SEC’s Bored Apes Probe – More Bad News for Crypto

1000 648 David Hoppe

Regulators Grow Bolder in Wake of FTX Saga

As if the crypto and NFT industry weren’t reeling enough in light of the FTX’s crash-and-burn, the U.S. Securities and Exchange Commission (SEC) is continuing its investigation into Yuga Labs Inc., the crypto company behind the (once) popular Bored Ape Yacht Club (BAYC), over its non-fungible token (NFT) collections and cryptocurrency.

According to Bloomberg, the probe seeks to determine whether some of Yuga’s digital assets operate and perform like stocks and are therefore be subject to the same disclosure and registration rules as publicly traded shares. The critical legal question at the center of the investigation is whether none, all, or some NFTs can rightfully be considered securities. The SEC reportedly has been pondering the issue at least since March. ApeCoin, Bored Aped Club’s native token, lost more than 10 percent of its value after news of the SEC investigation broke.

Yuga Labs has yet to be charged with any crime and the investigation does not necessarily mean that the SEC will file a lawsuit against the company. A spokesperson for Yuga Labs guaranteed that the company is cooperating with the investigation.

“It’s well-known that policymakers and regulators have sought to learn more about the novel world of web3,” a Yuga Labs representative said. “We hope to partner with the rest of the industry and regulators to define and shape the burgeoning ecosystem. As a leader in the space, Yuga is committed to fully cooperating with any inquiries along the way.”

The SEC declined to comment on what specific issues it is looking into or whether its concerns extend to other cryptocurrencies and platforms, though it did concede that it is “looking closely at all initial coin offerings (ICO)” in general.

Implications for NFTs and Cryptocurrencies

Multiple legal experts say the investigation could deal a crippling crucial blow to the NFT industry. They interpret the action as a clear signal that the SEC is taking unprecedented steps to solidify and uphold its dominion over the digital art marketplace. The agency may become even bolder in its quest for control over the industry. Many assume FTX broke its own policies and generally accepted best practices by co-mingling customer funds with its own and using those assets to prop up a sister company. The situation with FTX already sent congressional sharks circling the waters in quest of more stringent crypto and NFT legislation and governmental control.

Artist and NFT expert Alfred Steiner summed up the apprehension many minters and industry stakeholders are feeling about the SEC’s more aggressive stance in an interview with Decrypt.

“The potential for regulatory enforcement action is greater than I had anticipated, even with respect to NFT collections where each digital asset is unique,” Steiner said.

He said he is surprised that the SEC would target a blue-chip NFT collection like BAYC because the simians in Bored Ape NFTs in circulation are depicted with different visual traits (e.g., an earring, sunglasses, or a different colored background) that Steiner believes makes them appear less like securities and more like unique pieces of art.

“My impression prior to this news had been that the sort of diversity you have among digital resources in a collection like BAYC would be sufficient to keep regulatory action at bay,” he explained. “I don’t know of any previous signal that [SEC investigators] were going to do what they’ve done.”

However, other experts, including Brian Fyre, a law professor at the University of Kentucky, said the probe is long overdue.

“I’ve seen this coming for the last two years,” said Fyre. “What are all the different NFT collections that Yuga Labs is selling other than, functionally, investments in the future value of the Bored Ape Yacht Club brand? That’s all they really are at the end of the day.”

Fyre deems it reasonable for the SEC to open regulation of the space by targeting a famous NFT brand. People buy blue-chip NFT collections like Bored Ape BAYC solely because of their collective fame, not because of the artistic value of individual NFTs, which looks no different from buying shares in a company. People believe in blue chip NFT collections like Bored Apes because of their collective reputations, said Fyre, not because of the artistic value of individual NFTs.

“If you buy one of the Bored Ape BAYC series, then the value of your NFT will change as the value of the Bored Ape BAYC brand fluctuates,” he argues.

The Bottom Line

While the SEC currently does not have an official stance on all digital assets, SEC Chair Gary Gensler has repeatedly stated that cryptocurrencies are securities and should be subject to securities laws and the SEC has stated that XRP,  the native cryptocurrency on the Ripple network, is likely a security and that other currencies may also be subject to its jurisdiction. 

The implications of this for cryptocurrency exchanges are potentially far reaching. Any cryptocurrency that is deemed a security must be traded on a regulated exchange. All exchanges must comply with anti-money laundering laws, know-your-customer rules, and registration requirements—which can be time-consuming, expensive, and stifle innovation in this space. In addition, it’s possible that all tokens deemed securities must comply with strict disclosure requirements, which could effectively hinder their utility.

Given how the SEC’s investigations have expanded from ICOs to NFTs to cryptocurrencies, it may be that its involvement in these technologies has only just begun.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

EU to Launch Global Metaverse Regulation in 2023; Will the US Follow Suit?

1000 648 David Hoppe

The European Union’s (EU) “Thrive In The Metaverse” initiative for regulating the metaverse is intended to prepare Europe for the age of crypto and web3. What does it mean for European consumers, and is it likely that the US will follow suit and issue similar regulations?

Background              

The September announcement of the EU’s metaverse regulation framework is part of the continent’s digital regulation strategy, which examines new online opportunities and trends. According to Thierry Breton, European Commissioner for the Internal Market, any hype surrounding the virtual world or immersive social connectivity will be subject to scrutiny. Further, he said the commission will undertake steps to develop standards and increase interoperability in the metaverse market, as “no single private player should hold the key to the public square.” The commission aims to issue the metaverse regulation in 2023. It is anticipated that the EU’s metaverse regulation will cover three topics in particular:

  1.  Network Infrastructure Taxes
    It is likely that the EU’s metaverse regulation will introduce network infrastructure taxes on network providers. According to Breton, some of the profits made in an increasingly immersive software realm should flow to providers of the networks that serve as the backbone required to host these virtual spaces. If implemented, this provision is likely to prove controversial.
  2. Rebooted Digital Rules
    Judging from EU President Ursula von der Leyen’s ”Agenda for Europe,” new rules may be put in place to implement the landmark agreements contained in the Digital Markets Act (DMA) and the Digital Services Act (DSA). These acts saw the EU take global leadership in regulating the digital space to make it safer and more accessible.
  3. Safety and Interoperability Measures
    From Breton’s remarks, the EU appears poised to issue regulations related to user-centric safety issues, especially those related to content moderation, and to ensure that platforms remain open and contestable to the whole market via interoperability standards mandates

Indications are that the EU will adopt a blended approach to the metaverse and virtual communities. It will offer support initiatives to encourage development and infrastructure but take a more active role in shaping the development of the metaverse. This type of blended approach is likely to ensure that new forms of immersive technologies do not experience the same toxic growth exhibited by Facebook.

