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.

Poor (Or Rich?) Little Fool: NFTs and the Greater Fool Theory

1000 648 David Hoppe

Non-fungible tokens (NFTs) have exploded in popularity since the development of the blockchain. While NFTs are mostly created for art, sports collectibles, virtual real estate, or other in-game assets, they are unique, indivisible tokens registered on the Ethereum blockchain that give them unique fingerprints that cannot be replicated or altered. Powered by smart contracts that tie them to an owner at all times, the blocks on a chain are visible to the public and enable NFT creators to retain their intellectual property rights and royalties. They’ve changed the game for the digital content realm and power a new economy, one in which people with extra money to spend want to participate.

Eight-figure price tags and celebrity endorsements have driven the general public toward NFTs and pushed NFTs toward the mainstream. In 2021, the global NFT market value topped an estimated $15.70 billion and is expected to reach $122.43 billion by 2028. Yet, some savvy businesspeople aren’t convinced.  Bill Gates, for instance, recently described the rise of NFTs as being based on the “Greater Fool Theory.” He doesn’t think buying NFTs of bored monkeys or yesterday’s tweets will last because they won’t help the world. Gates describes himself as an old-school investor who won’t invest in cryptocurrencies since they aren’t a protected asset class. While his concerns have some merit, NFTs do boast many willing buyers and sellers, with many playing for high stakes.

Chain of Fools

The market has experienced two significant bubbles over the past 20 years—the real estate crash in the 2000s and the tech-stock bubble in the late 1990s. A market bubble forms when a series of assets increase in price dramatically beyond their fundamental value. Tulip bulbs, anyone? Investments are allocated to purchase these overpriced assets, contravening what, in hindsight, seem to be prudent strategies. No one really knows how a market bubble forms or what causes prices to continue to rise until the bubble bursts., One popular theory that describes this phenomenon is known as the Greater Fool Theory.

According to economists, the Ethereum blockchain takes hold when people can find buyers to whom to sell overinflated assets. These people buy the stock, commodity, or collectible without regard to its intrinsic value because accumulating value is not their objective. Profit is. And they can always find a bigger fool than they are who will pay more than they did. The bubble bursts when the “greatest fool” buys the item and is left holding the bag. This investing ignores all valuations, earnings reports, and any other market data. As long as there is a greater fool in the market, there is no need for prudence, so speculators can safely ignore the asset’s fundamentals.

Fool’s Gold?

As applied to the NFT marketplace, cryptocurrency markets significantly dipped in the spring and summer of 2022, thanks in part due to the TerraUSD crash, but will NFTs suffer the same fate? Perhaps not. Many stakeholders, Bill Gates notwithstanding, view NFTs as valuable investments because they verify the authenticity of the asset they represent, unlike an oil painting or a baseball card. With the rising popularity of digital images, the technology available makes it easy to copy a Caravaggio or counterfeit a Campanella. There’s nothing to authenticate whether you own an Old Master or a master forgery.

Smart contracts, on the other hand, allow NFT creators to identify their works and NFT owners to verify that their NFTs are indeed “original” pieces of digital art or collectibles. NFTs become digital versions of these collectibles, whether the underlying asset takes the form of wine, baseball card, film clip, event ticket, or something else. NFTs have ushered in a whole new marketplace for digital creations.

The technology behind NFTs—the tokens registered on the blockchain—authorizes them to protect all parties to any transaction. The seller knows the asset’s market value, and the buyer understands he or she is buying a legitimate, unique object.  For example, many NFTs have other items tied to them as part of the purchase, such as a concert ticket or a weapon that can be used in a video game. When a concert goer buys an NFT-based ticket on OpenSea, they will know it will gain them admittance to their show—peace of mind that does not come when buying from Craig’s List or a scalper. Likewise, gamers can purchase an NFT gaming asset such as a magic spell or character skin on the game platform from a trusted third-party site. When they decide to stop playing, they can then sell the NFT gaming asset to someone else or swap it for a different one for another game. So, NFTs have an authenticity with their place on the blockchain that other “collectibles” lack, which can arguably remove the “fool” from the Greater Fool Theory.

What a Fool Believes

Despite warnings about “fool” purchases, NFTs are an emerging asset class that will pique the interest of more investors in the future. While they aren’t considered securities by the Securities and Exchange Commission (SEC) because they don’t meet the “Howey test” guidelines, NFTs straddle the line between categorization as a product and a security.

Currently, the SEC doesn’t view NFTs as a security because they concluded NFTs fail the third prong of the Howey test—a reasonable expectation of profits derived from the efforts of others. But this designation may change in the future. NFT creators who consider their assets as products rather than investments but then market them based on their capital gains potential could be courting regulatory trouble. NFT creators can write conditions into their smart contracts stipulating that they receive a portion of the sale price each time it’s sold, generating passive income for artists. Within the smart contract, however, there is no expectation that the NFT will make money for the buyer. If the NFT value increases, that is due to the marketplace and not due to any expectation of profit upon its sale like security does. The SEC has greater concerns over fractional NFTs that allow many investors to own a piece of the NFT. Lawsuits, such as a class action against Dapper Labs and an SEC case against a former OpenSea employee for wire fraud and money laundering, have arisen over this very issue.

Although NFTs are not considered securities because they are not divisible or “fungible.” Fractional NFTs, however, blur the line, with some in the SEC viewing them as tantamount to shares in a company. Over time, the SEC has changed its legal purview to regulate other digital assets, and NFTs may be next. NFTs do hold significant value for many owners and creators despite the misgivings of old-school investors and their claim of the Greater Fool Theory that props up their value. While NFTs are more akin to a signed soccer jersey or an original oil painting, they do have intrinsic value that isn’t attributed to the Greater Fool Theory. The SEC has certainly taken notice.

