Non-fungible tokens (NFTs) – the next big crypto asset, or the emperor’s new digital clothes? How does intellectual property (IP) fit in, and what exactly are you getting if you purchase your very own token? We dive into all things NFT, the challenges and the hype, and where to next for this rising digital star.
What is an NFT?
NFT is a blockchain-based, non-fungible record that represents an asset.
A token is ‘non-fungible’ if it represents a unique asset, the value of which is relatively independent from another asset. The ‘non-fungibility’ of an asset is not a concept unique to NFTs (nor to the digital world generally): Van Gogh’s original ‘The Starry Night’ is ‘non-fungible’ since there is no other ‘The Starry Night’ of equal value, whereas five prints of the same work are ‘fungible’ since they theoretically hold the same value (as between each other). Other examples of non-fungible assets are domain names, social network account handles, and company names – in each case, there can only be one version.
The asset represented by the token could theoretically be any form of unique ‘thing’, but is most commonly a digital artwork. The opportunities for ‘minting’ (or, creating) NFTs are therefore far reaching: from digital baseball cards, to real estate titles and potentially even ‘credits’ for access to a service.
By way of recent example as to the breadth of tokens that may be minted as NFTs, recent NFTs include Twitter founder Jack Dorsey’s first Tweet, a scanned x-ray of William Shatner’s tooth, and the original ‘Charlie Bit My Finger’ video. Anyone can create an NFT and anyone can sell an NFT that they own. However, they are most commonly seen in digital artworks – from a moving GIF, to a video, to a static photograph or compilation.
One of the reasons these works are getting so much attention is that buyers are spending jaw-dropping prices to be the owner of their very own NFT. Dorsey’s tweet sold for US$2.9 million worth of cryptocurrency, and Charlie probably did not quite realize that munching on his brother’s finger would generate US$790,000 worth of cryptocurrency. Unsurprisingly, the buyers of these works have till now been relatively non-traditional, and many of the earlier adopters are those who are well versed in cryptocurrency and speculators in the field.
However, the NFT market is becoming increasingly mainstream. More traditionally understood pieces of digital art are being sold for record prices, and even the conventional auction houses are getting in on the action. Earlier this year the digital artist known as Beeple sold an NFT of his work for US$69 million worth of cryptocurrency at Christie’s. Just a year earlier, the most Beeple had ever sold his work for was US$100.
When these high prices are combined with the ability for anyone to ‘mint’ an NFT and claim ownership, you can see where things can get murky. Understanding the infrastructure the NFT world operates within is the first stage of getting to grips with the legal issues at play.
So what exactly are you getting when you decide to purchase an NFT?
An NFT is essentially just a token that represents an asset, which operates completely separately from the asset itself. This means that the NFT only provides a record of ownership, and this data is ‘hashed’ (a process of translating the data into a newly generated encrypted code) and stored on blockchain. The ‘thing’ (or ‘asset’) to which the record relates is not ‘part’ of the NFT, other than by reference.
In terms of how the record of ownership is managed, most NFTs are part of the ‘Ethereum’ blockchain. A blockchain is a co-ordination of information in the form of a ledger. Each NFT is sold with a digital token that certifies that the work purchased is original or authentic, and this information and the details of the sale are stored in an online register that automatically records all transactions and time-stamped data.
While the NFT’s relevant history is stored hashed on the blockchain, the asset is not. Instead, this metadata – which provides a description of what the token itself looks like – is typically stored off-chain, due to storage limitations of the blockchain. This means that the information stored on the blockchain is a descriptor that tells users where to find the token, rather than the token itself. Often, the token is stored in cloud storage controlled by the marketplace provider, and it is difficult to determine how reliable that storage is. While some NFT developers are using a peer-to-peer platform that hosts the content across a decentralised storage network, which more closely aligns with blockchain principles, no common approach has yet been adopted by the market.
In some ways, this blockchain process seems like a win-win for the seller and the buyer. For sellers, attaching their work to the blockchain in the form of a non-fungible token seems like a secure and verifiable way of selling the work online. For buyers, they are assured that the blockchain will automatically record and hold information regarding the work – including current and future transactions, who was involved, and the price paid – acting like a permanent identification of ownership across a distributed ledger. However, the reality is much more complicated, and there is a disconnect between the reality of NFTs (often held on an individual storage platform by the marketplace provider) and the ideology they represent (a decentralised ledger of ownership).
Can we really claim this approach to asset management is decentralised when the reality is that it is heavily reliant on often unstable marketplace providers maintaining the storage of the actual assets?