Implications for the Metaverse in America

In the United States, there has been no announcement per se on unilateral regulation of the metaverse. The consensus seems to be that, at least in the short term, self-regulation is the preferred policy, with the onus on the “most reputable players” in the metaverse to join forces, draw up their own code of conduct, and create a set of best practices. In the long term, Washington may issue an all-encompassing metaverse regulation after consulting with key stakeholder groups and representatives from participating industries. In the meantime, regulators in this country have delivered mixed and fragmentary messages:

  1. FTC’s Statement on Meta’s Acquisition of Popular Metaverse Application
    The most direct US regulatory development on the metaverse is the Federal Trade Commission’s lawsuit to block Meta’s acquisition of a popular metaverse application. The FTC is seeking to stop virtual reality giant Meta and its controlling shareholder and CEO Mark Zuckerberg from acquiring Within Unlimited and its popular virtual reality dedicated fitness app, Supernatural. This lawsuit is still ongoing, and it seems only a matter of time before the US government issues new guidelines or laws on how the metaverse will be regulated.
  2. Data Privacy Laws
    Earlier this year, Representative Suzan DelBene (D-Wash.) pushed for a bill to enact a federal data privacy law. The Information Transparency & Personal Data Control Act is a comprehensive consumer data protection protocol that would put people back in control of their data, require companies to publish end-user policies in clear language, and establish strong enforcement mechanisms to protect all Americans. If enacted, this bill might take effect sometime in early 2023.
  3. Antitrust Reform
    In 2021, the House Subcommittee on Antitrust, Commercial and Administrative Law released five bipartisan bills that would hold big tech companies accountable for alleged anti-competitive conduct. These bills were drafted after a 16-month investigation that suggested that big tech companies are using their near-monopoly powers to crush competition and innovation. Further, senators John Kennedy (R-La.), Amy Klobuchar (D-Minn.), and Chuck Grassley (R-Iowa) introduced an antitrust bill known as the American Innovation and Choice Online Act to stop big technology companies from limiting consumer choice. The aim of this bill is to restore online competition by establishing common sense rules for digital companies. These rules are intended to prevent abuse of dominant market power and to foster competition in the market. These reforms are also likely to come into force sometime early next year.

Conclusion

Countries in the EU, South Korea, and Japan have made significant strides toward regulating the metaverse. While the US has yet to issue a comprehensive framework or law on the metaverse, the scope and breadth of discussions on the topic of regulating the metaverse are quite extensive. It is best to consult an attorney specializing in emerging technologies to get an idea about these regulatory developments as it may have an impact on your business.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Apple Store Allows NFT Sales; Takes Its Slice of the Pie

1000 648 David Hoppe

As part of its new guidelines for the App Store, Apple has announced that it will allow developers to sell NFTs within apps and games. Despite the limitations and fees Apple attaches to certain types of NFT, this is a big deal because, as DigiDaigaku NFT project founder Gabriel Leydon tweeted, “…this could put an ETH wallet in every single mobile game onboarding 1B+ players!”

Apple’s New NFT Policy

Users can now sell and trade NFTs through a number of apps available on the Apple App Store. Apps that store or display NFTs may have been breaking Apple’s rules before this decision. In September 2021, Gnosis Safe, a crypto wallet that helps users manage and even sell digital assets on Ethereum, had been offering its app in the store for several months when it received notice from Apple that “Apps that access, whether it is just simple storage or marketplace, are not appropriate for the App Store. We suggest you remove this feature from your app.”

Developers can now sell NFTs with Apple’s approval. However, the company imposes the same monetization structure to NFT sales as it does to other App Store purchases: a 30 percent commission from app developers who earn over $1 million annually through the ‌App Store‌ and 15 percent from smaller sellers. Apple says apps can list, mint, and transfer NFTs and provide a mechanism for users to view their NFT collections as long as they do not unlock additional gameplay features or functionality within the app. Apps also can promote other NFT offers as long as they do not provide external links or purchase media that circumvent Apple’s payment system.

While it is one of the largest technology companies in the world, the Cupertino giant has done little to embrace blockchain technology, and its products are criticized for being too closed-off. This new development indicates that, while progress is slow, Apple is warming up to blockchain technology and its applications. 

Apple’s 30% Solution Remains Controversial

Apple’s hefty commission tag has drawn criticism from the global crypto community and drawn contrasts to several other NFT markets. OpenSea and Magic Eden’s commissions hover around 5 percent; others have kept their transaction cost threshold as low as 2.5 percent.

Tech blogger Florian Mueller called Apple’s “app tax” on NFT sales “abusive but consistent”, adding that the actual costs to developers can frequently exceed the 30 percent commission cited when referencing the App Store, as some geographic regions are subject to fees as high as roughly 35% in addition to other fees applied to running search ads. 

Persistent Apple critic, Epic Games CEO Tim Sweeney, also tweeted that Apple is “crushing” another nascent technology that “could rival its grotesquely overpriced in-app payment service,” and that Apple’s exorbitant fees could suffocate the entire NFT sector.

Apple’s commission policy is the basis for Epic Games’ lawsuit against Apple, which has been ongoing since 2020. The video game publisher sued Apple for not allowing it to use its payment platform instead of the App Store’s in-app purchases and for taking a 30% cut.

Challenges With The Secondary Market

Magic Eden, the largest Solana NFT marketplace, also needed clarification on the move, declining in-app trading support after hearing intense cost demands from Apple. “Our app remains available in the App Store as a tool showcasing Magic Eden listings and mints, but it does not have trading support,” a Magic Eden spokesperson said.

Secondary NFT sales are also problematic. Magic Eden and OpenSea, for example, typically charge a commission of no more than 5%.

“In this case, if a collector wants to buy an NFT through the Magic Eden or OpenSea app on an iPhone, the seller will only receive 70% of the purchase price,” Blockwork explained. “And the marketplace is unlikely to be interested in making up the difference.”

Apple’s decision to allow NFT sales at its standard premium is a significant roadblock for NFT startups. Several startups have complained about the rules Apple allegedly imposes, and that the fees make using the App store difficult to justify.

While a court decision last year required that Apple allow links to off-platform payment channels, this may not be relevant for NFT trading because Apple does not accept cryptocurrency payments. All item listings are in dollars and are paid in fiat. NFT marketplaces face the challenge of constructing additional infrastructure to support Apple’s payment system, and NFT dollar prices are constantly changing due to cryptocurrency volatility.

Few Blockchains Can Scale To Meet Apple’s User Base

But not all Web3 companies have balked at Apple’s policy. Some see benefits to Apple’s NFT acceptance because the market and Web3 apps available in its store gain the potential to achieve mass adoption. In addition, a 30 percent commission to Apple is better than being prohibited from the App Store altogether.

