The five-minute guide to what’s going on with Non-Fungible Tokens (NFTs) and the potential legal pitfalls.
The musician Grimes has sold more than $6 million in NFTs, digital artist Beeple recently sold one NFT for $69 million, and Twitter CEO Jack Dorsey will make at least $2.5 million for an NFT of his first tweet. It is safe to say that NFTs are having a moment, but there’s been little discussion of what they are or where they are going. I’ve created this high-level guide to help you understand what NFTs are, how they are used, and where we go from here.
1. What is a Non-Fungible Token?
An NFT is a secured token that is unique to the owner and represents ownership of a digital asset. Each NFT is uploaded to a digital ledger. The ledgers are similar to book-entry systems that reflect ownership of stocks. They show an NFT’s creation date, when it was sold, sale price, and new owner. Like other cryptocurrencies, all transaction data is recorded using blockchain technology.
2. What are NFTs used for?
NFTs are used to sell the unique versions of digital assets. For example, over 40,000 NBA Fans have joined TopShot, which allows you to “own the best moments from NBA history.” If you buy an NFT from TopShot, you can be the only person who owns a digital version of a specific LeBron James dunk.
Once purchased, you can resell your NFT or show if off in a personalized digital showcase. Think about your friends that own game-used Dallas Cowboys footballs or original art from well-known painters; it’s like that. Of course, as with physical memorabilia, art, or real estate, the value of an NFT will increase and decrease based on demand.
3. What’s so special about NFTs?
Exclusivity.
Other currencies like Bitcoin or cash are mutually interchangeable. NFTS are not.
Say your sister owns 1 bitcoin and your brother owns 1 bitcoin. If they swap with each other, each of them will still have the exact same thing: 1 bitcoin. However, imagine your sister owned an NFT of LeBron’s first NBA dunk and your brother owned an NFT of Michael Jordan’s first NBA dunk. If your sister and brother swap those NFTs, they would each have different things.
As the name “Non-Fungible” implies, these tokens are unique and cannot be “replaced” by anything else.
4. What’s the value in NFTs?
Like any other collectible item, NFTs have value because of perception — people believe that an NFT bought today will have a future increase in value. This obviously relies on demand.
Additionally, collectors are drawn to NFTs because NFTs are different than physical collectibles in two key ways.
- First, authenticity is a huge issue for collectors. Anyone involved in art or sneaker resell will agree. Use of blockchain is uniquely suited to solve this issue. As discussed above, the authenticity of an NFT is recorded on a secure digital ledger.
- Second, unlike paintings or sneakers which require physical transfer of possession, NFTs can be transferred in seconds.
Re: exclusivity and value — The one wrinkle here is that platforms like TopShot are already selling multiple copies of certain NFTs. This increase of the number of certain NFTs might negatively impact demand on the secondary market. On the other hand, just like the original edition of a painting is worth more than the second edition, we can presume that the original NFTs will retain at least some $$ advantage over the later editions.
5. Will there be regulatory blowback?
NFTs are interesting because, at first glance, they are not a “security” under the definition of the Securities and Exchange Act of 1934. Still, government agencies will want to make sure NFTs are not used to launder money or skirt U.S. sanctions against other countries.
Takeaway:
- NFT trading platforms (and consumers) should abide by the typical know your customer guidelines.
- If you run an NFT platform (or plan on selling an NFT independently), you might consider: (a) requiring all parties to verify U.S. citizenship or residency and (b) performing an OFAC search.
Intellectual property law is an additional area of concern for participants in the NFT market. The questions are interesting and may or may not be answered fully by resorting to existing copyright law.
- Does sale of an NFT equate to a sale of the original copyrighted work?
- If you own an NFT of a “moment” or artwork, can you prohibit other people from utilizing copies? (It would be weird indeed if your “ownership” of a sports moment then prohibited ESPN or Fox Sports from replaying that same moment.)
- Who “owns” the original moment — the person appearing in the work or the person behind the camera?
- How will NFT rights vary across national lines?
- Are there any governmental filings required to protect NFT rights?
- If someone attempts to counterfeit an NFT, do you have civil remedies or criminal remedies? Can the U.S. Secret Service or your local police help you with that?
NFTs are also interesting from an economics viewpoint. At first glance, economists would call NFTs rival goods. A rival good is a good that can only be owned by one person at a time. Consumption is competitive. This appears to accurately define NFTs.
However, NFTs have some features of nonrival goods. Specifically, one person’s use of an NFT does not necessarily diminish my use of it. To use the earlier example — your ownership of LeBron’s first NBA dunk has zero impact on my ability to look at videos and pictures of the same moment. To use a real example, even if Jack Dorsey sells his first tweet for $2.5MM, I can still view it.
The big question becomes “Who will regulate NFTs?”
Neither the Securities and Exchange Commission, the Consumer Financial Protection Bureau, nor the US Patent and Trademark Office have directly addressed NFTs, but the SEC did issue a February Risk Alert concerning digital assets.
6. How can I learn more about NFTs?
A few resources are below. Further Reading:
NFTs Explained: What’s Driving Prices for LeBron James and Kings of Leon Digital Collectibles: https://www.wsj.com/articles/nfts-explained-whats-driving-prices-for-lebron-james-and-kings-of-leon-digital-collectibles-11615205133
NFTs: A Legal Guide for Creators and Collectors: https://www.yahoo.com/entertainment/nfts-legal-guide-creators-collectors-164659603.html
SEC Continues its Focus on Digital Asset Securities: https://www.haynesboone.com/alerts/sec-continues-its-focus-on-digital-asset-securities
State of Crypto: It’s Time to Talk About NFTs and Intellectual Property Law: https://www.coindesk.com/nfts-legal-questions
What Are NFTs, Anyway? One Just Sold for $69 Million: https://www.nytimes.com/2021/03/11/arts/design/what-is-an-nft.html
Disclaimer: None of the above should be considered legal advice and is based on sources and reporting available as of March 11, 2021.