How does IP fit into this?
A common misconception is that NFTs work as an alternative to copyright, or that NFTs are even copyright works themselves. While it is easy to see how this confusion has arisen, it is not helped by the fact that the type of works that can be minted into NFTs overlap heavily with types of works protected by copyright. While the exact works protected differ slightly between jurisdictions, copyright generally protects works that are artistic, dramatic, literary, musical or works of film. In many jurisdictions, creators do not need to apply for protection, and copyright exists automatically upon the creation of a qualifying work.
It is important to differentiate the IP in the asset from the asset itself. Copyright in a work that an NFT represents would typically vest in the author automatically. When an NFT is created and sold, copyright functions as it would with a physical piece of art, where the author of the work typically maintains the copyright (subject to an agreement to the contrary). The current NFT marketplaces pose issues for the transfer of copyright. This is because without a separate agreement between the parties, the copyright existing in an NFT and reproduction rights are typically retained by the original creator or subsequent owner. The purchaser of an NFT simply owns the unique hash on blockchain and a hyperlink to the file with the purchased product.
Finally, there is the issue of an artist’s moral rights. While these vary internationally, moral rights typically protect a work’s attribution and integrity, and ensure it is not subjected to derogatory treatment. Earlier this year, one of Banksy’s original pieces was burnt in a livestreamed video, with the video being sold as an NFT representing the work for about US$380,000 worth of cryptocurrency. While this stunt appears to align with Banksy’s own non-conformist ideologies, without the artist waiving his moral rights this sort of activity could be infringing. It is unclear how these rights will be dealt with in the digital marketplace, but it is clear that the world of NFTs is increasingly intersecting with many of these more established rights and causing complex issues to arise.
So how should I deal with the IP in my NFT?
IP and the licensing or sale of IP rights can be complicated at the best of times, often involving technical discussions and contract negotiations. The speed and structure of the NFT market clearly does not lend itself to the same approach. However, without these discussions it is easy to see how misunderstandings can arise. Is the buyer sure that the seller has legitimately minted and has good title to the work it is claiming to own? Is the buyer obtaining the right to commercialise the work? Can the buyer alter the work? What happens if the hosting platform that ultimately stores the asset goes out of business? And what exactly is the buyer able to do with the NFT?
To try and overcome these pitfalls, potential purchasers should be conducting thorough due diligence on the work for sale. This should include contacting the original artist to ensure he or she is the creator of the work in question, and if someone else has minted the NFT, that the creator has consented to the creation, sale and use of the NFT, and the related copying of the artist’s copyright work. The purchaser should also be thinking about potential for re-sale, what terms govern this, and whether potential royalties are payable. The purchaser should also consider what platform will be used to store the digital asset, and its potential lifespan. Further, the purchaser should consider whether a separate agreement with the seller is required, depending on what the purchaser plans to do with the NFT in question (hopefully not destroying it in a viral video, but anything is possible).
How do I know an NFT is authentic?
The short answer is you usually do not. Since the NFT marketplace is focused on the sale of tokens (not the assets themselves), much of the focus in the marketplace has been on the value of newly minted NFTs selling for millions worth of crypto-currency. But what happens if the asset represented by the NFT is itself stolen?
As we have previously touched on, the variability of the medium means an NFT could in theory be used for anything. This has already led to accusations by artists (including Jay-Z) who have had their works minted as NFTs, and listed for sale, without the artist’s permission. One reason this may be occurring is that the NFT system does not require ownership of copyright in the original work as a pre-requisite for minting. And this is a tale as old as time: where there is art, there is art theft.
The nature of the technology on which NFTs are based means the problem of stolen art is exacerbated. Take the traditional purchase of art, for instance. An auction house will typically employ experts to meticulously research each piece of art so as to ensure that the art is authentic – this includes reviewing ownership history, supporting documents, and databases to ensure that title can be validly transferred to the successful purchaser.
For the NFT system this ‘provenance’ process is focused on the token itself, not the underlying asset. An NFT is ultimately aimed at providing a certificate of authenticity. The issue is that – unlike art auction houses whose reputation is staked on the authenticity of their products – online NFT marketplace providers have not historically shown a real interest in proactively and decisively ensuring that any asset is authentically owned by the relevant seller.