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.

As Good As Advertised? NFTs in Marketing

1000 648 David Hoppe

Non-fungible tokens (NFTs) are quickly establishing themselves as one of the fastest-growing and most innovative advertising media. “NFT” is now a key marketing buzzword, with Collins Dictionary naming it the 2021 Word of the Year.

From just $95 million in 2020, the NFT market exploded in 2021, reaching a total sales volume of $25 billion. This article will discuss how emerging technology companies and even mainstream consumer brands can engage their consumers through NFT marketing.

NFT marketing, too, has come to the fore as regulators struggle to find ways to protect consumers and bring a semblance of order to the NFT space. Businesses exploring ways to use NFTs in their marketing programs should take care that their tokens are not issued to create an expectation of profit to the buyer based on the efforts of others. Beyond that caveat, an attorney experienced with digital assets and technology regulation can assist businesses in their efforts to leverage the power of NFT marketing.

NFTs, like other digital assets, include metadata and security codes embedded in cryptographic authentication and blockchain technology. These digital works of art, collectibles, video and audio clips, virtual real estate, gaming resources, and other “property” may or may not include the right to leverage the intellectual property or “real-world” entity they represent. Those that do carry tangible benefits that extend well beyond any speculative value that may or may not be realized due to market sentiment. These NFTs also are more likely to remain on the unregulated side of the playing field if the Securities and Exchange Commision or another nation’s regulators decide that some NFTs behave as securities and therefore should be monitored and taxed as such.

Here is how companies can implement NFTs into their marketing strategy.

Create a Meaningful Story by Connecting NFT to your Brand

There is always a story behind everything brands attempt to accomplish. Many brands try to engage users through Discord or other onboarding platforms. However, they may quickly realize that it is better to understand their audience and its identity. Originality is key. Engage your audience by telling a story it can relate to. Cryptocurrency/ NFTs are not only for hardcore users. When you speak their language, people will love it too. They enable companies to tell their story using controlled, managed messaging that delivers several benefits:

  • Establishing intimate, emotional, personal connections with the community
  • Empowering customers by giving them a say in the brand’s mission and direction
  • Ending to the “fake it ’til you make it” mentality by demonstrating authenticity and exclusivity.
  • Rewarding loyal customers for their time and effort
  • Engaging followers with the company’s vision, leadership and raison d’etre

In today’s digital age, NFTs go beyond collectibles and art. For example, OG Esports dropped its third NFT at Binance. In place of trading cards, the organization used NFTs to tell the story of an OG astronaut’s landing on Binance. A pioneer of Esports organizations, OG Esports understands how NFTs can benefit their followers.  The release of fan tokens and other NFT-related projects allows OG Esports to interact with its community more effectively and generate more revenue.

Use NFTs as a Medium and Take Advantage of Their Marketing Utility

Brands reach a wider audience by joining NFT marketplaces. These diverse communities composed of digital creators, art collectors, young and experienced entrepreneurs, and a wide range of other participants are eager to engage, thanks to NFTs’ novelty and real-world profit potential As brands create more NFTs, they raise their profiles in the community and quickly become part of the conversation. The customer base will expand, presenting a larger pool of potential buyers that increases the likelihood of closing a sale. Brands can connect with their audience through NFTs in a way that no other marketing medium can provide.

A successful brand’s marketing contributes to its legacy, distinguishing temporary fads from long-term successes. Look at NFTs as a medium (with lots of utilities) for the marketing message and delivery mechanism, rather than being the message itself.

Video game producers, extended reality content generators, musicians, artists, and digital transformers can use NFTs as part of their marketing efforts, advertisements, analytical tools, billboards, and other marketing media. This is one of the best ways to leverage NFTs to create long-term business value.

Mobilizing NFTs in Marketing

NFTs are far more than jpeg images linked to blockchains – they provide utility to your audience and brand strategy. Savvy brands follow marketing best practices to squeeze the most value from their NFT campaigns:

  • Identifying the audience’s inner thoughts and feelings, not just its demographics
  • Performing due diligence to protect their own and avoid infringing on others’ intellectual property rights
  • Using a story to connect the brand to the audience
  • Making the story and the brand accessible across channels

As an example of doing things right, Warner Bros. used the Nifty social NFT platform to announce the availability of avatars via blockchain to promote the fourth installment in its successful Matrix franchise, The Matrix: Resurrections. With the NFT collection, fans could choose to keep their avatar in the matrix by swallowing the  “Blue Pill” or becoming a resistance fighter by choosing the “Red Pill.” It proved a great way to generate hype and engage fans and customers around the film’s premiere

Like buying physical action figures or baseball cards, the process allows the original consumers to sell or trade their avatars, creating scarcity and value.

Experiment, but Monitor the Market and Do Not Compromise on Authenticity

For marketers contemplating their first foray into NFTs and Web3, this new space may seem daunting. Observing what works and pitfalls trip up early adopters can help brands figure out how to proceed. This new paradigm favors the bold, offering immeasurable rewards for earnest adoption and experimentation than did earlier iterations of web technology. But consumers can spot a fraud a mile away. Trying to appear part of a community by co-opting NFT protocols in social media posts may backfire, making brands seem out of touch and token NFT art collection efforts will probably not resonate any more than dot-com era vanity websites.

Fortunately, the NFT universe will coalesce over the next few years, so there’s plenty of time for emerging media and technology firms to figure out how to incorporate them into their marketing tactics. A business’s prospective NFT customers should include not just the crypto community, but anyone who could benefit from the products and services offered.The prices a commercial concern’s NFTs fetch on OpenSea shouldn’t be the measure of the company’s success. Instead, they should focus on metrics that can better illustrate a future in which NFTs anchor all real-world products and experiences with digital extensions.

