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Vol. 39 No. 7 — September 2022

My uncertainty increases as we begin to explore the world of intangible art, specifically non-fungible tokens (NFTs). NFTs are blockchain-based digital certificates of ownership that can be applied to digital artworks and other digital content. Blockchain allows the inclusion of secure and publicly accessible data that verifies the ownership of the digital content.

NON-FUNGIBLE TOKENS

While the phrase “non-fungible token” is often used to mean the same thing as the digital art, they are actually separate digital entities. The NFT is used to create a unique connection between the digital art and its ownership. Essentially, the NFT proves that one person, and only one person, is the identified owner of the intangible art or object.

NFTs are big business. NFTs associated with digital art have been sold by auction houses such as Sotheby’s and Christie’s for prices in the tens of millions of dollars. One estimate projected $20 billion in NFT sales in 2021, doubling by 2025. The NBA set up NBA Top Shot as a marketplace for its NFTs of digital images of players and games. It offers multiple categories of NFTs—which the NBA calls Moments—from the less expensive and less exclusive Common Moments up to Legendary Moments, which may have one-of-a-kind exclusivity and can sell for thousands of dollars.

CYBERCURRENCIES

Blockchain-based NFTs are bought and sold using blockchain-based cybercurrencies such as Bitcoin and Ethereum. While some NFT sellers such as NBA Top Shot accept credit cards for individual transactions, the underlying purchase is in cybercurrencies.

As with the recent history of new technological developments, the law is slow to catch up. Regulatory agencies, courts, and government organizations are challenged to deal with the legal issues raised by NFTs and are generally relying on existing laws to manage legal challenges and disputes. Although early, a number of legal issues are emerging and getting the greatest degree of attention.

INTERACTIVE CONTRACTS

The NFT itself is being seen as a form of contract between the owner of the digital asset being sold and the buyer of the asset. The terms of the relationship between the owner and buyer, and the nature of the underlying asset, are fixed in the contract. The contract itself is often self-executing in the blockchain environment, much like the clickable terms and conditions statements on a website, but more interactive, automatically executing the contract’s various terms when specific events take place.

Like any contract, it is enforceable by the contracting parties, and, if breached, there can be liability. More to the point, however, is that the contract is generally created by the NFT seller, and the buyer is bound by the terms of the contract. Some contracts are reported to contain clauses that will shut down a buyer’s NFT account if a particular condition is breached or fails to be executed because an underlying event does not occur.

COPYRIGHT

Another issue is what exactly the NFT purchaser is receiving with their purchase and whether the NFT contract clearly outlines the limits (if any) of the purchase. While an NFT may convey ownership of an artistic digital asset, the NFT may or may not convey ownership of the underlying copyright in that asset. A simple parallel may be in the Warhol in my office. We in the office own the physical Warhol silkscreen. It was one of a limited edition, which is a key factor in its value. However, Warhol’s estate owns the copyright in the work and can sell or license copies of the work in various forms, including as posters, as postcards, and on the web. Those copies are without limits and, as such, have little value. Also, while we may own our Warhol silkscreen, because we don’t own the copyright, we do not have the ability to make additional copies of it.

Filmmaker Quentin Tarantino is being sued by Miramax over NFTs of scenes from his original handwritten script for the film Pulp Fiction. Miramax, however, owns the film and its distribution rights, including, Miramax asserts, the right to make NFTs from its films. The dispute is still pending, although Tarantino sold his first NFT for $1.1 million. Other cases have involved NFTs that fraudulently sell copyright-infringing digital art. Playboy Enterprises sued and shut down a website selling NFTs based on Playboy’s rabbit logo, but not before it made several thousand fraudulent sales.

MONEY LAUNDERING

Because NFTs live in the world of cybercurrency and blockchain—both of which have a history of connections to illegal money laundering—a number of governments and investigative agencies are starting to pay attention. Both the U.K. and the European Union have rules to prevent money laundering. These rules may come into effect if an NFT is based on art as its digital asset and if the NFT sells for more than $10,000. In the U.S., an NFT may trigger money-transmitting regulations. These are rules that banks must follow in reporting cash transactions of more than $10,000.

Also in the U.S., the Securities and Exchange Commission (SEC) has been investigating the use of NFTs to raise money in the same way that stocks are used to raise money for companies. When stocks are sold to the public, they must meet disclosure and other legal requirements. An NFT that is being sold to raise money for a future digital asset may be subject to SEC regulation.

KEY TAKEAWAYS