Key Takeaways
- Non-Fungible Tokens are a piece of computer code, usually stored on a blockchain, that represents ownership of underlying rights or assets with a unique value.
- NFTs can be found across industries and interest areas.
- NFTs raise intellectual property questions that may be addressed through a traditional IP analysis.
- NFTs also present challenges, such as the risk of counterfeit NFTs or digital tokens created using others’ intellectual property.
NFTs, or “non-fungible tokens,” are increasingly popular, but their use and operation—and any associated legal issues—can remain perplexing to those unfamiliar with the concept. This Quick Overview is intended to demystify NFTs at a broad level, introduce the concept and functionality to non-tech counsel, and provide a practical approach to addressing intellectual-property issues and other legal concerns that may arise in connection with NFTs.
What Is an NFT, Anyway?
An NFT is a one-of-a-kind piece of code, or computer data, that is typically stored on a shared public exchange called a blockchain. This unit of data certifies that a particular asset—often a digital asset—is unique and not interchangeable.
Non-fungible tokens, in a broad sense, are nothing new—a deed to a house, a ticket to a rock concert, a baseball card, all are “tokens” representing something else, which has a unique value, and the authenticity of which is maintained on some form of ledger. A deed, maintained on the town register, represents ownership of real estate that would otherwise be difficult, if not impossible, to prove definitively. Concert tickets represent ownership of an exclusive “right” to sit in a certain seat at a certain venue on a certain date. A baseball card allows ownership of one of a finite number of authentic properties, the total number of which is set by the manufacturer.
Such traditional “tokens” usually present certain characteristics:
- In each case, the value of the “token” is non-fungible, meaning it is unique and cannot be exchanged at equivalency—some houses are worth more than others, tickets for front-row seats cost more than those in the back, and a superstar’s baseball card is far more prized than that of an average player.
- In each case, the “token” is valuable only insofar as (i) it is authentic, verifiable, and has some degree of scarcity (i.e., nobody wants a photocopy of a baseball card purely for its artistic value), and (ii) there is a robust market (and aftermarket) for the buy, sale, and/or trade of these “tokens,” and of the underlying assets or “rights” they represent.
When similar tokens are used in the digital space, they have come to be known as NFTs. As with more traditional “tokens,” the details surrounding NFTs—including their creation date and ownership history—are maintained on a ledger to ensure authenticity. In the case of NFTs, this ledger is known as a blockchain. Though beyond the scope of this article, a blockchain is, in essence, a digital record that is maintained and updated simultaneously across a large number of separate computers, making it essentially impossible for any one person to falsify or tamper with the record.
Ultimately, an NFT is nothing more than bits of computer code entered on a blockchain or other reliable ledger, the ownership of which corresponds to a specific asset or right.
That asset may be digital (like digital artwork, or a crypto-collectible), or it may be physical (a new sneaker that has not yet been released), or it may be an entirely ephemeral right (the right to attend some future concert or celebrity meet-and-greet). Or it may be some combination of the three.
NFTs first generated tremendous media attention a few months ago in connection with the sale of multimillion-dollar digital art pieces—including the sale of an original, authenticated piece by the artist Beeple for over $69 million in March 2021. Although many wondered why anyone would pay so much money for an “original” (which does not even come with the underlying copyright rights) when you might otherwise obtain an identical digital copy for free, this is no different than the traditional art market that sells original pieces for millions of dollars while prints and posters of the same image sell in museum gift shops around the world. The value (to those in that market, anyway) is in ownership of an original, scarce, authentic artistic piece—and NFTs can hold the same significance, now that the blockchain can verify authenticity.
But digital art is only one aspect of the growing interest in NFTs, and the more prominent, mainstream use—and the use that will be most relevant to in-house counsel—is likely to involve other types of digital, physical, or ephemeral assets and rights.
How Are NFTs Being Used?
There are many existing and potential applications for NFTs, and this is one of the reasons NFTs are generating so much attention across multiple sectors. NFTs offer not only new ways to engage with customers, but also potentially lucrative new revenue streams. Many well-known global brands are already getting involved:
- NBA Top Shot – This is a blockchain-based platform where fans can buy and sell officially-licensed video highlights.
- F1 Delta Time – A blockchain game licensed by Formula 1 that has NFT components for use in game play, such as cars and drivers.