What Is the Value of NFTs in Marketing?

Brands may have difficulty selling NFTs because they are risky. The future is unclear, and it is too early to estimate their impact. But many of those who have used it have seen great success.

Based on HubSpot Blog Research, 39 percent of NFT users say their NFTs have the highest ROI among their advertising investments. More than one in seven say they plan to use NFTs for the first time in 2022. Brands benefit from more trackable incentives through Web3 and NFTs. The brand and goals will determine whether this is valuable. One thing is sure, though: It’s definitely worth watching.

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.

When NFT Deals Go Bad: Lessons from G2 v. Bondly

1000 648 David Hoppe

With Non-fungible tokens (NFTs) comprising a multi-million-dollar market, there is seemingly no limit to their potential – the summer 2022 slump notwithstanding. Though some NFTs sell for millions of dollars and make their creators rich overnight, most NFTs sell for much more modest prices. Bloomberg estimates the average NFT can be had for just under $2,000. While NFTs don’t necessarily offer a “get rich quick” scheme anymore, they can provide significant revenues for brand owners, artists, and minters. Companies can use NFTs to promote their products, events, or brands. NFTs no longer are the exclusive domain of digital art collectors and video gamers; they have since branched out into other collectible spaces, notably for entertainment, music, and esports. This rapid expansion has created growing pains for some participants. As G2 Esports recently discovered, forging partnerships with the wrong collaborators or if they fail to ddress each party’s rights and responsibilities, problems are bound to arise.

When Deals Go Sideways: G2 Esports v. Bondly

In March 2022, G2 Esports filed a lawsuit against Bondly in Los Angeles Superior Court claiming intellectual property rights violations and seeking damages. G2 alleges that Bondly breached its contract to develop and promote a series of NFTs based on G2 Esports’ intellectual property relating to the company and esports teams it sponsors.

The plaintiff is a European e-sports entertainment company that brings together industry-leading brands and players to compete in League of Legends, Valorant, Counter-Strike: Global Offensive, Hearthstone, Rocket League, Rainbow Six Siege, and iRacing esports leagues. The defendant, Bondly (since rebranded as Forj), is a blockchain technology company that creates NFTs based on music, entertainment, gaming, and collectibles and administers a suite of products and services that support the blockchain ecosystem.

In the lawsuit, G2 asserts that Bondly misled the company leadership about its NFT-creating abilities and missed key deadlines for deliverables and payments. The parties entered into an exclusive two-year contract in June 2021 under which Bondly agreed to develop NFTs for G2 Esports and to function as its agent and promoter. In exchange, Bondly would pay G2 a series of fees for its intellectual property rights, which it planned to recoup through sales of the NFTs.

The agreement granted Bondly access to G2 Esport’s intellectual property, including images, video, and audio files. Shortly after G2 sent the first rights-fee invoice to Bondly, it says it discovered that Bondly would not be able to deliver the NFTs as promised. The parties could not agree on who was responsible for certain deliverables and tasks as outlined in the contract. Bondly later attempted to end the contract, citing G2’s unwillingness to compromise.  Claiming breach of contract because of the non-payment and non-delivery of the NFTs, G2 filed suit seeking $5.25 million – two years’ worth of $2 million in annual rights fees and the agreed-upon advance guarantee of $1.25 million. The case highlights potential problems surrounding NFT partnerships when licensing, distribution, and other rights and responsibilities are not clearly delineated in the contract.

Web 3.0 partnerships

The G2 Esports/Bondly case highlights the key considerations in Web 3.0 world partnerships. Web 3.0 would not be possible without collaboration between diverse players bringing complementary skills and resources to the ecosystem. Any partnership agreement to create NFTs will clearly need to spell out rights, responsibilities, and any other pertinent factors in order to make these partnerships run smoothly. When entering a contract for an NFT, it is recommended to cover several considerations:

  • Intellectual property rightsNFTs should be considered intellectual property, subject to copyright protection and design patent rights. NFT creators often stipulate in their sales contract that they retain the copyright to their underlying assets. Copyrights on NFTs exist as soon as they are created, and copyright ownership does not necessarily transfer when the NFT is sold.
  • Trademark extension Brand owners should extend their trademark rights to cover additional uses, including technologies and media not yet in existence. These provisions will reserve owners’ rights to exploit NFT and other digital uses of their products’ images. Several well-known brands, including Nike and Hermes have learned this lesson the hard way and were forced to assert their brand autonomy in court.
  • Royalty rates – Because copyrights attach to NFTs, creators can specify royalty payments in the smart contracts governing their use. For each sale, the creator can receive a portion of that sale going forward. NFT owners will receive their share of the sale price.
  • Licenses – NFT purchasers should engage an attorney experienced in licensing, IP, and digital technology to review licenses that call for the reproduction of copyrighted content. Most NFT licenses only grant the buyer limited capacity to use, copy, and display the NFT. They usually cannot commercialize the NFT by creating derivative content or using the NFT to market a product or company. If that is the intent, buyers should negotiate those rights and be prepared to pay extra for the privilege. These expanded rights are becoming more common with the success enjoyed by Bored Ape Yacht Club and Cryptokitties.
  • Design patents – Brand owners should become conversant with how current and future design patents can protect their interests against counterfeits or infringement, so they will know how to protect their assets, enforce their rights, and recover damages. While NFTs cannot be duplicated due to their unique “fingerprint” on the blockchain that verifies their authenticity, they can be replicated.
  • Securities designation – The Securities and Exchange Commission does not currently consider NFTs securities, but there is a growing movement within regulatory communities to revisit this policy. Owners should be aware if the SEC decides an NFT is marketed based on potential profits accruing to buyers based on the efforts of others they could satisfy the “Howey test” and be categorized as investment contracts. Additionally, the fractionalization of NFTs has raised eyebrows and could lead them to be regarded as unregistered securities and regulated and taxed accordingly.
  • Private personal data – Several high-profile breaches have brought data security into the public eye, and governments in the US, Europe, and Asia have taken steps to mandate higher-level These laws could potentially cover NFTs. Any NFT agreement should include a personal private data policy to ensure that no NFT contains sensitive data or, if it does, how its security will be maintained.

