Legal considerations for Non-Fungible Tokens

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With the rise of Non-Fungible Tokens (NFTs) globally, it is critical that lawyers become well aware of the legalities and obstacles associated with these digital assets.

As digital assets have become increasingly important, this article will probe into the legal challenges faced when considering NFTs.

WHAT ARE Non-Fungible Tokens?

Perhaps you have seen them making headlines recently with some selling for millions of dollars? Whilst they are still a new phenomenon, NFT’s are taking the world by storm and are becoming the turning point for digital assets. NFTs are distinct representations of assets or goods stored on a digital ledger, called the blockchain. The blockchain is a secure data platform that certifies the uniqueness of the digital asset and uses smart contract functionality. These crypto tokens are labelled as ‘Non-fungible’ because they cannot be directly exchanged with another NFT due to their unique digital signature.

How are they represented? Well, NFTs are often represented as photos, videos, music/audio and other types of digital files like collectibles, gaming items, and tickets. NFTs can also be applied to verify identification certificates, licenses, real estate, vehicles, title certificates and other documents.

With the purpose of protecting real-world assets and proving digital ownership, NFTs will not only secure intellectual property but will also develop additional monetary opportunities for creators.

Noteworthy NFT sales

Paving the way for the future of digital art collecting, an NFT owned by Grimes titled ‘Death of the Old’, being a 50-second video was sold for $388,938.00. Similarly, someone paid $6.6 million for a video named ‘Cross Road’ created by Mike Winkelmann (the digital artist known as ‘Beeple’). However, most notably was the record-breaking sale of Beeple’s NFT titled “Everydays- The First 5000 Days” which sold for $69 million.

It is clear that NFTs are becoming the ‘next big thing’ and it is important to be well versed on the topic.

What are some legal considerations surrounding NFTs?

  1. Smart Contracts

Defined as self-executing paperless contracts, Smart contracts offer a set of promises on pre-agreed conditions between the buyer and seller. These contracts of sale are digital agreements written into lines of code that cannot be changed or altered after execution, resulting in a secure and fair transaction that does not require any trust between the parties. When transferring and selling an NFT, the terms of the agreement may include smart contract requirements.

The marketplace selling the NFT may set out the terms of the exchange between the parties. Some popular NFT marketplaces are OpenSea, Rarible, Nifty Gateway and Foundation.

However, where these contractual terms are coded within the smart contract, it may be needed to outline these terms in a legal contract considering transfer and sale rights. It is important to be aware of perpetual royalties. The creator of the NFT (i.e. the person that obtains full legal ownership of the NFT) can opt for royalties. This means that with each sale of the NFT, the creator will receive a royalty of this sale (e.g., 20% of the sale price). When transferring an NFT, a contract will exist between the buyer and seller, however, whilst the creator will not be a party to the agreement, they still maintain their rights to royalties. As such, it is important that from a legal perspective, this condition is preliminarily specified to the potential purchaser.

It is important that the terms and conditions are comprehensively reviewed and agreed upon prior to the execution of the contract because these contracts run on networks with immutable data that cannot be altered in any way. This way, all information is held secure.

  1. The IP rights held by the owner of the NFT

In Australia there is no existing legislation or case law yet in relation to NFTs. As such, the legal understanding behind NFTs is fundamentally based on the principles of commercial law, and Intellectual Property rights.

As a digital asset minted on the blockchain, each token has an owner, and this information is easily verifiable. A chronological list of all owners of the NFT is easily accessible. Sellers can opt for fractional ownership of an NFT by creating ‘shares’ for their NFT. This gives prospective investors and fans the opportunity to own a fraction of an NFT without having to buy the whole thing. Therefore, negotiations regarding the terms and conditions of ownership will need to be considered and a Shareholders Agreement may be put in place.

It is important to note that in most circumstances, purchasing of an NFT only grants the purchaser ownership of the specific version or copy of the NFT and does not always give the buyer a proprietary right to every copy or version of the underlying work.

  1. Copyright and infringement

Perhaps one of the most common asked questions in the NFT legal space is ‘When purchasing an NFT, is the purchaser granted automatic copyright in the underlying asset?’. Ultimately this position is often governed by the smart contract that outlines the proprietary rights transferred upon the sale of the NFT.

It is important to understand that the minting and sale of the NFTs can be vulnerable to the infringement of copyright of the underlying original work of the creator. For example, this can occur if a person mints an NFT of Picasso’s artwork and falsely claims to own copyright of the underlying asset, being the artwork created by Picasso.

Minting NFTs of works that you do not own and do not have permission to tokenise will cause copyright issues. This relates to work that has been taken from the public domain, such as people taking artists’ works online, or pictures of the artists’ works that they have seen in public, and minting them as NFTs. Similar to the Picasso example above, if an artist decided to mint a digital artwork of Mickey Mouse on the platform, Disney would likely come after the artist for copyright infringement, and request that you take the NFT down from the platform.

As per the principles of intellectual property ownership, the sale of an NFT is often accompanied with not only a smart contract but also a deed of assignment of copyright and an IP/copyright license agreement to expressly set out the terms of the transaction.

So, why are NFTs becoming increasingly popular?

The main four benefits of NFTs are:

  1. Decentralized

Creators can make and sell NFTs without the involvement of a third party or agent. This also extends the reach of your NFT across many different markets. This decentralized model also allows creators to earn royalties upon the sale of the NFT.

  1. Unique

No two NFTs are the same, each NFT is digitally unique. This means that each token has a unique identifier and is non-fungible, meaning that it is not directly interchangeable with other tokens. This uniqueness is a key factor in ensuring that the NFT is secure.

  1. Immutable

The data on the NFT can never be altered nor removed from the digital ledger. The NFTs are secured by the blockchain whereby ownership is easily verifiable, and no one can manipulate it in any way. Whilst the blockchain is not immune to hacking, it is extremely difficult to do so because it is decentralized. This means that the data is not saved in a central server, but rather across a huge network of computers, that constantly verify and check whether the records are accurate.

  1. You can monetize your NFTs

Many people will get involved with NFTs due to the monetary opportunities. NFTs have huge resale value and can lead to large profits for the seller. On top of this, the seller can earn royalties every time it is sold.

Takeaway

NFTs are paving the way for a digital and decentralized future. The future applications and challenges of NFTs are beginning to grow along with their investment and other monetary opportunities.

If you need help understanding the legal aspects of minting, selling, or buying NFT’s, get in touch. At Lazarus Legal, we have a team of trusted lawyers ready to help you with understanding your legal rights as well as other requirements in the digital space.

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Mark Lazarus

Mark Lazarus

Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.

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Legal considerations for Non-Fungible Tokens