Apple can attract hundreds of millions, if not billions, of people to NFTs and crypto by validating crypto and NFTs. The gaming industry, home to approximately 4 billion online players right now, is another sector that could generate large commissions. By current estimates, fewer than 100,000 people play cryptocurrency games, so the integration into iOS apps could bring in thousands or millions of new users.

Conclusion

Apple’s decision to allow developers to sell NFTs in its App Store may be portentous. Apple has traditionally been very protective of how its platforms are used, and this move could be interpreted as a sign that it is beginning to loosen restrictions and open to other types of apps and services. Everything from blockchain-based games to decentralized social networks could fall under this category.

This news has been interpreted as exploitation of an emerging industry as well as the green light for Web3 applications to branch out from being the sole province of Android. The truth is that it is both. While this may not be the most significant development in the crypto space, it does show that Apple believes in the technology and wants to help it progress. Finally, it remains to be seen how Apple’s decision will impact the nascent crypto app ecosystem and the blockchain industry. For example, gaming may now find a niche within the expanding ecosystem, with developers encouraged to create more diverse games and users willing to invest more time and money into the blockchain world.

This new allowance for NFTs represents a significant step toward decentralizing digital data for a company that has long been obsessed with protecting its bottom line. It also demonstrates that Apple is taking notice of what blockchain offers.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

N(o) F(reaking) T(hanks): The Backlash against NFTs in Video Games

1000 648 David Hoppe

Video games are historically a driving factor in the development of new technologies. When the crypto-based assets known as non-fungible tokens (NFTs) first arrived, video game developers embraced them with lightning speed. In what seemed like overnight, many PC and console-based video games announced they would incorporate NFTs into their platforms to expand the gaming universe and increase revenues. At first blush, it was an interesting and novel idea. Unique active wallets in blockchain gaming grew by 2,000 percent and won $2.5 billion in investment over the 12 months ending in March 2022. Gamers seemed intrigued by the opportunity to purchase NFTs to improve their in-game characters with skins, tools, and other items, but opposition arose shortly after NFTs began appearing in games. This increasingly vocal opposition continues to push back against gaming companies for even announcing plans to plug NFTs into games.

So, What Happened?

Some gamers became incensed at the idea that NFTs would force them to pay to unlock features they believe should be included with the price of the game purchase. Others maintained that grinding for the resources required to obtain in-game NFTs would rob many games of their fun. Many players view the incorporation of NFTs into video games as yet another predatory attempt by gaming companies to squeeze more money out of players. They clashed with Ubisoft, Square Enix, Zynga, and other major game developers over the introduction of NFTs and crypto into their favorite titles.

Many gaming companies, on the other hand, view NFTs as a means for verifying digital assets on the blockchain, conveying proof of ownership that players can sell for a profit in online marketplaces. Gaming companies claim that incorporating NFTs into the games helps build community and “play to earn” opportunities and take the position that NFTs support game players and NFT artists. Many gamers remain unconvinced, especially those still smarting from bad experiences with downloadable content (DLC) or loot boxes. Despite game companies’ attempts to draw distinctions by citing blockchain benefits and resale values, an extremely vocal contingent of gamers remains steadfast (this is very much reminiscent of the situation surrounding World of Warcraft in the early 2000s).

NFTs can offer exclusive in-game assets or highly sought-after items, making them potentially worth thousands of dollars and well out of reach of the average gamer. Far from democratizing and making gaming more inclusive, NFTs might reward players who can afford to “pay-to-win,” making the playing field more unequal than ever before. Further, some game enthusiasts fear the introduction of valuable NFTs could cause the price of games to increase dramatically, excluding even more potential players from the “community” and diluting the experience.

As if this weren’t enough, gamers have expressed significant concerns over scams, thefts, and hacks targeting NFTs and their owners. Illegal activities surrounding NFT transactions, such as those that launder money. The gaming industry is already a breeding ground for scams, spam, and fraud, and many gamers believe NFTs will only further attract the worst elements of society. The NFT marketplace isn’t regulated strictly, so the threat of gamers being cheated is real. The marketplace Itch.io gave voice to the anti-NFT contingent in a tweet slamming the NFT craze, calling it a “scam,” “get rich quick” scheme, and an avenue for dubious parties to exploit gamers. Security issues abound, such as the hacking of the blockchain of Axie Infinity uses where hackers stole $625 million. 

Gamers also decry the negative environmental impacts NFT minting and the blockchain inflict on the world. Ethereum, the main blockchain platform for NFTs, releases the same amount of carbon dioxide emissions into the atmosphere as the entire country of Libya. The enormous amount of energy consumption that occurs when minting, buying, and selling an NFT produces carbon dioxide emissions that cause climate change. NFTs’ carbon footprint is significant—the sale of one crypto art consumed 8.7 megawatt-hours of energy, the equivalent to two years’ use of energy in an artist’s studio.

NFTs Still the Future of Gaming?

Some gaming companies have acquiesced to the anti-NFT crowd and a few even agree with their view. Electronic Arts (EA), Team17, and Epic Games, have pumped the brakes on their NFT initiatives. Discord, STALKER 2, and MetaWorms canceled their NFT projects after being subject to backlash from gamers. Steam has banned all cryptocurrencies and NFTs from its online gaming platforms. Mojang’s July 2022 announcement that it would ban NFTs from its wildly popular Minecraft game sent shockwaves through the gaming and NFT communities. Citing a desire to foster a safe and inclusive experience for its players, Minecraft has prohibited the integration of blockchain servers. 

Despite several gaming companies abandoning, or at least taking a step back from NFTs,  others continue to embrace them. 

Perhaps they are banking on attracting the “silent majority” of gamers who are intrigued by the potential of earning NFTs from their activities. A survey of 1,500 players earlier this year revealed that only 23 percent were “not interested” or “not very interested” in play-to-earn NFTs. In fact, the poll revealed that more than two-thirds are already doing so, including 4 percent who are using video games to build their NFT collection and another 12 percent who have already monetized their play by selling NFTs they have earned. According to Interpret, the firm distributing the survey, “NFTs could play a major role in retention (of critical importance to live-service games), as over 45 percent indicated that being able to earn NFTs through gaming would increase their current engagement levels with games. Ultimately, Interpret expects gamer sentiment to continue to warm towards “play-to-earn” as the industry unpacks how best to position this new model. NFTs represent a shift in power to the players and provide a greater sense of true ownership from the items they earn both in and out-of-game. ”

Conclusion

Gaming companies will have to figure out the balance of using NFTs to enhance gaming experiences while compromising the experience for gamers who can’t or refuse to utilize them. Due consideration of players’ security and support needs as well as minimizing environmental impact will certainly help improve the outlook for NFT in gaming. Significantly, GameStop is moving ahead with its NFT marketplace. Others, like NFT World, which sold NFTs that fit into the Minecraft world, have committed to exploring other options, including developing a Minecraft competitor. But for now, a reckoning has arrived for the otherwise burgeoning crypto-based gaming market. While the gaming and NFT worlds are still evolving, game companies’ romance with NFTs may have cooled for the foreseeable future. 