The legal rules and regulations surrounding NFTs and the blockchain are still evolving, so partnerships in Web 3.0 will have to adapt as the law eventually catches up to the new technology. To avoid litigation, any NFT agreement should consider the rights of each party in the partnership, who’s in charge of marketing, which platform to sell the NFTs, and the blockchain to use as well as intellectual property and passive income streams. Companies that want to avoid poor collaboration choices as befell G2 Esports should understand the potential pitfalls and plan accordingly. A consultation with an attorney specializing in the blockchain/NFT space and well-versed in contract law could prove valuable.

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.

Do’s and DAOn’ts: Setting Up a DAO For Your NFT Project

1000 648 David Hoppe

Decentralized autonomous organizations (DAOs) are increasingly popular as the organizational structure of choice for many individuals, groups, and companies pursuing NFT-based projects and businesses. In this article, we delve into the legal considerations that NFT ventures should keep in mind while setting up their own DAOs.

What Are DAOs and Why Are They Important for NFTs?

DAOs are organizations governed by rules encoded as computer algorithms to ensure transparent operations and transactions controlled by the organization’s members rather than an elevated group such as a board of directors or C-level executives. These community coalitions use tokens to represent voting power, as decided by the size of each member’s investment or work performed to further its development or objectives. DAOs use smart contracts to automatically execute commands whenever a set of conditions are met. For instance, these contracts may trigger payments, authorize transactions, or initiate a course of action when a majority of the voting stock is cast in favor of a particular action.

The rules of a DAO are stored on an open-source blockchain, so anyone can look into the code and view the transaction records, but they cannot alter the code unless conditions are met that instruct the smart contract to do so. Since there is no central authority that can direct decisions in a DAO, members can share proposals and potential projects within the community where they may be adopted according to the vote. DAOs function similarly to corporations, but without the hierarchical structure. Their primary advantage is in promoting a flat, democratic process through decentralized governance. Unlike a traditional corporation or similar organization, members of a DAO are not bound by any formal contract. Instead, they share a goal or a joint purpose written into rules. There are many different types of DAOs.

Legal Considerations for DAOs

Any project or business utilizing a DAO should perform due diligence and seek the advice of an attorney experienced in the digital space to ensure compliance and protections afforded by law. There are several variables to consider.

  • Legal Status – DAOs are not recognized as legal entities in the vast majority of US states and are not expected to comply with registration provisions in these states. Only Wyoming and Vermont extend DAOs corporate privileges such as limited liability that are usually available to traditionally incorporated entities. The other 48 states and the District of Columbia may even exclude DAOs from entering certain commercial contracts with other entities or the government, due to their lack of legal status.
  • Asset Protection – Unlike corporate shareholders, DAO members do not generally enjoy financial protections if their organization is sued. This is because DAOs are unincorporated entities and are not subject to the legal formalities of incorporation such as registration, bylaws, and contracts. Instead, they are treated as partnerships in which each member assumes joint and several liability. Therefore, if the DAO is hacked, declares bankruptcy, or owes money it cannot repay, each member is responsible for making creditors whole, exposing their personal assets. To address this weakness, a DAO would have to register and be recognized as an LLC or LLP.
  • Regulatory Framework – Because many states treat DAOs as partnerships, not only are their members exposed to personal liability, but other legal risks are created as well. For example, regulatory inconsistencies may lead to investigations into financial and asset trading violations. A report issued by the Securities Exchange Commission (SEC) in 2017 concluded that a DAO that sells tokens without properly registering them may violate multiple federal laws.
  • AML/KYC policies – Many traditional corporate entities are subject to anti-money laundering and know your customer (AML/KYC) policies that prescribe safeguards organizations must implement to ensure they deal only with legitimate partners, customers, and token holders. The rules also require verification of members’ identities and reporting of certain financial transactions. DAOs often are formed precisely to allow their members to remain anonymous; reconciling this advantage with AML/KYC policies becomes complicated, considering DAO memberships can include individuals from around the world. Deciding which country’s laws apply can be difficult and is likely to result in protracted legal battles if a dispute arises.
  • Decision Making and Dispute Resolution – Decision-making in a DAO is carried out by voting by its members. This means that each member of the DAO can influence its actions or future by initiating a new governance or management proposal themselves. This is in sharp contrast to traditional corporations where decision-making is centralized and the final authority to make decisions rests solely with the senior management, shareholders, or a board. The aforementioned jurisdictional issues can make resolving disputes a tricky proposition.

From the above, it is clear that there are a number of legal risks and considerations involved in creating a DAO in the US. There are jurisdictions friendlier than the US for DAOs such as the Cayman Islands, British Virgin Islands, El Salvador, Singapore, and Gibraltar. It is best to consult a corporate attorney with a current understanding of DAOs and related developments to check whether a DAO is the correct legal structure for your organization.

