The Rise of Non-Fungible Tokens- The Legal Issues
Legal Implications of NFTs
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Are NFTs like Buying into Magic Beans?
Described most recently by Michael Burry, the 'Big Short' investor, as buying into magic beans, most people are still struggling with the concept of non-fungible tokens (NFTs) as having any intrinsic commercial value. Meanwhile, NFTs have enabled the sale and resale of valuable collectibles for millions of pounds.
The significant profits entrepreneurs can make in NFTs' have been trending in current news. There was a sale of NFTs this month by Sotheby's by Pak of a digital art piece valued in total at £12.2m. Remember the Kipchoge Keino's 1:59 Ineos Marathon challenge in Berlin? Well, this is one of the latest entrants into NFT sales where the marathoner has sold his career milestone NFTs for 17.98 ETH to NoDaolsLimited. Other notable recent NFT transactions are the February 2021 sale of an animated GIF of a Nyan Cat for $500,000/-, while an NFT of the first-ever tweet promoted by the Twitter founder Jack Dorsey sold for £2m in February. Similarly, another sale of an NFT by Christie of a digital artist Beeple for $69M this March broke the record for NFT sales in the art world.
What is an NFT?
An NFT is a specialised form of cryptocurrency linked to an asset where each token sold is unique and cannot be exchanged directly for another. To define an NFT in simpler terms you would say it’s a digital replication of a physical intellectual property asset that is tokenised. NFTs thrive by rivalrousness, which in practical terms means capitalising on the competitive nature of the free market, rarity and uniqueness.
Since blockchain guarantees the provenance of digital assets, the rarity and uniqueness of digital work are preserved. The rivalry between the different collectors will continue to drive up the price of the asset (c.f. JOSHUA A.T. FAIRFIELD, OWNED: PROPERTY, PRIVACY, AND THE NEW DIGITAL SERFDOM 148 (2017).
Given the unique features, NFTs are used to create a verifiable digital scarcity, thus giving artists the ability to monetise their work through blockchain. While NFTs are gaining prominence in recent times, they are not a new concept. Traditionally, NFTs have been used in the gaming environment to represent assets controlled by the user rather than by the developer. For example, in Cryptokitties, players used NFT technology to breed collectable digital cats.
Tokenised digital assets
NFTs in Practice
To understand NFTs better, think of a digital object that you cannot cut and paste. The main problem with digital items is that originality can be disputed because they can be easily copied. Ownership of NFTs are recorded in the blockchain which is an innovative way of protecting ownership of intellectual property in the digital item. When the NFT is created it is stored on a decentralised specialised blockchain database like IPFS. However, NFTs are a new technology so a lot of NFTs are stored on peoples databases, their servers and on the eWallet. Think of an NFT as the digital replication of the physical asset with an electronic record of ownership of the digital asset on the blockchain. As such, when you purchase an NFT, you hold the right to claim ownership of the digital item itself to the exclusion of all others. The terms of the NFT will determine if the intellectual property in the digital item remains with the author or if the rights are passed to the buyer of the NFT.
If you wonder if NFTs make sense, look at the recent legal attention they are drawing in the UK.
The Rise of NFTs and its Legal Treatment
In the UK, NFTs are governed by case law and statute covering financial services and intellectual property (copyright, design rights, trademarks, patents).
Financial Services
Under the Financial Services and Markets Act (FSMA) 2000, all financial activities within the UK must be regulated by the Financial Conduct Authority, and to be regulated, the FCA or the Prudential Regulation Authority (PRA) must authorise your business (including not for profit and sole traders).
Businesses involved in crypto-assets may include NFTs. The FCA has released further guidance on whether your business requires authorisation here.
As of January 2020, the financial activity includes businesses involved in crypto-assets under The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 as amended by The Money Laundering and Terrorist Financing (Amendment) Regulations 2019.
NFTs may be classed as e-Money, depending on how they are used.
Are NFTs Tangible Property?
As a form of cryptocurrency asset, NFTs in the UK have not yet been largely contested in courts owing to their fairly new exponential nature, but a few case laws are indicative of the trend as below:
AA v Persons Unknown [2019] EWHC 3556 (Comm) is one of the most important English decisions confirming cryptocurrency status as property under English law. The question for consideration, in this case, was whether the court could grant a proprietary injunction, and therefore a consideration of whether crypto-currency qualifies as property became inevitable. This decision endorsed the findings of the UK jurisdiction task force on "Crypto assets and smart contracts", which held that crypto-assets are property. As such, it is settled law that NFTs are recognised and treated as property in the UK.