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Regulators Leaning Toward Treating NFTs as Securities?

1000 648 David Hoppe

Recent legal developments in the US and elsewhere seem to point toward the eventual classification of NFTs as securities. Should the trend continue, these rulings and regulations are sure to have important consequences on the video game industry and on emerging technologies companies aiming to launch their own NFTs in the near future. 

Background

Just how NFTs should be regarded by law enforcement, tax collectors, and financial regulators has been the subject of debate for almost as long as there have been NFTs. They can be owned, so are they private property? They have to be created, so are they art? They can be bought and sold freely on a number of markets, so are they commodities? And they can often accrue significantly higher value than their purchase price, so are they investments? Any digital asset, including NFTs, can be classified as “securities” by the US Securities and Exchange Commission or similar regulatory bodies in other countries. In the US, however, one court case has set the precedent under which NFTs act as securities and therefore should have to follow the rules established for these financial instruments.

The US Supreme Court, in the SEC v W.J. Howey (Howey) laid down four elements to determine whether digital assets such as cryptocurrencies or NFTs could be considered a “security” or “investment contract”:

  1. An investment of money…
  2. into a common enterprise…
  3. in which investors expect to profit…
  4. from the efforts of third parties.

Any NFT that fulfills these four conditions is likely to be deemed to be a security by the SEC. The primary responsibility of regulating NFTs lies with the SEC and Commodity Futures Trading Commission (CFTC) under federal securities law. In addition, each state has its own securities law, which may have different or additional requirements to those of the federal securities law.

Several moves by regulators and private citizens are poised to make a clearer delineation of when NFTs and other digital assets stray into securities land:

  • Lawsuit over NBA Top Shot Moments
    A Virginia resident filed a class-action lawsuit on behalf of anyone who has purchased NBA Top Shot Moments. The case accuses NFT creator Dapper Labs and the NBA of marketing and selling “unregistered securities.” The plaintiff has alleged that NBA Top Shot Moments (digital video basketball cards) pass the Howey test and should be subject to the Securities Act of 1933. Dapper Labs responded with a motion before a Manhattan court requesting that the court dismiss the lawsuit as its digital basketball cards are simply collectibles like any other sports trading cards, coins, or stamps. The case is pending, and the final decision is likely to shed light on a number of issues related to the legal status of NFTs as securities.
  • SEC Scrutiny over Illegal NFT Offerings
    Around the middle of the year, the SEC started scrutinizing NFT creators and crypto exchanges for securities violations. The scrutiny has been specifically geared toward ascertaining whether certain NFTs are being utilized to raise money like traditional securities. The SEC is particularly interested in fractional ownership of NFTs, which it believes looks a lot like owning shares in a company or project. Selling small pieces of more valuable NFTs is a big part of New Jersey-based crypto lending company BlockFi’s business model. The SEC has ordered BlockFi to pay a record fine of $100 million for failing to list its “high-yield” lending products as securities. More action could be forthcoming in light of SEC Chairman Gary Gensler characterization of “the vast majority” of the nearly 10,000 tokens in the crypto market as securities.
  • Litigation against Former Open Sea Executive
    Former Open Sea executive Nate Chastain has been charged with insider trading – a phrase and an offense reserved for people accused of using proprietary information to buy or sell company stocks or other securities. It can be argued that the attempt by the Department of Justice (DOJ) to charge Chastain with insider training is actually an attempt to label at least some of the NFTs on the Open Sea marketplace as securities. OpenSea has instructed its employees to avoid using securities-related words such as “trading” and “derivative” when talking about the platform’s NFTs.
  • Yuga Labs Threatened with Class Action Lawsuit
    Bored Ape Yacht Club (BAYC) creator Yuga Labs was threatened with a class action lawsuit for “inappropriately inducing” investors to buy BAYC NFTs and ApeCoin. A law firm has alleged that Yuga Labs used celebrity promoters and endorsements to inflate the price of its NFTs by overpromising returns. They further alleged that this was in contravention of the US securities law
  • Regulatory Action Sand Vegas Casino Club
    In April 2022, securities regulators in Texas and Alabama issued a cease and desist order against Sand Vegas Casino Club, a Cyprus-based virtual casino developer, to stop selling NFTs on the grounds that they are unregistered securities. The states found that the company failed to take several important steps such as registering a physical address, warning against the risks of operating a casino, and registering the NFTs with the states in marketing the NFT to consumers and prospective investors in its metaverse and online gambling site.
  • Proposed Crypto Bill
    In June 2022, US senators introduced a bipartisan bill calling for new rules on cryptocurrency and bestowing the bulk of the responsibilities for regulating NFTs on the CFTC. If the bill passes, the CFTC and not the SEC will be responsible for regulating crypto products since the authors believe the currencies are more likely to operate as commodities than as securities. While the proposed bill does not explicitly mention NFTs, it is likely to be applied to them. This bill is expected to be discussed in the senate sometime early next year.  

These legal developments suggest an increasing push in the US to categorize certain NFTs as securities. The legal categorization of NFTs as securities will have a huge impact on the video game industry and on emerging technologies companies aiming to launch their own NFTs as it would require potentially onerous compliance with the US securities law. Non-compliance can attract heavy penalties, therefore it is best to consult an NFT lawyer about the legal status of NFTs before embarking on an NFT project. A consultation can prevent legal liability down the road.  

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Defining NFTs: Property, Securities, or Commodities?

1000 648 David Hoppe

The legal classification and regulatory environment for NFTs remain unclear, making it difficult for Web3 developers, video game publishers, and metaverse architects to be fully confident they can employ NFTs without inviting lawsuits or government investigations. Some semblance of clarity, however, may be on the horizon, as US courts in the near future will decide several potential landmark cases, regulators deliver commentary that hints at pending rulings, and industry groups weigh in with suggestions for self-policing.

Securities, Commodities, or Property?

Defining NFTs’ status among personal and business assets is a logical first step in determining whether and how they should be regulated. Some experts are convinced that NFTs constitute securities because they act as investment instruments. People purchase them in the hope that their uniqueness and scarcity will drive up their value so they can be sold at a profit.