Conclusion

DAOs are taking the NFT world by storm as the next generation of financial and business innovation. They offer many advantages over traditional corporations including decentralization, member-driven voting and decision-making, and pooling of funds. Nonetheless, they pose many legal risks as they are not generally recognized as legal entities in the US. Further, DAOs that involve multiple jurisdictions may complicate compliance for parties using NFTs. It is best to consult a law firm specializing in legal structures for emerging technologies organizations to reap the benefits of a DAO without falling foul of potential legal risks and pitfalls.

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.

Not-So-Bored Aping: Chinese NFT Copyright Law and the US Courts

1000 648 David Hoppe

A recent Chinese court’s ruling on copyright infringement of NFTs could define how tokens and other digital assets are viewed by regulators in the United States and around the world. The court found that an NFT platform is liable for contributory copyright infringement with respect to a digital artwork it hosted. In addition, the ruling touched upon other related issues such as intermediary liability and the applicability of safe harbor provisions to NFT platforms. Here, we will examine the decision, review how US courts have ruled in similar cases, and analyze how the Chinese decision may influence future cases in the US.

Background

Hangzhou Internet Court decided that NFT hosting and commercial platforms are responsible for the digital works traded there. The plaintiff, Shenzhen Qice Diechu Cultural Creativity Co., alleged that Hangzhou Yuanyuzhou Technology Co., Ltd. infringed upon its copyright to a series of “Fat Tiger” illustrations. The defendant operates an NFT marketplace and digital art trading platform called Bigverse. The plaintiff initiated the lawsuit after finding that a third party had created a digital illustration identical to its copyrighted work (down to the artist’s Weibo watermark) and sold an NFT that uses the image on Bigverse.

The plaintiff claimed that, as a specialized NFT marketplace, Bigverse assumes a heightened obligation to monitor artwork hosted on its platform. According to the plaintiff, Bigverse must protect copyright holders’ intellectual property by conducting preliminary reviews to determine whether users who create and market NFTs on the site actually hold the copyrights to the underlying artworks. Failure to do so, the plaintiff argued, constitutes contributory infringement.

The defendant sought refuge in the safe harbor rule, which intends to shield ISPs that provide passive distribution and facilitation services for copyrighted works. Bigverse argued that, as an intermediary, it should not be liable for damages incurred as a result of the sale of counterfeit artwork and that its obligation only extends as far as taking down works upon receiving a notice of infringement from a copyright holder.

The Hangzhou Internet Court ruled in favor of the plaintiff, effectively narrowing the interpretation of safe harbor. The court held that Bigverse was liable for copyright infringement as a transaction involving an NFT digital work is subject to the copyright holder’s right of information network dissemination under the People’s Republic of China’s copyright law. The court decided the nature of the plaintiff’s business in actively promoting not only the distribution but also the creation of copyrighted works carries an additional burden of care in deterring intellectual property infringement. It should have taken the proactive step to prevent the NFT from being uploaded rather than reactively taking it down when its authenticity came into question.

In ruling for the plaintive, the court ordered compensatory damages of $600 to cover the economic loss and reasonable legal expenses incurred.

Applicability to the US

The fundamental question arising from this case is whether the US courts will agree with the Chinese decision that the intermediary liability exception contained within safe harbor standards does not apply to NFT platforms. Our view is that domestic judges would reaffirm safe harbor for these platforms and not hold them contributorily liable in the event of copyright infringement. This is due to the policy and legal considerations explained below:

US Policy: Chinese Judicial Trends

There has been a strong recent trend among Chinese courts to strip e-commerce platforms of their liability protections. Responding to strong government criticisms and retaliatory actions against e-commerce companies in China, courts have taken an activist stance, not just regarding copyright but also other issues such as real-name authentication and data protection. There is no policy reason for an open society and free-enterprise system such as exists in the US to over-regulate these sites or hold them responsible for the third-party content they host.

US Jurisprudence: Safe Harbor Precedent

Internet providers, social media sites, and other online communications networks have enjoyed the safe harbor provisions outlined in the Digital Millennium Copyright Act (DMCA) for nearly 25 years. US courts likely would not exclude NFT platforms from this precedent. In fact, some NFT marketplaces claim safe harbor protections within their terms of service. There are certain situations, however, in which the courts may consider that a platform’s participation in NFT creation and sales nullifies safe harbor. For instance, an NFT marketplace may lose protection if it receives any financial benefit directly attributable to the infringing activity, takes any action in selecting the content it hosts or modifies the content after it is uploaded and before it is transmitted to the audience. As such, the system of receiving fees for sales, either from the buyers or the sellers, could cost the platforms their ability to rely on the DMCA safe harbors. This also suggests that the American courts may hold differently if a similar case comes before it.

US Legislation: The Future of NFTs

In recent times, Congress has shown some willingness to address the shortcomings of the existing DMCA procedures. In 2020, Senator Thom Tillis released a discussion draft of his Digital Copyright Act, which is likely to significantly reform the DMCA. It is expected that in 2022 Congress may return to the question of updating the DMCA takedown regime. Consequently, it is likely that any decision on the liability of NFT platforms by US courts would be codified in future iterations.

Conclusion

The Chinese court ruling established a landmark regarding the rights and liabilities of NFT platforms. Only time will tell how the courts in the US will rule when a similar case comes before them. Given the weight of authorities and current precedents in the US, it seems that NFT e-commerce sites may find recourse in the safe harbor rule and avoid liability for contributing to copyright infringement simply by hosting dubious art or digital works, provided they do not profit directly from their sale. Nonetheless, due to impending changes to the DMCA take-down provisions and the complexity of the issues involved, it is recommended that NFT platforms and related parties should seek up-to-date advice from an attorney or a law firm specializing in NFTs if any potential risk is identified. In particular, having well-drafted legal documents, especially with regard to DMCA take-downs, is extremely important for mitigating legal liability under the DMCA. 

