Non-Fungible Tokens: An Overview Of The Legal Implications Of NFTs

By Halima Ummi Ismail

Overview

The blockchain as an emerging technology and the foundation of cryptocurrencies has proven to be an essential component of modern technology. The current development of Non-Fungible Tokens (NFTs), which involves the tokenization of various collectibles and art into large sums of money, has highlighted yet another aspect of blockchain technology’s useful cases. The main objectives of NFTs are to protect works of art, prevent all forms of fraud and have absolute control of transactions. Because of the nature of their operations, NFTs are gaining the attention of global investors and collectors around the world.

However, just like any other emerging and budding technology, the operation of NFTs is not without implications as there are various  issues from the terrain of the law that needs to be taken into consideration in order to create and build a sustainable atmosphere for it. This article aims at bringing out those legal issues that needs to be considered and the impact of those issues on NFTs. While delving into this, the article will also give a better understanding of NFTs, the potential risks surrounding them, and the benefits they offer to society.

Keywords

Non-Fungible Tokens (NFTs), blockchain technology, cryptocurrencies, digital assets, legal issues.

Introduction

Whenever the blockchain technology is mentioned, people’s attention have been focused on bitcoin and cryptocurrencies. However, bitcoin and other cryptocurrencies are not the only outcomes of the blockchain technology as there are also other aspect of it, one of which is the NFTs which has garnered incredible interest from investors across the globe within a short period of time. It is pertinent to note that the creation of NFTs as digital assets comes along with some legal issues that needs to be taken into consideration. This is due to the fact that the transaction of goods and services has always been through physical transactions, except recently, when the development of technology is bringing about the virtual transactions of goods and services, including digital goods.

In January 2022, an international luxury brand, Hermes, filed a complaint against a digital artist who goes by the name Mason Rothschild, alleging amongst other things that a series of NFTs he created constituted a trademark infringement on their famous Hermes Birkin Bags.[1] The case has raised many questions concerning issues of damage in the real world versus the virtual world, as brands are beginning to take note of the implications of NFTs for their real-world creations.[2]  With NFT sales now running into billions, the market faces issues that touches on many areas of law, from copyright and intellectual property rights to anti-money laundering regulations and estate planning.[3]

Definition of NFTs

Non-fungible tokens (NFTs) are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other.[4] It can be seen as a unit of digital information (token) that is stored on a blockchain and is not inherently interchangeable with other digital assets.[5] It can thus, be said to be a certificate of ownership of an object, virtual or real. The same non-fungible token cannot be owned by two people at the same time. They can only have one official owner at a time and they are secured by the Ethereum blockchain; no one can modify the record of ownership or copy/paste a new NFT into existence.[6]

By contrast, bitcoins and other cryptocurrencies are fungible tokens, like a U.S. dollar. Any bitcoin is equal to any other, while NFTs are one-of-a-kind.[7] Most NFT sales to date have been transacted in cryptocurrencies such as ether and registered on the associated ethereum blockchain, though that is not a requirement of the form. [8]  In its simplest form, NFTs are digital goods, while cryptocurrencies are digital money used in purchasing these digital goods. NFTs can be anything ranging from tweets to collectibles, digital art, event tickets, and so on.

A Brief Historical Development of NFTs

If NFTs were a superhero movie, then colored coins would be the origin movie.[9] Colored coins indeed have a number of similarities with the modern-day NFTs. While not as sophisticated, the idea was to use the blockchain for assets like digital collectibles, coupons, property, company shares, and more.[10] In 2014, Robert Dermody, Adam Krellenstein, and Evan Wagner founded counterparty, a peer-to-peer financial and distributed open source Internet protocol built on top of the Bitcoin blockchain.[11] Counterparty allowed asset creation, had a decentralized exchange, and even had a crypto token with the ticket XCP.[12]

On May 3, 2014, Kevin McCoy, a digital artist, minted the first known NFT “Quantum”.[13]  A Quantum is a pixelated image of an octagon filled with denoting circles, arcs, or other shapes that share the same centre with larger shapes surrounding smaller ones and hypnotically pulsing in florescent hues.[14] As of today, the one-of-a-kind “Quantum” art piece (2014-2021) is on sale for seven million dollars.[15]