Several high-profile court cases hinge on plaintiffs’ contention that NFTs are securities. The US Department of Justice has accused Nate Chastain, a former OpenSea executive, of insider trading based on confidential information about upcoming issuances that OpenSea would promote. The government alleges that he purchased many of those NFTs in advance and profited when the ensuing publicity on the platform increased demand and drove prices higher. Chastain’s attorneys argue that even if Chastain did as the DOJ alleges, he should not be prosecuted because his actions would not constitute criminal activity. Insider trading, they say, is only illegal if it is done using stocks or other securities and NFTs are not securities. In this view, Chastain’s actions may be the definition of workplace misconduct, but they do not rise to the level of a federal felony.

Many business models adopted by video game and Web3 companies leverage the collectibility of NFTs. That’s the premise behind NBA Top Shots Moments. The National Basketball Association contracted with Dapper Labs to distribute the Moments, which are video clips from NBA games. The value of Moments with low serial numbers, featuring stars of the game, and capturing stellar plays consistently rises to well above their initial selling price. A class action lawsuit alleges that Dapper Labs violates US securities law by actively promoting, offering, and selling the NFTs. Plaintiffs argue that Dapper Labs failed to comply with the securities disclosure requirements, downplaying the investment risks involved and inducing uninformed purchases. Dapper Labs counters that Moments are not investments but rather simply digital basketball cards offered to fans and collectors.

Finally, a Senate bill would classify most NFTs as commodities and weaken the Securities and Exchange Commission’s oversight powers. The bulk of regulatory duties instead would fall to the Commodity Futures Trading Commission, whose mission is to protect buyers, sellers, and the public from fraud, investigate misconduct and minimize the risks inherent in derivatives transactions. Categorizing NFTs as commodities would impose strict disclosure requirements, trading guidelines, and marketing standards upon sellers. Companies that allow buyers to obtain NFTs on margin or through leveraged accounts would have to operate on registered exchanges or make physical delivery of the NFT and/or the asset tied to it within four weeks of purchase.

The outcome of these court cases and the fate of the Senate bill will further define how NFTs are regulated, taxed, and transacted.  

AML / KYC

According to a report issued by Elliptic, a London-based blockchain analysis company, over $540 million in crypto proceeds were processed through money laundering schemes over the last two years, including over $153 million that allegedly originated from ransomware payments. The study found that 22 NFT marketplaces, 4 NFT-based games or metaverse platforms, and 2 NFT swap services were being investigated for money laundering.

In February 2022, the United States Department of the Treasury (the Treasury) issued a Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art. The report discusses how the high-value art market, including certain NFTs, is vulnerable to financial crime and susceptible to abuse by bad actors. It also makes recommendations for art market participants to implement and maintain anti-money laundering/countering financing of terrorism (AML/CFT) programs. Similarly, in April 2022, a consortium of governing bodies, including the Internal Revenue Service, issued warnings to banks, legal authorities, and private collectors about the growing money laundering and fraud risks surrounding NFTs. This consortium is known as the Joint Chiefs of Global Tax Enforcement and was formed in 2018 to share intelligence and combat transnational tax crimes. Given these developments, it is likely that the US will require KYC measures to fight money laundering related to NFTs in the near future.

Intellectual Property

It is well established that buying an NFT does not grant ownership over the underlying asset, unless that transfer is expressly stated in the smart contract that enables the transaction. In fact, according to a recent study conducted by crypto merchant bank Galaxy Digital on the NFT marketplace, Web3’s promise of digital ownership and property rights “remains far off.” The study found that the vast majority of top NFT collections do not convey any form of intellectual property or ownership of underlying artwork or media. Nonetheless, this has not prevented many NFT buyers and sellers from trying to convince themselves and others that owning a screenplay, a handbag, a shoe, or some other possession grants them the right to mint digital assets based on them.

For example, Miramax sued to prohibit Quentin Tarantino from selling NFTs based on Pulp Fiction. The studio’s recently-settled suit noted that simply having written the screenplay does not convey IP rights to Tarantino to the movie. Tarantino’s view was that the NFTs were derivative of the screenplay, not the production.

Several other cases pertaining to NFTs and IP loom. Courts will decide a host of thorny NFT issues related to trademark infringement, copyright, and right of publicity. The recent spate of litigation pertaining to NFTs and IP suggests that new regulations may be required to address how innovators are employing NFTs in gaming and virtual worlds.

Privacy

The blockchain on which NFTs are based is a public ledger, which means that anyone in the world can view its contents. The blockchain is also immutable: information contained within it cannot be altered or deleted. These factors give rise to significant privacy and data protection concerns related to NFTs. Hackers could potentially use NFT transactions to steal users’ blockchain addresses, financial activity, physical location, metaverse avatars, and more.

Given the dynamic and relatively young state of gaming, metaverse, and other digital technologies, there are no laws that specifically tackle privacy and data protection over the blockchain. Current data protection laws in the US and other countries are inadequate to address privacy-related challenges posed by the increasing use of NFTs. For example, the fact that data cannot be deleted from the blockchain runs contrary to basic data subject rights under the California Consumer Privacy Act. It seems likely that the US will eventually introduce new laws to reconcile these disconnects.  

Conclusion

As an emerging asset class, NFTs and their marketplaces require a new set of guidelines and rules for consumer protection, particularly with regard to NFTs’ classification, IP ownership, and security.

In order to avoid or minimize legal risk, game publishers, metaverse developers, and web entrepreneurs should protect themselves by speaking with an attorney before embarking on any NFT project.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Sell the Sizzle, Not the Stake: Marketing NFTs

1000 648 David Hoppe

Numerous celebrities, musicians, athletes, and other influencers have invested in NFT artwork and technology, whether for their personal use or for building the next stage of their brand and empire. Concurrently, NFTs have evolved from the exclusive domain of digital artists to become major marketing tools for companies like Twitter and Warner Bros.

Investors and consumers alike have been captured by the non-fungible token craze, which skyrocketed in 2021 with about $44 billion worth of crypto sent to NFT smart contracts on the Ethereum blockchain – an exponential increase from 2020’s $106 million. Sales reached a record high of $6.13 billion in January 2022 before coming back to Earth in the following months.

Still in its nascent stages, the NFT market presents some real legal and regulatory issues that are complicated by confusing jurisdictions and the application of laws designed for more traditional investments and technologies. Some investors and attorneys deem NFTs to be shielded from securities and investment laws, but other fintech lawyers and Securities and Exchange (SEC) experts warn that NFTs are increasingly blurring the lines.