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.

RFIA Seeks Crypto Clarity and Consumer Protection

1000 648 David Hoppe

With more investors participating in cryptocurrency markets, the need to clarify and modernize the rules governing digital asset trading, buying, selling, and taxation has become ever more pressing. Senators Cynthia Lummis (R-WY) and Kristen Gillibrand (D-NY) responded earlier this month by introducing the Responsible Financial Innovation Act (RFIA) as a measure to protect consumers, brokers, financial institutions, coin issuers, investors, and other market participants. RFIA would expand the Commodities Future Trading Commission’s (CFTC) purview into the crypto asset sector and update Securities and Exchange Commission (SEC) parameters for regulating and taxing digital assets. The bill would distinguish between crypto “ancillary” assets to be overseen by CFTC, and crypto “securities” which, like stocks and bonds, would fall under the SEC’s jurisdiction. Other provisions contained within RFIA would include consumer protection reforms, clearer definitions of “broker” and decentralized autonomous organizations (DAOs), and more. 

Our previous article on this topic explored the bill’s key legal definitions, the cryptocurrencies that would be regulated as commodities, taxation de minimis for certain sales of digital assets, and how the Act seeks to avoid the stablecoin conundrum. Here, we will discuss additional RFIA provisions such as brokers’ roles, information disclosure, consumer protections, and DAOs.

Brokers and Selling Crypto Assets

Section 202 of RFIA narrows and clarifies the definition of a “broker” within the crypto asset space as “any person who (for consideration) stands ready in the ordinary course of a trade or business to effect sales of digital assets at the direction of their customers.” It would amend the definition included in the Internal Revenue Code of 1986 and the Infrastructure Investment and Jobs Act that some have interpreted as including transaction administrators and facilitators.

The definition of “broker” excuses many employees from reporting and fiduciary responsibilities. Only people who perform the traditionally understood activities done by brokers (i.e., effecting trades for retail clients) and earn compensation by connecting crypto sellers with buyers would be subject to taxation of income accrued through these duties. Crypto miners, buyers, and other participants would not be taxed on their investments until they are converted to cash.

RFIA reforms how brokers can sell cryptocurrencies in the marketplace, requiring the reporting of certain information on digital assets. In mandating custody procedures, RFIA would require the SEC to adopt amendments to Rule 15c3-3 (the “Customer Protection Rule”) under the Securities Exchange Act of 1934 to permit broker-dealers to take custody of digital assets for customers. If ultimately enacted, RFIA would provide a meaningful and long-awaited path for broker-dealers to maintain custody of digital asset securities.

Digital Assets Safe Harbor Trading Provision

Currently, non-US citizens who trade stocks, securities, and commodities—even when using a domestic agent—are not subject to domestic taxes because their activity is not considered as being conducted within the country. To extend this protection to cryptocurrency investors, RFIA carves out an exception for digital assets. The introduction of a “safe harbor” provision for non-Americans who sell digital assets allows non-US traders without US-based offices to use a domestic financial institution to conduct their trading activities.

Section 203 creates this trading “safe harbor” exception under section 864(b)(2) which covers commodities and securities trading. Non-US based traders would not be considered conducting business “within” the US for purposes of taxation as long as they are customarily dealt with in the digital asset exchange. However, if the non-US trader does maintain a US-based office or a fixed place of business, this provision would not apply because the exchange would occur on US soil and therefore be taxable.

Consumer Protection Provisions

If enacted, the bill will provide additional protection provisions for consumers. As cryptocurrency has become more popular and mainstream, many have bought often-volatile digital assets based on incomplete and incorrect information or understanding of the risks involved. When these digital assets collapse, as occurred with Terra/UST stablecoin, millions of dollars of collective consumer capital can be wiped out. Crypto markets carry inherent risks, so consumers must have sufficient information and disclosures to help them make educated and informed investment decisions. RFIA Section 505 would require suppliers of digital assets to clearly disclose information about their product in customer agreements, including a discussion of investment risk, applicable fees, redemption procedures, digital asset treatment in bankruptcy actions, and more.

RFIA’s consumer protections extend beyond brokers and sellers. The bill also would require customer disclosure requirements from digital asset service providers, which would include digital asset intermediaries and financial institutions as defined by section 1a of the Commodity Exchange Act (7 U.S.C. § 1a). The legislation further requires that any person conducting digital asset activities pursuant to a federal or state charter, license, registration, or other similar authorization would need to be disclosed. Additionally, the Act requires the SEC to complete its Custody Rule (17 C.F.R. § 240.15c3-3) and Consumer Protection Rule (17 C.F.R. § 275.206(4)–2) within 18 months of enactment. The new rules would need to account for the regulatory changes in custody practices, digital assets, broker-dealer practices, changes in market structure, technology, and parity of state and national banks.

The legislation closely follows other emerging approaches to crypto market regulation, such as the European Union’s proposal for governing markets in crypto-assets, and amending Directive (EU) 2019/1937 (MiCA). It imposes similar mandates on token issuers, brokers, and other market participants as RFIA. 

Decentralized Autonomous Organizations

The legislation also includes provisions for decentralized autonomous organizations. These entities are relatively new phenomena but are becoming increasingly popular. There are some 4,000 DAOs with over $8 billion in assets in the US, with the majority organized in Wyoming and the Marshall Islands. These entities have become power players in the crypto and NFT spaces.

RFIA attempts to “mainstream” DAOs, at least for the purposes of categorizing them in the IRS tax code. The Act specifies that certain DAOs constitute business entities for taxation purposes. These entities must be properly organized or incorporated under a state’s DAO statute. Under the law, DAOs can be structured as an LLC, corporation, partnership, foundation, cooperative, or similar organization.

