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Owning NFTs: What are the legal issues?

Non-fungible tokens have attracted significant media attention. Lawyers will need to watch closely.

Bored Ape
Photo by Markus Spiske on Unsplash

Twitter co-founder Jack Dorsey sold a non-fungible token, or NFT, of the first tweet he ever sent for nearly USD 3 million. Charmin joined in the fun with its non-fungible toilet paper, or NFTP, including an auction of NFTP-themed art to raise funds for charity.  It seems like everyone with a spot in People magazine or an online influencer role, or even just the name Justin Bieber, is in on the NFT frenzy.

So what’s up with these tokens? And what does the law say about this new digital asset?

NFTs can be appealing and profitable for creators and artists as they offer an alternative to going through a gallery or dealer to sell their art. Instead, they can sell rights in a work directly as an NFT, allowing them to keep more of the profits by eliminating intermediaries. A well-known performer might get a lot more from an NFT of their first song recording sold than they would see from Spotify in decades.

Artists in Canada usually receive nothing when their work is resold. With an NFT, they can include an automatic royalty allowing the artist to collect a percentage of the price paid on resale, typically in a cryptocurrency.   

Like cryptocurrencies, NFTs reside on a blockchain, most commonly Ethereum, home of the cryptocurrency Ether. 

Because blockchains are encrypted and distributed in multiple copies on multiple computers or systems, they are difficult to hack or compromise.

However, while cryptocurrencies such as Bitcoin or Ether, like good old regular fiat currency, are fungible, NFTs are not. Each NFT has a digital signature that makes it unique, and therefore its value is not equal to that of another NFT.

An NFT is typically brought into existence, or “minted”, from a digital object representing both a tangible item and the intangible rights encoded in the NFT.  

Tangible objects that are part of or related to an NFT include art, photographs, music, videos, designer items like shoes, avatars, or even Jack Dorsey’s tweet. The only limitation is likely the imagination of the person minting the NFT. You may not even need a tangible item – a tweet barely is one.  

I could mint an NFT of my first car, even though it was junked decades ago, and I have only a photograph. All I need is to find someone gullible enough to agree to be parted from their money by buying an NFT linked to that photograph and the fact that it was my first car (or at least I would tell them it was). The price of any resale of an NFT is what a buyer is prepared to pay for it.

NFTs can enable selling limited editions, each somehow distinguished from others in the same collection. An example is the Bored Ape Yacht Club, a series of 10,000 cartoon depictions of Bored Apes, each unique and numbered. The collection has sold out, but there is an active after-market for auction bidding and resale.  

Justin Bieber recently bought his second Bored Ape for $470K, after paying $1.3 million for his first (maybe he got a discount as a repeat customer?) Only 9,998 to go.

Legally, as many as three parties may be involved in an NFT transaction - the creator of the original work or object, the minter, and the buyer.

The creator or original owner may have copyright and moral rights to the work, or have transferred or waived them, or never acquired those rights. They may or may not be the NFT’s minter.

The rights in the NFT will be defined in a smart contract on the blockchain platform. To gain title to the NFT, its purchaser typically must accept the contract’s terms and cause payment to be executed as required. Because the NFT remains linked to the blockchain and the smart contract, subsequent transactions are typically governed by that contract, or by code programmed into the NFT.  

An easy way to think of smart contracts is a vending machine. As you walk up to it, an offer is made to purchase an item of your choice (assuming it is on display and available). If you accept the offer, you put the required amount of money (which is fungible) into the machine and push a button to make your selection. The machine becomes “aware” that you have placed the correct amount of money into it and ultimately executes an “if – then” statement, common in computer code and a key part of a typical smart contract. IF you put in the right amount of money and press a button, THEN the machine will deliver the selected item. 

Still, the legal issues can become complex. The rights in an NFT acquired by a purchaser may not include any rights to the underlying physical object or work. The purchaser only acquires the defined and granted rights in the NFT set out in the smart contract.

The artist may have sold all or some of their copyright. The artist could also retain their moral rights if not waived. So, can the use of the NFT somehow breach those moral rights? The NFT itself may not even be subject to copyright. After all, the NFT is likely not the art, but a piece of data in digital code, typically not authored by a human but minted by a process, sitting on a blockchain. Is it even a work under copyright law

The minter may not even have any authority to deal with the original work. What recourse might a buyer have if they have not received what they bargained for? And what if a trademark is used without permission in advertising an NFT for sale?  

We are still in the early days of blockchain-enabled assets and rights. But as more transactions and commerce move to blockchains and smart contracts, expect the unexpected and plenty of unintended consequences.

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