NFTs Are Not Considered Securities…Yet

NFTs are typically thought of as collectibles, like pieces of art or baseball cards, and they are non-fungible, meaning that each NFT is a one-of-a-kind asset. NFT creators can set the sales price and the maximum number of items that can be produced, as well as explicitly state which, if any, licenses NFT ownership conveys, and how royalties are to be paid in their smart contracts.

Transactions involving NFTs don’t need intermediaries for sales because they can be sold peer-to-peer or in an NFT marketplace. However, NFTs can be linked to a variety of aesthetic and intangible assets, including digital art, video clips, and game items. They are registered on the blockchain and possess their own unique, digital “fingerprint.” NFTs can also be tied to other assets that can be digital or physical as determined in the smart contract. Use cases to date have included physical art pieces, rare wines, concert performances, real estate, and more.

Initially, NFTs were marketed and sold as single lots but now more are being fractionalized to allow for shared ownership. What might have begun as a single collectible now may start to look like a security or share of stock in an investment, especially when the NFTs lean towards more brand-based collections. While NFTs are non-fungible, the smart contracts tied to them and the terms contained therein may make them less fungible, such as in cases whereas one “share” of an NFT accrues the same royalties, profit sharing, and profit upon resale as any other share. If an NFT transaction triggers cryptocurrency or security regulation, creators and owners may need to demonstrate that the assets involved are non-fungible in order to avoid legal hot water and unfavorable tax treatment.

Non-fungibility and the ability to pass the three-pronged Howey test are not always mutually exclusive. The process is case-specific and the devil is in the details when it comes to determining whether an asset is an investment contract. Howey indicates that something is a security when the purchaser invests money in a common enterprise with the expectation of making profits through the efforts of someone else. The Howey test applies to any contract, scheme, or transaction regardless of whether it appears to be a traditional security.

NFT Staking

Staking NFTs has become more popular in recent years. Staking is a way to put a unique NFT on the blockchain and into the marketplace. When an NFT is staked, it’s attached to a platform or protocol. In exchange for allowing his or her NFT to be used as “proof of stake” (POS) in crypto mining operations, the NFT creator earns rewards as well as other unique benefits.

NFTs can also be staked in similar fashion as cryptocurrency. Using a smart contract or appropriate blockchain protocol and a suitable crypto wallet, NFT stakers lend their assets and in return receive a percentage of their worth (similar to bond investing) and other benefits as determined in the relevant smart contract. The owners retain ownership of the NFT and reclaim possession at the end of the contracted staking period.

Similar to DeFi lending, NFTs can earn passive income when staked on a blockchain based on the annual percentage yield, the staking period, and the unit or quantity of NFT being staked. Many NFT owners take this approach to earn passive income instead of selling their NFTs, which disposes of their assets and often takes time to complete (the “illiquidity” problem). NFT lending relies on a POS mechanism to reward participants (the stakers). NFT owners might stake their assets to access crypto loans according to an agreed-to loan value (LTV) ratio or to obtain hard-to-buy or rare video gaming items.

While NFT staking is still in its infancy stage, it functions as a key bridge between NFTs and the DeFi economy. With the growing popularity of NFT staking, owners need to be aware of potential securities issues. Staking could be considered a securities scheme (failing the Howey test) unless the NFTs involved demonstrate utility and the marketing is aimed at that utility rather than the possibility of financial gain. The SEC has begun to investigate certain crypto exchanges for violating its rules. BlockFi received a $100 million fine for failing to register products it uses to pay customers for putting their digital tokens up for lease. In particular, the SEC is gathering information regarding fractional NFTs to determine where exactly they fall on the regulatory spectrum.

Keeping NFTs in the Non-Security Realm

Investors and minters interested in NFTs should be aware of growing government scrutiny of NFTs, including staking and fractionalization of NFTs. Most whole, unique NFTs assets are unlikely to be considered securities. However, fractional NFTs will likely receive closer scrutiny by the SEC for appearing and acting more like securities than traditional NFTs, especially if the owners are expected to receive profits, the money is used to build a platform, or if the NFT acts a license to another digital asset and will receive a share of attributed revenues. Marketing fractional NFTs as assets that will generate profits places emphasis on the potential for investment returns based on the NFT promoter’s ongoing efforts as compared to the consumptive value of the NFT as a digital asset.

Owners and creators of NFTs will want to avoid financial penalties and reputational damage from violating SEC rules. Working with an attorney who understands the current and upcoming regulatory conditions can help NFT creators and owners avoid potentially violating SEC rules and enjoy their unique digital assets.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Phonies, Phishing, & Functionaries: Risks in Buying and Selling NFTs

1000 648 David Hoppe

The market for non-fungible tokens (NFTs) has boomed (and busted) over the past year. As businesses and asset owners continue to create and sell NFTs representing a range of physical assets, digital images, internet memes, event tickets, memorabilia, and more, the legal risks associated with buying and selling NFTs have come into greater focus than ever. This article outlines these risks and offers proven practices that emerging technologies companies can adopt to protect themselves.

Regulatory Uncertainty Reigns

One of the biggest legal risks surrounding NFTs is the uncertainty surrounding the legislative context in which NFTs exist. While certain aspects or features of NFTs may be regulated by existing laws, there is currently no uniform regulatory framework pertaining to NFTs in the US.

For example, if the Securities and Exchange Commission and other regulators determine that a specific NFT has the characteristics of a security, they may classify it as such under the Securities Act 1933 and the Securities Exchange Act 1934.

On the other hand, NFTs could be considered commodities under the Commodity Exchange Act (CEA), which defines the term to include several enumerated items and a catch-all for “all other goods and articles.” The Commodity Futures Trading Commission (CFTC) is on record as saying the definition applies to cryptocurrencies like Bitcoin and Ether, as well as renewable energy credits, emission allowances, and other fungible items. From a recipient, buyer, or investor’s perspective, it is unclear whether they would receive any protection from the US law or regulatory policy.

In addition, the ownership of the underlying digital asset that an NFT represents may bring the NFT’s copyright into question. The absence of a coherent legal framework for NFTs elevates any potential risk associated with buying and selling them. Buying NFTs might be particularly risky from a consumer welfare point of view, as lawmakers and regulators are concerned about protecting vulnerable and naive populations.

Counterfeit Products and Trademark Infringement

Another legal risk related to buying and selling NFTs pertains to counterfeit products and trademark infringement. The immense popularity of NFTs has increased incidents of cyber fraud in the market. In numerous cases, spoofs of original NFT stores have been launched on the internet. These fake marketplaces utilize the defrauded site’s branding, content, and legal documentation, such as terms and conditions and privacy policy, to make them appear authentic. These fake NFT stores exist to sell bogus NFTs to which they either have not secured the intellectual property rights to reproduce or that do not even exist in the real world. This creates massive risk for emerging technologies companies who purchase NFTs for use in games, extended reality content, or virtual meta worlds.