- Nike’s patent – In 2019, Nike was granted a patent for a “system and method for providing cryptographically secured digital assets,” including digital assets for articles of footwear.
- RTFKT – This Chinese virtual sneaker brand designs digital shoes for video game enthusiasts, including a custom sneaker for Chinese New Year that sold for $28,000.
Many companies already use the blockchain to authenticate, track, and/or maintain ownership and repair records for their physical products. NFTs—which ostensibly allow for the instant, online transfer and sale of unique items with confirmed ownership and provenance—have the potential to further revolutionize supply chain logistics and commerce (and even change the way we buy and sell real estate). We expect that many existing (and brand new) companies will offer NFTs of some kind or another as the market matures, whether they be digital versions of products already being sold or new, possibly virtual products that do not yet exist.
Indeed, one of the most popular applications for NFTs currently is in “crypto-collectibles” of various kinds—essentially digital trading cards or other assets that people seek to collect individually or in sets, and that otherwise have no real intrinsic value. These collectibles may be cartoonish online characters, or they may be branded clothing or other products for use in digital “worlds” online. Just as with “real world” trading cards and collectibles, the manufacturer may create multiple original, authentic copies of any given digital collectible, but the number will typically be finite to maintain at least some degree of scarcity. When successful, collectible NFTs can be extraordinarily valuable; “crypto mogul” Justin Sun recently purchased one of a hundred collectible clip-art “EtherRock” NFTs for $611,700, and OpenSea (a leading marketplace for collectible NFTs) reportedly became the first NFT marketplace to exceed $1 billion in monthly trading volume (as of August 17, 2021).
NFTs are also used to sell ephemeral experiences, either on their own or with other physical and/or digital assets. For example, the rock band Kings of Leon used NFTs to auction off packages to its fans that included, at the highest level, tickets to one concert on every tour that Kings of Leon ever presents for the rest of its career, along with various physical and digital music rarities. The winner is then free to sell or trade the NFT to anyone else, and whoever is the record owner of the authentic token at the time of the next concert may redeem it.
While brand owners can (and do) offer NFTs through their own website, there are an increasing number of third-party platforms available on which users can offer, buy, sell, or trade NFTs of all kinds. These transactions are recorded on the blockchain and are made using cryptocurrency like Bitcoin or Ether (cryptocurrency, in which each unit has the same value as any other, is the quintessential example of a fungible digital token).
Importantly, many NFTs are encoded with digital smart contracts, which, for our purposes, are bits of code that can effectuate various aspects of an agreement, including the distribution of digital revenue received in exchange for a subsequent sale of the NFT. In this way, for example, a digital artist can include a stipulation that for any resale of her NFT (from anyone, to anyone), 10% (or more) of the sales price is to be deposited immediately in the artist’s online cryptocurrency wallet. Given the digital nature of these transactions, these “contracts” effectuate automatically and are, at least in theory, unbreachable.
What Practical Legal Issues Are Associated with NFTs?
The practical legal issues associated specifically with NFTs are primarily associated with intellectual property law (notwithstanding potential securities-law implications for so-called “fractionalized NFTs” in which investors can buy, sell, and trade individual “shards” of a valuable NFT.) NFTs often involve the display and/or transfer of various forms of intellectual property, and thus raise the same type of copyright, trademark, and right-of-publicity concerns as any other commercial endeavor using potentially protected content.
The good news is that, although the medium may have changed, the legal approach to addressing these issues is in many ways the same. Conscientious counsel should generally treat NFTs no differently than with any other use of intellectual property (IP), at least for the time being, and may rely on many of the same techniques and strategies as in the past.
- Clearance – As with any other use of intellectual property, counsel should carefully clear all rights (and/or obtain associated indemnity) in connection with any intellectual property to be used in any NFT, including as to any copyrightable computer code that may be at issue. Another important consideration is whether existing grants of rights, perhaps made before NFTs existed or were even contemplated, are broad enough to encompass NFT-related uses, or if a revised agreement may be necessary or advisable. As always, and as necessary, counsel should consider reservation-of rights issues (for long-term or perpetual licenses) and moral rights (for relevant non-U.S. copyright holders), but NFTs do not seem to present any unique issues in that regard.