This makes enforcement for rights-holders difficult. While most marketplaces will require sellers to be ‘authenticated’, this does not mean it is straightforward to track down the individual seller ‘behind’ any one account. In order to have an NFT that represents infringing works removed, an artist is forced to rely on reporting that user to the marketplace provider. This mode of enforcement in turn relies on the provider receiving, agreeing with, and acting upon a user-submitted report.
Are NFTs regulated?
NFTs are a new type of crypto asset, and they are not currently regulated by any type of internationally recognised system.
Copyright law differs depending on jurisdiction. However, there is a global framework set out by the 1886 Berne Convention (an international agreement signed by 179 countries guaranteeing standardised copyright protection) and the 1996 WIPO Copyright Treaty, which brought the Berne Convention into the digital space. This global framework has laid a path for the NFT world to grow into, should it decide to do so.
While these international treaties do have their limits, to move NFTs away from a speculative asset to one of recognised value, international copyright compliance needs to be considered. To do so would be a big leap for the NFT marketplace, but would help minimise the risk of fraud, and could allow for tokenised copyright exchange to occur within the blockchain itself.
So what are the benefits of NFTs?
While the benefits of NFTs can seem obscure when they relate to works that can easily be downloaded or copied by others on the internet, NFTs share features of other types of collectible assets, in which one person owns the original authentic piece. Like other types of artistic works, anyone can own a print of his or her favorite Picasso artwork, but only one person or gallery/public institution can own the signed original work. NFTs have simply digitized this process – although you cannot hang the work on your wall, it can live in your phone, computer, or screen.
Artists and companies are also harnessing the opportunities NFTs represent, to great success. Earlier this year, a New Zealand team created 10,000 unique 3D animated rabbit collectables, each of which comes complete with its own theme song. While these ‘Flufs’ operate as unique pieces of art, buyers can also use them for everything from a metaverse avatar to a ticket to exclusive online gigs and gaming platforms. Within 40 minutes of the public launch, they were completely sold out.
NFTs have also opened up the door to many younger collectors, who are digital natives and knowledgeable about cryptocurrency. Many NFT works are steeped in popular culture references, a far cry from more highbrow traditional artworks on offer. From viral tweets to memes to YouTube videos, these NFTs resonate with a different demographic than more traditional art collectors. While some NFT works fetch astonishing prices, many are much more affordable than traditional forms of art and younger buyers are enjoying the lower access point which they are traditionally excluded from.
What about the potential?
NFTs are also popular because they have the potential (or, as some would say, realized potential) to invigorate the digital creative marketplace. NFTs are typically comprised of software code in the form of ‘smart contracts’ – essentially, blockchain protocols that automatically trigger a consequence following the transfer of tokens between parties to a transaction. A useful way to conceptualize smart contract software is ‘if this, then that’.
The smart contract technology underpinning NFTs has laid the foundation for a revolution in respect of royalty payments to creators. NFTs can be configured so that the original creator of the work to which the NFT relates receives a royalty each time the NFT is sold. Since the code underlying the NFT is held on the blockchain, the terms giving effect to the royalty payments are permanently stored, making it impossible to modify or delete them.
Previously the monetization of digital works was unfavorable to creators. For many, a royalty regime attached to the resale of their works was as good as an honesty box at the end of a long and winding path: completely reliant on faceless third parties paying the correct amount to the correct creator. Smart contract technology gives creators the opportunity to commoditize their works in an immutable and relatively simple manner. Regardless of the number of hands through which their works are passed, creators can rest easy that they will see their cheque.
Other benefits to the technologies underpinning NFTs have also contributed to the popularity of the medium among creatives. The flipside to the issues discussed above is that arguably the nature of NFTs enables creators to control – and therefore benefit – from their works in a far more effective manner than ever before.
For example, creators have the ability to limit the number of copies sold of the work underlying the NFT (thereby perpetuating value in the scarcity of the work). A creator can limit the persons with access to the work itself to only those who have purchased the relevant NFT. Blockchain technology allows creators to quickly and immutably prove their ownership in the underlying work (insofar as the blockchain record is an accurate record).
What’s to come?
It seems clear that NFTs are just one example of the potential of blockchain tech when it comes to IP.
We are also likely to see more consumer-friendly marketplaces emerge, together with other crypto-based products throughout internet subcultures. We can already see video game giants such as Fortnite develop sophisticated in-game economies that are premised on crypto tokens and the opportunities for digital creation. Given younger users will continue to demand decentralized and globalized systems for digital creations, NFTs may well pave the path for an Internet 3.0.
But the other side of the coin is suspicion of the hype. Is this a bubble that is going to burst? Only time will tell.