Cybersecurity Risks

Hacking, phishing, brute-force attacks, and social engineering that plague online communities also present a worrying threat to buyers and sellers of NFTs. Hackers are using these and other techniques to convince individuals to willingly transfer their NFTs from their wallets. It is important to clarify that although NFTs exist on the blockchain, the key to unlocking the block and using and transferring the NFT is housed in wallets. In other words, even though it might be possible to track down stolen NFTs, it is generally difficult to recover them.

Loss or Damage to the Physical Asset

Another risk associated with NFTs is related to the loss or damage of the physical asset to which it is tied. Generally, the NFT and its underlying asset are separate assets. An NFT could be rendered worthless if the underlying asset is destroyed, lost, or stolen, even though the NFT generally includes the NFT holder’s title to the NFT. Owners of NFTs tied wine and liquor are forewarned. Dropping, partaking from, or even simply uncorking the bottle could affect the NFT’s worth.

Take Steps to Protect Yourself

  • Appropriate Legal Documentation
    Every NFT project should have a certain set of documents that includes terms and conditions, a privacy policy, and a license agreement. If you are a seller, make sure that you have these documents for your NFT project. If you are a buyer, read these documents carefully as they should outline what you are purchasing. In any case, it is best to engage an NFT attorney to review the documents before signing an agreement to buy or sell.
  • Legal Due-Diligence
    Beyond a document review, it is often worthwhile to conduct due diligence to ensure the legitimacy of any transaction, especially if a large financial transfer is involved. Companies might be tempted to conduct their own research or perform a perfunctory background check themselves but there is a risk of missing out on important details as the catch usually lies in the details. Many law firms specialize in conducting due diligence for NFT-related transactions; engaging these experts can help avoid extremely costly or damaging situations.
  • Reputable Dealers and Services
    Given the cybersecurity concerns, it is important to follow some best practices when buying and selling NFTs. These include but are not limited to setting up a reputable crypto wallet, safely storing the wallet’s private keys, installing anti-virus software, and enabling two-factor authentication. To mitigate the risks of purchasing NFTs, buyers should ideally make sure that they trade only on reputable marketplaces, research what they are actually purchasing, and check that the related smart contracts accurately match the terms related to the transaction.

Conclusion

NFTs offer exciting opportunities for digital creators, sellers, and buyers alike. As the market continues to evolve, it is crucial that market participants fully understand the risks inherent in these products. To minimize exposure, buyers and sellers should consult an NFT attorney before transacting NFTs, as timely advice can help mitigate potentially significant legal risks. Among other things, an NFT attorney can be helpful in conducting legal due diligence, drafting legal documents, and advising on the regulatory regime applicable to NFT transactions.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Mint Conditions: NFT Artist Agreements

1000 648 David Hoppe

Legal issues arising from intellectual property-related concerns have received wide coverage in recent months and, in some cases, have derailed popular NFT projects. It’s no exaggeration to say that the success of an NFT project may hinge on how well the NFT artist agreement is drafted and how well it defines the terms under which an NFT minter can use any underlying art. This article covers the main ingredients in a strong NFT artist agreement and some important points that NFT minters and artists must know to protect their rights.

Meaning and Importance of an NFT Artist Agreement

An NFT artist agreement is a legal document that outlines the terms and conditions under which the creator of an original work—a piece of art, music, consumer good, or another type of intellectual property—grants certain rights to the minter of an NFT based on that work in exchange for compensation. Artists very reasonably seek to protect their work (irrespective of the medium) from unauthorized reproduction and sale and to participate in their commercialization. An NFT artist agreement is the equivalent of a license agreement used in traditional or digital media to say, produce and sell T-shirts emblazoned with a sports team logo or a cartoon mouse. It defines the scope of the grant of license in advance, reducing the likelihood of conflict or disputes between the NFT minter and the artist. The agreement may be called a non-fungible token digital art commission contract, commission agreement for NFT artwork, NFT digital artist commission agreement, digital art agreement, artist commission agreement, licensing agreement, or another similar term.

If NFT minters or developers fail to obtain a signed NFT artist agreement before creating an NFT based on artwork they do not own, they may be inviting conflicts down the road pertaining to the underlying asset’s copyright, trademark, or other intellectual property rights. For example, recently, an art collector has filed a lawsuit before a New York federal court to clarify rights over celebrated Indian artist M.F. Husain’s painting, Lightning or The Guernica of India. The art collector purchased the 60-foot mural and plans to sell NFTs based on it. The artist’s estate objected, claiming that buying the painting does not convey the rights necessary to carry out the plan. Because the purchase agreement makes no mention of NFT rights, there is no clear way to assess each party’s position on what actually changed hands when the collector bought the piece.

Key Provisions in NFT Artist Agreements

A strong, comprehensive NFT artist agreement will delineate the arrangement’s scope, each party’s rights and obligations, the working relationship between parties, timelines and deadlines, copyright ownership, and more:

  • Scope of the Agreement
    At a minimum, the NFT artist agreement should clearly describe the artwork being licensed or purchased, the duration of the license, what fee, royalties, or other consideration the artist will receive in exchange for signing the contract, and what the licensor is allowed to do with the NFTs he or she creates.
  • Relationship Between Parties
    In many cases, an NFT minter will simply commission artwork from artists on a work-for-hire basis. In this scenario, the minter would be considered a commissioning agent or commissioning party while the artist serves as a contractor who produces a product that will be owned by the minter. In other situations, a company might use in-house illustrators or graphic artists who produce works to be minted into NFTs. In this situation, the employer-employee relationship takes precedence. The worker would have no more right to the NFT than an assembly line worker to a car she helps build. Other cases are not so cut and dry. IP owners and artists may engage a third party to produce NFTs based on their owned works and display, market, sell, or otherwise leverage them in various partnership arrangements. These may include advance payments, royalty splits, profit sharing, options, and other sophisticated deals best drawn up by an experienced NFT attorney.
  • Rights and Obligations
    The license should explain any obligations the artist, the NFT minter, and any future purchaser of the NFTs created must perform and the compensation they will receive. Agreements commonly spell out whether the artist is allowed to make physical or digital copies of the artwork, license the artwork to other parties, and receive royalties for the original and/or subsequent sales of NFTs based on the artwork. Similarly, the agreement should stipulate whether the minter can retain exclusive rights to the NFT for a certain period of time, determine its sale price, or sub-license the rights granted. The artist’s obligations may include the duty to produce high-quality artwork, deliver it in a timely manner, and ensure that the rights of any third party are not infringed in its production. The contract should lay out how and when the NFT minter will pay the artist and may require attribution of the work to the artist or author at all times and maintain the spirit of the art and reputation of the artist in any derivative works.
  • Copyright
    Copyright ownership can cause significant issues when not sufficiently defined in an NFT artist agreement. The courts have decided that copyright to underlying assets does not automatically transfer to NFT minters, purchasers, and licensees. The artist retains the right to transfer the copyright, grant a license for specific purposes, or limit the use of NFTs. If the intent of the minter is for the artist to convey any of these rights, it must be expressly stated in the NFT artist agreement. If not, the artist who created the original artwork retains the copyright.
  • Jurisdiction
    With NFT legislation still in its infancy and each state and country creating regulations and setting precedents within their borders, it is recommended that the NFT artist agreement specify which jurisdiction will rule should any disagreement arise. Some jurisdictions are proving to be sympathetic to NFT minters, while others tend to side with artists. The country in which the artist lives or the licensing company is incorporated may play a role, giving one side a “home field advantage.”
  • Liability
    Since the rules surrounding NFTs are still evolving, it is important for the NFT artist agreement to include a clause laying out the consequences each party will face should they fail to deliver on their obligations. These consequences should take into account that the failure may be the result of forces beyond their control. For example, a jurisdiction may pass new regulatory controls that make minting NFTs more difficult or even illegal; natural disasters may destroy the means for creating the artwork or minting the NFT.

