Legal Implications of Non-Fungible Tokens (NFT)

We recently covered NFTs here, but due to the heightened interest regarding this topic, here’s a deeper dive into Non-fungible tokens (NFTs) that have taken the blockchain industry by storm.

An NFT is a type of cryptocurrency asset wherein each item, or token, is unique. It is not easily exchangeable for another value or item. An NFT is also a digital certificate of ownership for any designated digital asset. It is like a smart contract written by assembling parts of open-source code found in platforms such as GitHub. The written code is then permanently published into a token on a blockchain.

NFTs are different from fungible tokens (FTs) which are tokens with a part or quantity that is exchangeable by another equal part or quantity. The reason for this is that every FT token is identical to other tokens. An NFT, on the other hand, is unique.

NFTs also differ from FTs in terms of divisibility. If one borrows something with an NFT, it needs to be returned as a whole because NFTs are indivisible. An FT can be lent to somebody as long as the borrower returns it as a whole or in parts.

Due to how NFTs work and how they are used, they have legal implications relative to intellectual property (IP).

The Legal Nature of NFT

Utility, security, and payment tokens are all FTs. In the United States, tokens that are not pure utility tokens or cryptocurrency are considered security tokens. Most of these are FTs. They are exchangeable with any other token of the same class. For example, 1 Bitcoin can be exchanged with 1 Bitcoin. Meanwhile, NFTs tokenize assets although they are not financial instruments.

Creators and users of NFTs need to understand the rights granted to token holders. When the token holders have the right to profit-sharing, what they have is a security token. As such, it is subject to financial regulations. NFTs do not grant such rights, although they grant access to future content or give rights to royalties. An example of this is the standard ERC-1190 token.

NFTs also do not grant their holders entitlement against the issuer. NFTs are transferable but not to organized markets (such as Kraken or Bitstamp). Important characteristics of NFTs are immutability and scarcity. As discussed earlier, an NFT is rare and unique.

NFT and IP

The NFT's usefulness when it comes to IP rights is currently limited, and even problematic. The dilemma here is that ownership of NFT does not translate into ownership of an original work. In other words, buying an NFT does not mean that one is buying the underlying IP rights in a given content. Section 106 of the US Copyright Act states that a copyright owner has exclusive rights in reproducing and preparing derivative works. They also have exclusive rights in distributing the copyrighted work. Buying a piece of art does not mean that the copyright to that artwork transfers to the buyer.

From the perspective of copyright, an NFT is a digital receipt showing that the holder owns a version of a work. Buyers’ beliefs about what they own do not translate to legal reality. Moreover, companies dealing with these are not always transparent. An example here is Decentraland, which is a virtual world where land is in the form of NFTs.

Conflicting Views

Decentraland has conflicting views about its NFTs' IP rights. First, the company explains that it is a virtual world that its users own. Yet, according to Article 12.1 of Decentraland's Terms of Use, it is Metaverse Holdings Ltd. that owns all IP rights on the site. Metaverse is the company that provides Decentraland users different essential tools.

Decentraland's ambiguity about users' IP rights is not a barrier or turnoff for users. Users continue to spend millions on Decentraland's NFTs. Some users even believe that Decentraland would be a leading figure in any real estate boom in the future. In comparison, Dapper Labs Inc. has done something about the ambiguity of NFTs' IP rights protection.

Dapper Labs is the Canadian firm that first had success with NFT CryptoKitties. The company established an NFT license to resolve IP rights issues plaguing NFTs. This is an important step forward in informing users that with NFT, they do not buy the copyright. Users are buying only a form of licensed content. Nonetheless, an NFT license is only suggested as a contract that buyers and sellers can use as they deem appropriate.

NFT and Art

An area where NFTs currently generate significant impact is in the world of art. Virtual images with their unique codes can be sold to buyers. Aside from ownership, the digital art linked to an NFT minted online can be traded in different marketplaces. Here, NFTs have two major impacts.

First, NFTs provide a form of authenticity to digital art. As a unique token, it can be used to tag specific works of art. For example, an NFT can be used on a Van Gogh painting. For that specific artwork, no other painting can replace Van Gogh's painting if someone borrows it. If someone borrows a painting by Van Gogh, the borrower must return that same painting.

Second, NFTs create a potentially useful online canvas. This way, digital artists can share a new genre of performative artworks. It is the nature of the NFT as a unique token that provides this sense of authenticity to digital art. This is valuable these days when forged art is proliferating online.

Indeed, authenticity in art is crucial because of concerns about originality. There are beliefs that pieces of art that are not authentic are defective. A piece of art is also authentic when attributed to its real artist. Thus, when people think that NFT valuations are inaccurate, this is more likely because of the marketplace for art, not the NFTs.

Because NFTs can authenticate, they can be the ideal instrument in creating new performative digital artworks. An example of this is Twitter's Jack Dorsey who sold his first tweet as an NFT for over $2.9 million on Monday when bidding ended on the “Valuables” platform, which is run by Cent, a blockchain-powered social media network.

The tweet, which says, “just setting up my twttr,” was first posted by Dorsey on March 21, 2006. Dorsey tweeted that he would sell his first tweet, garnering millions of dollars of offers from different people. Dorsey's tweet is of little value since other people can forge it. That tweet was not art although it was authentic. But, NFTs do not authenticate IP rights.