- Registration – Timely registration of copyrightable content, in any medium, is always a good idea, and counsel should continue this practice with NFTs. Trademark registration is also good practice, and there are currently multiple United States applications to register new or existing trademarks for “crypto-collectibles and non-fungible tokens (NFTs)” or something similar. Given their unique nature, it seems prudent for trademark purposes to treat NFTs both as downloadable goods in Class 9 and as software-as-a-service in Class 42.
- Licensing – When licensing intellectual property for use in connection with NFTs, it is good practice to insist that your contracting partner—likely a developer of NFTs—represent and warrant that the NFTs it creates will otherwise be compliant with all relevant laws in all relevant jurisdictions (including anti-money-laundering and know-your-customer laws), and to have associated indemnity and hold-harmless language. Given that many businesses (and their counsel) remain unfamiliar with the technical elements of NFTs—including the collection, conversion, and distribution of cryptocurrency—it is also helpful to confirm contractually that your partner will handle all of this itself in a manner appropriate for your client.
- Transfer – Just as with any artistic work, the sale of an NFT—even an expensive original digital artwork—does not in and of itself transfer any copyright rights. Separate written assignments should be used for the transfer of any rights. If the sale of the NFT is meant to grant any nonexclusive licenses to display or otherwise use the work in certain ways, these should be expressly identified at the time of sale.
- Enforcement – Enforcing against the unauthorized use of protected content in NFTs is largely no different than with any other online infringement, and brand and content owners can seek relief directly from the usual suspects, i.e. website operators, ISPs, registrars, etc. The most popular online “gallery” platforms, on which third parties may post their NFTs for display, are increasingly compliant with the U.S. Digital Millennium Copyright Act (DMCA), allowing for “notice and takedown” as to copyright-infringing NFTs. As is typical, however, remedies for online trademark infringement are less straightforward; the Terms and Conditions of NFT platforms will generally prohibit any type of intellectual property infringement, but (beyond the DMCA) will not offer express remedies for those who own the rights being infringed. More particularized enforcement—including efforts for monetary recovery—are likely to be complicated as transactions on the blockchain are typically pseudonymous and determined actors can ostensibly make it impossible to detect their true identities (though the recent recovery of cryptocurrency ransomware payments suggests there may be room for hope).
Some Open Questions
Although many existing legal strategies will apply equally well to NFTs, this is not to say that NFTs do not raise a number of novel and potentially thorny questions.
One of the most prominent issues—and which has more to do with smart contracts than with NFTs specifically—is the potential tension between an automatic 10% (or more) “resale royalty” payable to the NFT’s original creator, and the first sale doctrine, which generally allows for the unrestricted resale of lawfully purchased copies of goods protected by US copyright or trademark law. Notably, the US Copyright Office has expressly considered—yet never adopted—a resale royalty for copyrighted works in this country.
Another issue involves the potential to create “counterfeit” NFTs, despite the security benefits provided by blockchain technology. Although far beyond the scope of this article (and the technical knowledge of its authors), those with the expertise and inclination to do so can apparently create duplicate NFTs that appear in all respects to be the unique original—someone claims to have already done so in connection with the famous $69 million Beeple artwork. More generally, until consumers become much more familiar with NFTs—and until they can recognize the difference between a genuine blockchain entry created by an NFT’s true originator and a non-legitimate entry created by a counterfeiter—the enhanced security provided by the immutable blockchain may remain somewhat ephemeral.
This is particularly true because essentially anyone is able to create an NFT out of anything, including digital content owned by others. This obviously raises the potential for a sort of theft, in which third parties “mint” or “tokenize” protected content and sell it themselves, and indeed this has already begun (one artist, after tweeting about the evils of non-consensual monetization, discovered that those very tweets had been tokenized and monetized by third parties without his consent). And because NFTs, like blockchain entries generally, are essentially impossible to destroy (at least in theory), an infringing NFT has the potential to live forever, sold and re-sold among anonymous parties, with the infringing creator receiving a royalty on every resale.
Conclusion
NFTs present an exciting new opportunity for connecting with consumers and generating new revenue streams, among many other possibilities. Although the concept may be new, and may well present some more complicated legal issues in the future, the legal approach to using, protecting, and enforcing against NFTs relies on many of the same time-honored techniques used in more traditional areas of intellectual property (and other) law. As NFTs become more popular and more mainstream, corporate counsel of all stripes should be familiar with these best practices.
Authors: Rob Potter and Sarah Anderson – Kilpatrick Townsend & Stockton LLP
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ACC Interest Area: Intellectual Property
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