the NFT grants no rights over, or that the NFT minter has no rights over.
The key point for GCs is that NFTs can be associated with certain rights over the relevant digital asset, but those rights need to be decided and specified. There are no standard terms for NFTs.
2. Push, not pull
Once minted by the person creating the NFT, the NFT can then be sold on, either via an “on-chain” transaction transferring the NFT from one crypto-wallet to another, or “off-chain” by transferring control of a wallet which holds an NFT from one legal person to another.
The recipient of an on or off-chain transfer of an NFT does not necessarily have notice of the applicable terms, and usually a transfer does not require the recipient to take any action to indicate acceptance of an NFT. Indeed, an NFT could be sent to a wallet without the recipient knowing in advance.
3. Down, not up
The digital asset itself is typically not stored on the blockchain (although new forms of ‘generative art’, for example, are now changing this). Most NFTs contains a limited set of metadata, including a web address that acts as a one-way pointer to the relevant digital asset. Provided the link remains live, the NFT can be traced to its digital asset. If the digital asset stops being hosted, the NFT points to an empty address.
However, digital assets often have no mechanism allowing an observer to find its related NFT. Indeed, there could be none, one, or many NFTs that point to a particular digital asset – with none, one or many of those NFTs being “official”. There are no technical restrictions on what digital asset an NFT points to, nor are there any checks (or mechanism for any checks) that the minter of the NFT has any legal rights relating to the digital asset that they can grant or transfer.
4. Perception vs reality
The fact that different NFTs come with different terms and bundled rights, and that digital assets are hosted “off-chain”, means that a gap seems to be developing between the perception of NFTs and the reality of owning one.
There is a large difference between an NFT and its digital asset. While owners of NFTs have the ability to transfer technical control of an NFT on the blockchain, if the additional terms set out that the licensed rights cannot be assigned person-to-person (whether “on-chain” or “off-chain”) that could severely limit an NFT’s value. This means that in practice the NFT does not have “digital sovereignty” because the IP licences lapse if the NFT owner performs a person-to-person transfer. Such an NFT is more akin to a receipt than a bearer instrument.
5. Public privacy
NFTs need to be created on a blockchain, and blockchains can be public or private. A public blockchain allows for anyone to interact with it, either holding a wallet, being a miner, staking funds, etc. In practice, public blockchains cannot be directly manipulated by any one person or even a relatively large group of people.
A private blockchain generally restricts access to a closed group – meaning existing relationships and trust normally exist between the parties, and authority is not typically determined by a ‘strength of computing power’ type process like Proof of Work. In private blockchains, small groups might be able to amend records, which can be advantageous if errors need to be corrected but may leave purchasers of NFTs concerned about the security of their purchase.
Whilst the concept of NFTs is becoming more meaningful and more widely used, the reality is that NFTs can take many forms. For businesses wishing to monetise their brand and IP through the sale of NFTs associated with digital assets, there are many decisions to make. Careful consideration needs to be given to what rights the NFT should carry, how the underlying digital assets should be hosted and what type of blockchain should be used. These are legal questions as well as technical ones, and lawyers should be involved in making them.
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