Going Forward

RFIA has the potential to reform the digital asset marketplace within the US by bringing long-overdue government regulation and clarity to the space. If signed into law, its provisions would be rolled out within certain time frames—not overnight. Some of the tax revisions would go into effect from December 31, 2022, while others would not take effect until 2025. Until then, RFIA will have to overcome the hurdles of congressional committees in order to eventually become law. This gives industry participants time to plan their strategies for dealing with increased regulation and to consult an attorney experienced in the space to reduce their tax burden and ensure they comply with the new rules on disclosure.

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.

UK Recognizes NFTs As Property; Implications for the US

1000 648 David Hoppe

Recently, the UK’s High Court recognized non-fungible tokens (NFTs) as “property” separate from the underlying assets or objects they represent. This decision is likely to have far-reaching implications for disputes involving digital assets and digital art. The High Court’s ruling is likely to influence how the US views NFTs when it comes to trademark, copyright, and other intellectual property rights.

Background

In a landmark decision, the UK’s High Court has ruled that NFTs are property, separate from the underlying content that they represent. The court rendered this decision in light of Lavinia Osbourne’s stolen NFTs. Earlier in the year, Osbourne, founder of Women in Blockchain, claimed that two Boss Beauties NFTs were stolen from her Metamask wallet  Earlier in the year, Osbourne, founder of Women in Blockchain, claimed that two Boss Beauties NFTs were lifted from her Metamask wallet. Boss Beauties is an NFT collection linked to images of ‘beautifully diverse, empowered women.’ Osbourne did not provide details about how criminals were able to steal the NFTs, the tokens were later listed on OpenSea, the popular NFT marketplace. It seems that these NFTs ended up in the possession of two anonymous OpenSea account holders. Osbourne filed an injunction against OpenSea seeking to reclaim the NFTs. The court issued an injunction to freeze the assets on the accounts of Ozone Networks (the host of OpenSea) and compelled OpenSea to disclose information about the two account holders in possession of the stolen NFTs.

Legal Consequences

The outcome will bear on worldwide NFT, crypto, and blockchain law on several touchpoints.

First and most importantly, it removes the uncertainty —at least in the UK—about whether NFTs constitute property in and of themselves, distinct from the artwork, songs, tweets, or other “assets” they represent. The significance of this opinion is that the court held that an NFT represents a kind of asset that can be frozen, much like a bank or investment account. Nonetheless, this case also raises some ambiguity as the court remained silent on the relationship between an NFT and the underlying asset. As things stand, simple ownership of an NFT does not convey copyright, usage rights, moral rights, or any other rights. These rights must be explicitly granted in a written contract.

Second, the ruling clarifies that, contrary to the contention of many crypto supporters, code is not law. The term “code is law” is popular among crypto enthusiasts who believe in the proposition that written code is a legitimate form of legal enforcement even if the software contains a glitch or performs in an unintended manner. Practically speaking, it means that if someone obtains an NFT simply because they are able to access the rightful owner’s private keys via phishing or other scams, it should not be considered illegal. The code, some would argue, enabled the activity, and the perpetrator acted in a manner that is consistent with and permitted by the code, whose jurisdiction should be respected. The High Court, however, took the view that a person’s legitimate claim to a particular private key is legally significant. The fact that another party is capable of taking possession of an asset doesn’t mean that ownership is conveyed or that they should be allowed to do so.

Third, the court issued an injunction against ‘unknown persons’ as the holders of the wallet containing the stolen NFTs remained incognito at the time the injunction was issued. Further, the court compelled OpenSea to provide information about the two account holders, shredding the cloak of anonymity many blockchain users find desirable when conducting financial transactions.

Finally, the court ordered OpenSea to freeze the relevant accounts so that the NFT could not be moved or traded. Rightful owners of NFTs will find such action a valuable method for preserving their intellectual property rights. Freezing an asset and preventing it from being sold or moved to untraceable accounts will preserve the chain of evidence and give investigators time to unravel the events that led to the NFT’s misappropriation. Following an investigation, legal action can then be initiated.

Implications for US Policy

The High Court’s decision reinforces and coincides with the Internal Revenue Service’s (IRS’s) existing policy of viewing NFTs as property. The IRS and scholars share the view that NFTs possess all the traditional attributes of property. The owner can sell it, trade it, give it away, and prevent others from engaging with it. There is, however, some difference of opinion as to how completely separate jurisdictions can assure the security of an NFT. According to one view, the UK’s official recognition of NFTs as property means that holders can be assured that their tokens will be secure and they will have legal recourse in the UK if their property were stolen. Conversely, other commentators have noted that since the US has not officially declared NFTs are property, NFT holders have no recourse if someone hacks into their wallet and steals an NFT. This has led some experts to opine that the UK is leading the way in preserving NFT ownership rights. The fact that NFTs already enjoy the status of property in the US, according to the IRS and other executive-branch agencies does little to fill the current legislative vacuum in assigning property rights to NFT holders. There is an urgent need for a federal law on digital assets, and discussions are underway.

Conclusion

This High Court’s decision has helped clarify the important point that an NFT should be considered property and therefore is eligible to receive all the remedies and benefits of physical possessions. It is, however, unclear as to whether US courts will follow similar reasoning even though NFTs are already considered property in certain contexts in the US as well. This ambiguity has important consequences in determining the scope of protection extended by the NFT platforms. It is particularly unclear whether courts in the US will step up to protect stolen NFTs in the same way as the UK High Court. It is best to consult an attorney specializing in NFTs for advice about the best legal strategy to keep your NFTs secure. An attorney can also draft appropriate legal documents for protecting your 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.