Any business or individual intending to create, sell, mint, or develop NFTs should always protect their rights and clarify their responsibilities by creating and entering into an NFT artist agreement with their artist partners. It is best to hire an attorney experienced in NFTs and contract law to draft the NFT artist agreement as they can be complex documents. It is important to note that many NFT artist agreements fail to adequately safeguard the interests of both parties, as they are drafted either by artist advocacy groups or NFT minter proponents.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

Star Power: NFTs and the Right of Publicity

1000 648 David Hoppe

Lately, there has been a lot of buzz around celebrities endorsing or investing in NFTs. The trend raises several legal implications surrounding the minting of NFTs and the right of publicity. This article specifically delves into personality rights and outlines some strategies NFT minters should keep in mind while minting NFTs that are based on a celebrities’ likenesses, images, name, or personality.  

Background

It is important to understand the legal definition and nuances involved in publicity rights. The right of publicity (also known as ‘personality rights’) refers to an individual’s right to control the commercial use of their name, image, likeness (NIL), and other aspects of their identity. In essence, it allows a person to keep his or her image and likeness from being commercially exploited without permission or compensation. The right of publicity varies by jurisdiction. About half of US states recognize a distinct right of publicity, stipulating the scope of an individual’s right of publicity, the assignability of those rights, and the statutory damages for violating the right of publicity. Others view it as part of other protections such as the common-law right to privacy or statutes prohibiting unfair competition.

California has enacted the most comprehensive laws with regard to publicity. In the Golden State, a celebrity or well-known personality needs to prove four elements in order to prevail in a claim of violation of their right of publicity:

  1. The defendant used the plaintiff’s identity
  2. The defendant appropriated the plaintiff’s name or likeness to the defendant’s commercial or other benefits.
  3. The appropriation was perpetrated without the plaintiff’s consent.
  4. The appropriation resulted in an injury to the plaintiff.

The above test essentially aims to protect individuals’ proprietary interest in their own identity. The protected elements of a person’s identity include name, likeness, voice, signature, and other uniquely identifying traits.

Licensing

If NFT minters fail to obtain express permission to use an individual’s NIL, they may receive a cease and desist order demanding they discontinue all use of the individual’s persona. Some letters may demand monetary compensation or threaten legal action. There is a very real possibility that an NFT minter who depicts a celebrity in an NFT without permission could be sued without the opportunity to negotiate a settlement. Being found in violation of a person’s right of publicity can result in substantial monetary penalties. Further, depending on the state, the NFT platform/marketplace may be held contributorily liable for allowing the sale of the infringing NFT. If the NFT minter used the platform to create, mint, or sell the offending NFT, the creator may be obligated to indemnify the site per its terms of use.

Free Speech

One of the fundamental questions that arises when assessing the right of publicity is whether celebrity endorsement of NFTs constitutes free speech. Over the years, hundreds of cases have contemplated how the right of publicity claims relate to the First Amendment. A key issue in many of these cases is whether the claimed violation was intended for commercial use; the right to control one’s persona is not intended to supersede the five freedom protections deemed necessary to ensure an independent press and open expression in art and entertainment.

In California, where many rights of publicity cases are litigated, the relevant statute protects only against the unauthorized uses of one’s NIL “in products, merchandise, or goods…for purposes of advertising or selling.” Determining whether a work is “commercial,” however, is made more difficult due to a lack of judicial clarity. In fact, it has not been definitively determined whether depicting an individual in a non-commercial NFT without that person’s consent constitutes a violation of that person’s right of publicity or whether it should be considered protected speech. Until the courts deliver a definitive ruling, publicity rights claims against NFTs will continue to be decided on a case-by-case basis.

Best Practices to Avoid Right of Publicity Claims

Projects and  businesses that plan to or currently use NFTs for commercial purposes should protect themselves by implementing strict policies before minting NFTs based on a celebrity or on an individual’s NIL:

  • Seek permission or license For minters intent on depicting a real person (alive or dead, celebrity or average Joe) in an NFT, the safest course of action is to license that person’s persona for use in the NFT. Licensing content is common practice, but the process takes time and money. It is also a good idea to license the rights over specific images, as the majority of the NFTs are based upon existing images. To minimize potentially damaging legal risk, it is best to engage an attorney to draft the license agreement.
  • Create a disclaimer Having appropriate disclaimers in place can minimize the risk of NIL claims. Such a disclaimer should stipulate the background information, intended usage, and the terms of the license. Consult an attorney or a law firm specializing in intellectual property and NFTs to help you in drafting a disclaimer.
  • Rely on publicly available resourcesIt is advisable to base NFTs on publicly available records such as property records and public financial information as minting an NFT based on such information runs a reduced risk of being deemed an invasion of someone’s privacy. In these cases, copyright ownership and related requirements should be closely observed.

As the popularity of NFTs continues to soar, projects and businesses intending to mint their own NFTs should be aware of the legal risks associated with using an individual’s likeness without their consent. Even though you might have the necessary licenses and permissions, you might not be completely insulated from legal liability since certain forms of statutory legal protections may still leave grounds for claims. Consequently, legal advice from a qualified legal professional is highly advisable at every stage of bringing an NFT to market.

Gamma Law is a San Francisco-based firm supporting select clients in cutting-edge business sectors. We provide our clients with the support required to succeed in complex and dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.

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