You’ve probably heard about NFTs, but maybe you aren’t 100% sure exactly what they are and why they matter… Here’s our introduction to NFTs, what they are and the things you need to know about them.
Let’s start at the beginning. What is an NFT?
An NFT is a Non-Fungible Token. They are different from the cryptocurrencies you may be more familiar with, such as bitcoin, in that they are a crypto asset on a blockchain, with a unique identifying code. In essence, they are a ‘digital certificate of authenticity’, which means they can’t be traded or exchanged for an equivalent. Whereas bitcoin, like physical currency, can always be exchanged for another bitcoin as they are equal in value i.e. they are fungible. Hence the name.
How can businesses use NFTs?
NFTs can digitally represent any asset online or in the real world, such as digital artwork or real estate. The current market for NFTs is focused on collectibles; artwork, whisky, sports cards and fashion, to name but a few sectors. For example, in the whisky world, NFTs are being increasingly used as a way to buy and trade bottles of whisky without the hassle of needing to ship or store the actual bottle.
How do NFTs work?
Non-fungible tokens are an evolution of cryptocurrencies. As digital representations of assets, they are essentially reinventing the financial infrastructure of today’s markets by linking the virtual with the physical. In 2021, NFT sales were close to $25 billion.
The benefit of an NFT on a real item is it reduces the risk of counterfeiting. For example, NFTs are being used for event tickets, an area rife with fraud and forgeries. But it can also simplify and speed up the practicalities of investing.
Sticking with the whisky world for a bit longer, for those investing in whisky (and not planning to drink it) NFTs represent a practical option. The NFT represents a real bottle of (usually) rare single malt. The bottles remain safely stored for the investor until they can be redeemed, from an agreed date. Investors receive a digital certificate that will verify their ownership of the bottle and its authenticity. It also enables collectors who are not comfortable with cryptocurrency to pay by credit card.
What are NFTs used for?
NFTs have multiple benefits. They can increase a brand’s awareness, enhance customer trust and loyalty due to the authentication process and create new streams of revenue that are also sustainable due to the enduring nature of them. For many businesses, NFTs are also an opportunity to improve processes. NFTs that provide access to online-only media are increasingly common, with big brands like Disney, Marvel, Macy’s and GAP all breaking into the market this way. In 2021, Tim Berners-Lee, inventor of the world wide web, sold an NFT of the web’s source code for $5.4 million. The NFT included an animation of the code, a letter written by him about the creation of the code and a digital poster of the full code.
However, NFTs that bridge the gap between virtual and real world items are also becoming popular and businesses are using this style of NFT in creative ways. For example, Levi’s ran a competition in France with a prize of limited edition jeans partnered with an NFT that allowed the winner to access free repairs until 2027.
What legal issues do you need to consider in relation to NFTs?
There are several legal issues that you will need to consider before entering your business into the NFT market. Here’s a whistle-stop tour of some of the key considerations:
Intellectual property – As a general rule, brands will want to restrict the rights granted to the purchaser. Purchasing an NFT does not allow you to reproduce or transform it, create any work that imitates it or use the NFT for commercial purposes, ensuring that the issuer’s brand is protected. These restrictions need to be clearly communicated to potential purchasers to avoid any legal issues of NFTs and include remedies if the issuer’s intellectual property rights are misused.
Trademarks – Yes, you can trademark an NFT. You can specifically trademark the name or logo you use in association with your NFT or the property represented by it. You can also trademark services relating to the NFT such as trading, digital tokens or the creation of an online retail store. Trademarking your NFT is a legal confirmation of ownership. Companies that have trademarked their NFTs or have filed for a trademark include Nike, Estee Lauder, Mattel, Lion’s Gate and McDonalds. Hermès recently filed suit against Mason Rothschild, the creator of ‘MetaBirkins’ NFTs. The lawsuit claimed trademark infringement on the name Birkin. Rothschild argued that he should be allowed to create art based on his interpretations of the world, citing a ‘fair use’ defence under the First Amendment and using Andy Warhol’s Campbell Soup Cans series as justification.
Royalty payments – This is another interesting difference when it comes to the legal issues of NFTs. In the real world, when you resell an item such as a car, the original owner will not benefit from it. However, in the digital world, creators can continue to perpetually reap the rewards. Brands need to make it clear from the offset that purchasing an NFT does not confer the right to participate in royalties.
Due diligence in third parties – Other legal issues of NFTs that businesses should be aware of are that the creation and sale of NFTs will involve third parties and therefore increase liabilities. It is not only prudent but essential for due diligence to be carried out beforehand and for any agreement between the parties to include assurances that intellectual property rights and confidential information will be protected.
Taxation – How does this all work for tax purposes? At the moment, in the US, there is no guidance from the IRS on how NFTs will be taxed. Cryptocurrency in America is currently taxed as property so that is something to also bear in mind. In the UK, the two main taxation types to consider are income tax and capital gains. It is worth noting that if an NFT has any characteristics of a regulated investment unit it may trigger legal obligations. You will also need to demonstrate the non-fungibility aspect of your NFT to avoid it being confused with other cryptocurrencies and therefore subject to financial regulations, such as the upcoming MiCAR.
GDPR – Data protection seems simple on the surface but GDPR regulations and blockchain technology have several grey areas. While it is unlikely that the sale or transfer of an NFT would involve disclosing personal data, the issuer will need to bear this in mind when creating the NFT as ownership details are stored on the blockchain. Compliance can be achieved but will need to be continually reassessed.
Contractual – NFTs do represent a whole new world of opportunities for businesses but with that comes challenges when it comes to the legalities. Traditional legal contracts can be used when dealing in NFTs but it is more common to use a ‘smart contract’ that is embedded into the NFT itself. Smart contracts grant protection for both seller and buyer and allow for automation of processes such as royalty payments. Any contracts should be drafted in compliance with local consumer protection legislation and take into account all of the NFT legal issues we have outlined above. Businesses should also include how they will handle dispute resolution and how judgements will be enforced. Smart contracts allow protection for both seller and buyer.
Are you interested in buying NFTs? How we can support you at Arbor Law.
There is no doubt that NFTs are a fast growing industry and present a range of opportunities, not only for investors but for businesses too. Arbor Law is a team of senior lawyers with broad experience on all the legal issues you need help with around NFTs, from IP, media, data protection and commercial which means we can help you navigate this ever changing landscape. Contact us and get NFT legal advice via our team of legal experts.