Between the years 2018 and 2021, NFTs have moved slowly and steadily into the public domain. The seemingly underground movement that was taking the crypto community by storm has slowly been transitioning into more mainstream art.[16] With the growth of this technology, numerous platforms have surfaced, each hosting various creators and collectors. Opensea is considered the largest marketplace for art, music, domain names, collectibles, and trading cards.[17] Other platforms, like Niftex, allow users to buy fractions of NFTs, or “shards”, which are ERC20 tokens representing a piece of the full NFT.[18] As time goes on, NFTs are becoming very sophisticated moving from pictures to the gaming industry and also allowing the sale of tweets. In March 2021, Jack Dorsey who was former the Chief Executive Officer of the famous Twitter sold his tweets for over 2.9 million U.S. dollars.

This tweet was considered a work of art. Beyond their uniqueness as digital assets, NFTs have three main features: ownership, interoperability, and transparency.

Legal Issues For Consideration

Like every other disruptive technology NFTs raises some legal questions which needs to be considered for it smooth operation. Some of these issues are as follows:

• Dispute Resolution

NFTs, being a new and evolving system, do not have regulatory frameworks and laws governing their transactions. As such, there have been contentions about where and how to resolve disputes arising from such transactions. When an NFT is created on a public blockchain like Ethereum, everyone can see how it was developed and linked to the underlying right or asset.[19] Although it is possible to see the NFT owner’s or creator’s wallet address and the metadata linked to it, it is not enough to match these with the real-life owner or creator.[20] Due to the anonymity or pseudonymity of blockchain and the lack of conflict of law provisions, it is challenging to determine where a lawsuit would be filed and what the applicable law would be. [21]

• Copyright Law/Intellectual Property Right

Selling a claim to a unique piece of content might seem at first glance, to be equivalent to an assignment of copyright.[22] Nevertheless, that is not the issue in question as IP rights are usually retained by the issuer. Such is the case when selling a physical copy of nearly any type of creative work. The transfer of the underlying copyright is up to the creator or most recent copyright owner.[23] Care needs to be given as to how and whether IPR is licensed through the sale and subsequent transfer of the NFT, particularly to ensure that the issuer’s valuable brand is protected (including effective remedies if their IPR is misused).[24] Thus, as stated under many copyright laws, a mere digital sale may not necessarily serve as an exclusive assignment of the asset in question.

• Data Privacy/Data Protection and Security

Although it is highly not likely that NFT transactions will cause damage to the personal data of those involved, this issue cannot be overlooked. Thus, the platforms dealing with NFT transactions need to obtain the consent of necessary stakeholders before obtaining or making use of the data of individuals. Technical teams will need to consider which security and data-sharing standards and which blockchain protocol (most commonly Ethereum) will be deployed.[25]

• Financial Regulations

NFTs, unlike cryptocurrencies, cannot be exchanged at face value. As of recently, NFTs have not been qualified as securities for them to fall under securities regulations. Although NFTs are in most cases not regulated, a time will come when countries will have to determine under what category this transaction will fall and the appropriate regulatory body that should be responsible for regulating its affairs.

• NFTs and Taxation Laws

Taxation laws are yet to catch up with a number of digital technologies such as cryptocurrencies and, most recently, NFTs. However, we look forward to a future where digital goods can also be subjected to tax regulations for the sustainable development of a number of countries’ economies. Taxation, being the backbone of most economies, needs to be integrated into the digital world for proper regulation.

• Cyber Security

Most emerging technologies usually face the challenges of cyber attack. Thus, NFTs are not an exception, as the case may be. While the blockchain ledger is immutable, the digital artwork itself may not be as secure—for example, if hosted on the servers of a third-party website that is not secure.[26] As such, adequate care needs to be taken in dealing with NFTs in order to prevent cyber attacks.

