Technology has changed the way the world generates, grows, stores, and maintains value. The concept of “asset” has evolved from strictly tangible exchange media to digital property such as cryptocurrency and non-fungible tokens (NFTs). Digital assets are the latest trend, occupying the thoughts – and wallets – of a growing number of buyers, investors, and speculators. While many remain convinced that crypto represents the future of legal tender, experts are less sanguine about the prospects for NFTs. To be sure, there is a lot of money to be made in the NFT market, but how to approach these opportunities and how to manage risk are critical considerations in any NFT business dealing.
Issues Surrounding NFT Offerings
NFTs have opened the door for people all around the world to convert their artwork, collectibles, and other original creations into revenue-generating digital property. Because NFTs have become a global phenomenon, numerous jurisdictions have promulgated diverse rules governing their use, sale, and distribution. The monetization of NFTs often must conform to financial, legal, and contractual guidelines, that vary depending on where the deals are struck. In most cases, jurisdictions base their NFT copyright guidelines on European Research Council rule no. 721 (ERC-721) blockchain smart contract standard. Under this standard, creators and owners of unique crypto assets (UCAs) can verify the digital scarcity of their possession by recording it on the Ethereum public distributed ledger, where UCAs can be stored and transferred. The technology provides UCA holders in copyright-intensive disciplines such as gaming collectibles with certain intellectual property rights protection and authority over their NFT-backed creations.
However, some questions linger over the relationship between artists, collectors, investors, and licensors. Since these artworks have subjective value and cannot be sold off in pieces (the essence of “non-fungibility,”) the question of how NFT transactions should be regulated, taxed, and policed remains unanswered. Other questions surround the relationship between an NFT backing an asset and the asset itself. Unlike cryptocurrencies, which are governed by financial regulations, the assets associated with NFTs contain aesthetic value as well as monetary value, muddying the regulatory waters and subjecting them to consumer protection, truth-in-advertising, and other aspects of the law in addition to IP and investment law:
- Can, and if so, how, can an NFT’s investment value be distinguished from its intrinsic value?
- How should the transfer – sale, gift, inheritance – of NFTs be regulated and treated for tax purposes?
- What rights do NFT owners have, vis-à-vis the original creation on which the NFT is based?
These are all questions an experienced intellectual property and blockchain attorney should be engaged to answer. A lawyer specializing in crypto transactions and IP law can be a critical resource to navigate the jurisdictional and contractual issues to advise NFT owners, licensees, and buyers on their rights and responsibilities.
By most reckonings, a person owns an NFT if he or she has rightfully purchased it from or been assigned by a legitimate source, as documented and recorded on the relevant blockchain.
In cases where the original creator or owner of the tangible artwork or collectible maintains ownership even after someone else purchases the associated NFT, licensing agreements must specify exactly which rights each holds, and what the NFT owners can and cannot do with a digital certificate. Most NFT licensing agreements contain several standard clauses:
- Whether the buyer or licensee may transfer the permissions to a third party, and if so, whether and how the original creator will be compensated.
- How the NFT may be used, such as in advertisements, marketing campaigns, promotions, or merchandising.
- If the NFT can be copied and sold (similar to numbered prints of an original painting). If so, how will the revenue be split between the licensee and the creator?
- Whether the NFT owner can create derivative or modified versions, and how he or she can use them.
NFT license agreements were developed to protect creators’ intellectual property rights and enable them to profit from their talent and assets. Cryptokitties, one of the pioneers in the NFT trade, developed the first licensing agreement and set the standard for future deals. The Cryptokitties licensing contract accomplished its stated goal of establishing “a framework for blockchain developers to establish sustainable businesses and offer them a secure path to monetization, much like the App Store did for early third-party developers…The NFT License is a first step in determining what it will mean to own digital assets.”
NFT license agreements are executed and stored in blockchain-enabled smart contracts. This allows the autonomous code to also execute resales and manage monetary transfers. Some smart contracts call for the originator to receive a portion of the proceeds from every resale. These transactions can be tricky, and creators and buyers should take care that the license contains precise, legally binding language and that all parties understand the revenue-sharing or royalty model being used. An attorney experienced in blockchain and digital media can ensure everyone’s interests are addressed.
Know the Risks
As with virtually any investment, purchasing NFT licenses carries several types of risks; some involve the market and others center on the transaction and the platform:
- Platform unreliability and inaccuracies
- Tax liabilities stemming from NFT ownership
- Potential for detrimental changes in blockchain, crypto, and NFT regulation
- Token availability, storage issues
- Market volatility
Your attorney can advise you of the risks involved and help structure NFT license agreements to mitigate the risk, protect your interests, and create licenses that clearly outline the rights and responsibilities of NFT minters and purchasers.
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.