With the explosion of web 3.0 and the metaverse, non-fungible tokens (NFTs) have come to the fore. Whether it be digital collectibles, gaming, artwork or sport, these unique tokens play an important role in metaverse based systems.
But NFTs are not new. They first came to prominence with the CryptoKitties craze in 2017 and are the foundation of many ‘real world' blockchain use cases. This means that when examining gaming, DeFi or even blockchain for commodities, it is important to understand what NFTs are, and some of the legal issues which may arise.
What is an NFT?
An NFT is something unique, or which represents something unique, recorded on a blockchain.
NFTs can create unique digital assets or can be digitally linked (via a QR or other ID code) to a tangible asset, presenting opportunities including in the areas of art, games and interaction between digital and physical assets.
The term NFT reflects its technological properties. “Non-fungible”, means each NFT is uniquely identifiable and not interchangeable with another. The term “token” reflects its technological character rather than the legal characteristics. Technologically, NFTs can be divided into two key categories:
- Digitally native NFTs – tokens that are inherently digital in nature and do not rely on real-world assets for their existence. This includes assets such as:
- collectibles (such as CryptoKitties, digital basketball collectibles, Australian Open’s commemorative day passes and art balls);
- in-game assets (such as skins, weapons or virtual real estate); and
- artwork and music (such as the right to listen to a piece of music or display an artwork).
- NFTs related to other assets – These NFTs can also be used to reflect the ownership of other (tangible or intangible) real world assets on a blockchain. This may be a representation of a real-world asset, an interest in that asset or title, (or evidence of title) to that real world asset. Examples include physical artwork, real estate, sound recording, and diamonds. Theoretically, an NFT could represent or be linked to any asset at all.
From a legal and practical standpoint, tokens represent control of the relevant asset - not necessarily ownership. The precise technology and programming adopted governs how they are created, acquired, used, transacted, changed and possibly also destroyed.
Legal issues associated with NFTs
As with all new technologies (and is inevitable where blockchain is concerned) this raises interesting questions regarding the nature of and legal rights associated with NFTs.
“What rights does an NFT holder have?”
As an NFT exists on a blockchain, it can only be transferred on the blockchain itself and is subject to its smart contract protocol. Practically, ownership and access to the NFT is reliant on maintenance of the blockchain. Legally, an NFT’s treatment should depend on the nature of the rights provided when the NFT is minted and transferred. These rights are found in all the facts and surrounding circumstances. This may include:
- the terms of the agreement to transfer an NFT, which may include both smart contract and natural language terms. These may be in rules of an exchange or auction site on which the NFT is bought and sold, or between the parties themselves;
- the terms of a platform on which an NFT is minted, including the terms with the person receiving the NFT; and
- the rights provided by the creator of the NFT, such as whether the NFT is a record of ownership, a right to reproduce, or a right to display an artwork in limited circumstances.
It is therefore essential to be precise about what an NFT is, so that the holder knows what rights and responsibilities they have, as well as what rights they can transfer to others.
Regulation and other legal issues
At this stage, regulation of NFTs specifically is very rare, although some jurisdictions have issued warnings. It is also impossible to generalise on regulatory treatment given an NFT can be anything from a representation of a digital cat to a digital company share (and everything in between).
It is also important to remember that fraudulent conduct may still arise (although it may be more difficult). It is technologically impossible to issue an NFT at a past date, meaning that if an artwork is known to have been created at a particular time, and the artwork has an NFT which indicates that it was created after that time, this may assist to establish that the artwork is not genuine. However, the NFT is only evidence of the date of the NFT’s creation, not the artwork. Even with digitally native NFTs, using a blockchain record does not prevent unlawful conduct from arising. Much like a photo can be taken of a painting, or photo and prints reproduced, so too have NFTs been created from existing works without the permission of the author. Ultimately, the technology is part of, but may not be the whole solution.
What’s next?
All interacting with NFTs should be mindful of these issues. Whether as a creator, purchaser, exchange, auction site, investor, gamer or even payments provider, dealings with NFTs may appear technologically uniform, but are legally, and commercially far more complex.
To understand what an NFT actually is, it is important to “look through” the technology to understand the nature of the asset beyond its technological properties as non-fungible and existing as a token on a blockchain. When creating and interacting with NFTs, it is equally important to consider the role contracts play, whether it be the platform, user terms, or artist contracts (amongst others). All these can impact what the NFT is, and what you own.
Further information on NFTs and additional considerations are set out in KWM’s full Legal Guide to NFTs and NFRT Platforms from which this article is adapted. This guide is available here.
KWM has also prepared a guide to taxation of NFTs. This guide is available here.
We are actively advising clients across this space and engaging with a number of parties. If you have any specific questions, we would be very happy to assist.
Adapted from KWM’s “A legal guide to NFTs an NFT platforms”, published June 2021 by Urszula McCormack, Peter Bullock, Hannah Glass, Luke Hawthorne, Evan Manolios, Nikita Ajwani and Jack Rathie