Conclusion

In a nutshell, NFTs being a recent development in the blockchain industry, are yet to have precise and adequate attention from the law in many countries. Whether or not transactions carried out through NFTs will be legitimized by appropriate authorities in divergent countries is still a matter of contention. It is however, an indisputable fact that NFTs cannot be ignored for too long due to their rapid growth and the potential they have for changing and impacting a number of industries, especially in the arts, sports, and other sectors. This makes it almost impossible for lawmakers to evade their eyes. It is therefore advisable for businesses and platforms dealing with NFTs to tread with caution in order to protect their commercial interests and to avoid regulatory issues.

Halima Ummi Ismail is a penultimate law student of Bayero University, Kano. She is an avid researcher with a keen interest in tech law. She can be contacted via email: ismailhalima99@gmail.com

[1] O.M. Atoyebi S.A.N. ‘Non-Fungible Tokens(NFTs) and legal Considerations’ (2022) https://omaplex.com.ng/nfts-legal-considerations/ accessed 11 April 2022

[2] ibid

[3] Hamed Oviasi ‘What the legal issues around NFTs?’ (2022) https://www.solegal.co.uk/insights/what-are-legal-issuesaroundnfts#:~:text=Copyright%20%20When%20you%20buy%20an,display%20or%20perform%20the%20art. accessed 13 April 2022

[4] Rakesh Sharma ‘Non-Fungible Token(NFT) Definition’ (2022) https://www.investopedia.com/non-fungible-tokens-nft-5115211 accessed 11 April 2022

[5] Usman W. Chohan ‘Non-Fungible Tokens: Blockchains, Scarcity, and Value’ (2021) Discussion Paper Series: Notes on the 21^st Century https://ssrn.com/abstract=3822743 accessed 13 April 2022

[6] Ethereum ‘Non-Fungible Tokens (NFT)  (2022) https://ethereum.org/en/nft/ accessed 11 April 2022

[7] Sam Dean ‘$69 million for digital art? The NFT craze explained’ (2021) Los Angeles Times https://www.latimes.com/business/technology/story/2021-03-11/nft-explainer-crypto-trading-collectible accessed 13 April 2022

[8] ibid

[9] Rahul Ravindran ‘The Fascinating history of NFTs’  (2021) https://eattheblocks.com/the-fascinating-history-of-nfts/ accessed 13 April 2022

[10] ibid

[11] Andrew  Steinwold ‘The History of Non-Fungiible Tokens (NFTs)’ (2019) https://medium.com/@Andrew.Steinwold/the-history-of-non-fungible-tokens-nfts-f362ca57ae10 accessed 13 April 2022

[12] ibid

[13] Alternative Press ‘Where do NFTs actually come from? A short history of non-fungible tokens’ (2021)

https://www.altpress.com/meta/historyofnftsnonfunfibletokens/#:~:text=Who%20created%20the%20first%20NFT,in%20a%20quite%20hypnotic%20way. accessed 13 April 2022

[14] Portion ‘The History of NFTs & How They Got Started’ (2021) https://blog.portion.io/the-history-of-nfts-how-they-got-started/amp/ accessed 12 April 2020

[15] ibid

[16] Ravindran n.9

[17] Ravindran  n.9

[18] Ravindran n.9

[19] Pinar Caglayan Aksoy and Zehra Ozkan Uber ‘NFTs and copyright: challenges and opportunities’ (2021) Vol. 16, No. 10 Journal of Intellectual Property Law & Practice, https://scholar.google.com/scholar?hl=en&as_sdt=0%2C5&q=legal+implications+of+nfts&oq=l#d=gs_qabs&t=1649881226664&u=%23p%3DIQsfoNDuoMkJ accessed 13 April 2022

[20] ibid

[21] ibid

[22] Osborne Clarke ‘What are the legal issues around NFTs?’ (2021)  https://www.osborneclarke.com/insights/what-are-legal-issues-around-nfts accessed 11 April 2022

[23] Gregory J. Chinlund, and Kelley S. Gordon ‘What are the copyright implications of NFTs? (2021) https://www.reuters.com/legal/transactional/what-are-copyright-implications-nfts-2021-10-29/ accessed 11 April 2022

[24] Osborne Clarke n.22

[25] Osborne Clarke n.22

[26] Oviasi n.3