Non-fungible tokens are on the rise, and they have become more prevalent in the past couple of years. In Q3 2021, more than $208 million worth of NFTs-based artwork were sold globally, as compared to the $250 million of total NFT volume traded in all of 2020. In addition, creators are increasingly using NFTs to generate new ways to monetize their digital creative works. One example is the Kings of Leon, who became the first band to release an album as a limited edition NFT, with six NFTs offering lifetime tickets to front row seats for the band’s shows. There has been a new era of astonishing sales figures for artists. One example of this is Beeple, who sold one of his works for an NFT worth $69 million. Before his NFT sale, Beeple sold his art for as little as $100. This article tackles the legal issues when dealing with NFTs and their underlying technology.

The utility of NFTs is based on blockchains. These digital ledgers are secure and unchangeable, and they can be used to record transactions for digital creative works. These transactions are recorded in “blocks” of computer code that are time-stamped and linked together, indicating the provenance of a digital asset. Blockchains also represent decentralized networks that allow people to store and record digital assets. They can prevent unauthorized transactions and make them impossible to modify or remove.
Tokens are digital assets that are easily transferrable between two parties through blockchain networks. They can be assigned specific uses or properties. Bitcoin and other cryptocurrencies are fungible. They can be easily exchanged for equal value. On the other hand, an NFT has a unique identification code and Metadata that distinguishes it from other NFTs and represents items on the blockchain that cannot be replicated. A cryptocurrency like Bitcoin, for example, can be substituted for another Bitcoin without losing its value or changing its attributes, similarly to when one US dollar can be substituted for any US dollar. While an NFT is non-fungible. It is like a ticket to a specific event. Its data is unique and separate from every other NFT.

NFTs are digital currencies that are composed of software code in the form of “smart contracts” that can be created to offer various benefits to NFT creators. These features can be executed through smart contracts, which are open-source blockchain protocols that control the transfer of digital currencies and assets between parties under certain regulations. The code could also detail the limitations of the NFT to be used by a purchaser. It could also offer automatic royalty payments from resale transactions, and prove ownership.
The smart contract code is then permanently minted into a token on a blockchain, such as Ethereum, and it serves as a non-replicable certificate of ownership for a digital creative work. This technology allows creators to have greater control over the value and the conditions of the sale of their creations and offers them new distribution channels of art.

Before the rise of NFTs, creators had limitations when it came to earning from their digital creative works due to how easy it is to make and distribute copies across the internet, which has historically made it difficult for art creators to monetize their digital artworks. While now NFTs allow digital creative works creators to create unique and finite tokenized versions of their digital creations while protecting the work’s authenticity and keeping it scarce online. For instance, NFT creators can now set both the sales price and the maximum number of replicas of the digital artwork that can be sold.

NFTs are valuable to the creator as they can increase the value of their asset by artificially inflating the market value, similar to a lithograph that grows in value because of its exclusivity and limited number of prints. They can also prevent creators from losing money due to piracy since NFTs cannot be replicated.

NFTs also make it easier to transfer digital creative assets over traditional sales models, without the need to go through an intermediary. They can also be sold on any NFT market or peer-to-peer.

While the excitement surrounding NFTs has grown significantly, their legal treatment continued to evolve and has also remained unsettled. We address in this article a few legal issues regarding NFTs:

Data Hosting and Storage: An NFT is typically stored on the blockchain as a separate entity and has information on where the digital asset is located. Its connection to the digital asset is through a link. If the server hosting the digital asset is offline, the link will break and there will be no way to back up the NFT. Hence, the NFT becomes worthless. Also, since the NFT is unique, its owner cannot be replaced, the NFT purchaser might be left without recourse. This can lead to business interruptions, regulatory record-keeping violations, and loss of data.

Royalties: “Smart contracts” written into the code of NFTs are designed to allow for the distribution of funds for the payment of royalties to the creator each time the work is resold. However, they can only be used if the work is resold through the same platform. Although US law does not recognize the rights related to creative works, its law does not provide for unpaid resale royalties. This is in contrast to other countries, such as the UK and the EU, which do.

Data Protection Laws: Some data protection laws give people the right to correct or delete their personal data, but the immutable nature of blockchain technology makes it harder to execute this right. In addition, data protection laws sometimes allow individuals to correct errors regarding their personal data which is impossible to do through blockchain technology that makes it impossible to enforce these rights. This means that NFTs that include personal information might violate data protection laws.

Intellectual Property Rights: Many NFT participants are unaware of the legal restrictions on copyrighted work. This leads to potential liability infringement. For instance, an individual purchasing an NFT might assume that the art is associated with the NFT. However, in reality, the original creator retains the exclusive right to modify, distribute, and publicly display the art (unless specifically granted to someone else). The holder of the NFT will only be receiving a token and the right to use the copyrighted art associated with it for personal use. A buyer who believes that the rights attached to an artwork were not properly valued may create litigation liability for the NFT seller under a variety of legal theories. This person could argue that the value of the artwork was lost due to the misrepresentation.

The introduction of NFTs represents a major step toward a more digital world. NFTs are transforming the way we think about digital assets, allowing us to imbue them with physical properties like scarcity and uniqueness. They have inspired new methods of monetization of items. The NFT market is still in its infancy, and although many of the infrastructure solutions are already in place, more will be built in the future in the form of intermediaries, tokenization platforms, distribution channels, custodial solutions, e-commerce integrations, etc. As the market keeps evolving, so do the legal and regulatory issues.

Don’t wait until a breach occurs to consult a lawyer. Start proactively consulting a lawyer for your NFT purchases today.

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