Key Highlights from the Responsible Financial Innovation Act

1000 648 David Hoppe

As cryptocurrencies and other digital assets continue to establish themselves as economic powerhouses and enter into mainstream acceptance, the call for regulation has grown louder. In an effort to protect consumers and investors, Senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) introduced bipartisan legislation that would create a regulatory framework for cryptocurrency markets and classify the majority of digital assets as commodities. The 69-page Responsible Financial Innovation Act (RFIA) would empower the Commodity Futures Trading Commission (CTFC) to regulate crypto markets and set new legal definitions for digital assets. The bill would also establish new federal law governing stablecoins, implement taxes on small-scale crypto payments, and codify regulatory jurisdictions. If successfully implemented, the bill would go a long way toward dispelling legal uncertainties that have plagued the cryptocurrency space and further establishing its legitimacy.

Legal Definitions Related to Cryptocurrencies

One of the most glaring holes in the digital asset space is the lack of legal definitions in the US Code. RFIA would regulate cryptocurrencies as commodities under the purview of the CTFC, which would treat them as raw commodities such as corn, coffee, gold, soybeans, and crude oil. The bill proposes to endow the CTFC with new regulatory powers to oversee cryptocurrencies, making it the primary regulator of the digital asset spot market as well as creating a new registration category for digital asset exchanges. The proposed legislation adds “digital asset” and “digital asset exchange” to definitions contained within the Commodity Exchange Act as well as definitions for “virtual currency,“ “payment stablecoins,” “smart contracts,” “decentralized autonomous organizations (DAOs),” and other related terms.

Cryptocurrencies Regulated as Commodities

Under RFIA, digital assets will be brought into the regulatory sphere, bringing some semblance of order where little currently exists. The text of the legislation distinguishes between digital assets that perform as commodities or securities and those comprising tangible, fungible assets that are offered or sold concurrently with the purchase and sale of a security. The determination of the category into which an asset falls would be made by examining the rights or powers they convey to the owner. The bill provides that digital asset companies will play the primary role in determining and carrying out their regulatory obligations while providing further clarification to regulators so they can enforce the commodities and securities laws where applicable.

Digital assets would be defined as “ancillary” if they are offered in conjunction with securities unless they behave like securities that a corporation would issue to investors for the purpose of accruing capital. The Securities and Exchange Commission’s Howey Test holds that an asset should be considered a security if four conditions exist:

  1. There is an investment of money.
  2. The asset represents a common enterprise.
  3. Contributors invest with the expectation of earning profits.
  4. Those profits would accrue solely from the efforts of others.

Organizations can avoid categorization as a “security” by satisfying specified periodic disclosure requirements. RFIA would also direct the SEC not to treat cryptocurrencies and other digital tokens like traditional securities unless the holder is entitled to privileges enjoyed by corporate investors, such as dividends, liquidation rights, and financial interest in the issuer, as outlined in the Howey Test.

If passed, the legislation would give the CFTC wider power by extending its reach into the crypto spot market in addition to creating a process whereby crypto trading platforms such as Coinbase must register their businesses. The CFTC would be authorized to generate revenue by levying fees on the companies it oversees.

Taxation Reforms for Digital Assets

RFIA also introduces changes that would define and clarify the taxation of digital assets.

Currently, any time a cryptocurrency holder sells a digital asset, he or she may be required to pay capital gains tax on the profits. Even if the digital currency is used only to buy a good or service, the transaction constitutes a disposition of that asset. If the holder makes money on the cryptocurrency because it has appreciated in value, they would be liable for the tax. RFIA will potentially eliminate this tax for small transactions.

As more merchants come to accept cryptocurrency as a form of payment, tax reform is needed so consumers will not be taxed every time they spend their Bitcoin or Ethereum. Under specified conditions, RFIA would provide a de minimis exclusion of up to $200 per transaction using virtual currency for the payment of goods and services. In other words, consumers would be able to buy products and services totaling less than $200 without incurring capital gains tax.

Avoiding the Terra-ble Problem

Even before the TerraUSD (UST) meltdown, regulators were concerned with the risk that stablecoins present in the financial system. The Federal Reserve maintains that they are “vulnerable to runs” and lack sufficient transparency about the assets that purportedly support them. The legislation seeks to implement regulations that would help avoid situations such as Terracoin arising again. Issuers of stablecoins—which are cryptocurrencies pegged to a traditional financial asset such as the dollar—would have to maintain cash or cash-equivalent reserves that would fully back their digital assets. This reserve requirement for 100 percent of the face value of all outstanding payment stablecoins is intended to eliminate the collapse of the digital asset. They would also have to complete detailed public disclosure requirements for all stablecoin issuers.

What’s Next For RFIA?

RFIA still must overcome several hurdles before it can be enacted into law. The legislation will be heard in the Senate Committee on Banking, Housing, and Urban Development, which oversees the Securities Exchange Commission, and the Senate Committee on Agriculture, Nutrition, and Forestry, which regulates commodities and the CTFC. Lummis is a member of the Banking Committee, and Gillibrand sits on the Agriculture panel. The bill is unlikely to become law before the congressional session adjourns on January 23, 2023. It would then be taken up when the new Congress convenes after the election. Even if it fails to become law, the legislation can serve as a benchmark for future bills and offer a game plan for wider crypto industry integration.

Overall, the legislation intends to clarify the legal uncertainty surrounding digital assets in the marketplace to create a new regulatory framework. Together, the CTFC and the SEC are powerful regulators who will be given more authority to oversee virtual currencies and digital assets in the US. The latter would regulate digital assets as a commodity and the former would police companies, executives, and securities for greater investor protection.

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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