In Robertson v Persons Unknown (unreported), the question of recovery of cryptocurrency arose where a claimant could trace a section of his lost Bitcoins to a Wallet at Coinbase UK and consequently, the court granted him an asset preservation order. This decision again demonstrated that UK courts do recognise crypto assets such as NFTs.
In the Robertson case, the court diverted from the decision in Colonial Bank v Whinney where property was defined concerning tangibility and its enforceability as a right. The court instead followed the reasoning in National Provisional Bank v Ainsworth. In this latter case, the court defined property as property being definable, identifiable by third parties, capable of assumption by third parties and having some degree of permanence. Looking at this broader definition, the court opined that crypto assets are property.
In both of the above cases where the question of property arose, the courts placed heavy reliance on paragraphs 71-84 of the Task Force findings where the task force likened the novel intangible property in crypto-assets to other already accepted intangible property such as carbon credits and milk quotas and therefore offering a solid guide as to how NFTs would be classified should the question of definition arise. Likewise, considering the Theft Act of 1968, the Proceeds of Crime Act 2002 and the Fraud Act 2026, it is not far- fetched to see how crypto-assets would fit within the meaning of "things in action and other intangible property." Thus, there is no conceptual difficulty in treating intangible assets such as NFTs as property despite not falling within the traditional definition.
How Do the Courts Value NFTs In an Unpredictable and Constantly Shifting Market?
Another legal question arises in the valuation of NFT as a crypto asset, given market volatility. This is considering that a call for valuation is an essential aspect in a claim for asset recovery. In Vorotyntseva v Money-4 Ltd [2018] EWHC 2596 (Ch), the court fixed the valuation of Euthereum and Bitcoin in GBP and regarding a specific date. In itself, this recognition and attempt by the courts to assist in the valuation of crypto-assets in recovery cases have gone a long way to restoring confidence in the insurance sector, especially for the insurers who are already issuing policies to cover the payment of ransoms following cyber-attacks.
Again, in considering the practicality of granting injunctions to preserve crypto-assets, the court in Toma V Murray [2020] EWHC 2295 (Ch) developed its thinking even further by recognising the unique characteristics of crypto-assets such as NFT and their volatility and potential quick change in value. In this case, the court considered whether it was practical for a contract to require consent to be obtained before a request for an injunction when transacting in cryptocurrency. In considering this, the court pointed to the impracticability of the pre-condition as any delay would result in a significant drop in the value of the asset. As such, the UK courts have proven themselves to be quickly developing a sophisticated practice by recognising the practical considerations that one has to address when dealing with crypto-currency.
Non-Fungible Tokens and IP Law
Non-fungible tokens and the Role of Intellectual Property
Copyright
Copyright in the UK is governed by the Copyright Designs and Patents Act 1988. The copyright works making up the tokenised asset will be protected. So would any designs which would also be protected as a design right. In some cases, both copyright and design right can apply cumulatively for the same asset.
Can you patent NFT based innovations?
The applicability of the law to NFTs includes patents. Would it be possible to obtain a patent in the UK for an NFT invention? The answer to this question is yes! For as long as the invention solves a technical problem and is a novel one, nothing stops the patenting of an NFT. While the definition of "technical problem" is quite broad, NFTs are software-based and qualify for patenting.
Generally, patents are difficult to establish and register as the qualifications are pretty stringent. Examples of the works that patents exclude include: literary, dramatic and artistic works; a way of doing business; discovery of a scientific theory or mathematical method; a manner of presenting information; some computer programs or mobile applications; and biological processes such as cross-breeding plants and new animal varieties.
The patenting process involves firstly searching as to the existence of a similar invention. If you do not find one, then a patent application is prepared and filed. The application is published within 18 months, and the applicant can request a substantive examination of the Patent within six months of publishing. Once an examination is carried out, the application can either be granted or denied.
Trademarks
Other than patents, which raises more technical questions, a proprietor can use trademark registration to add additional protection to the tokenised digital item. An owner of a digital item can trademark the name to a digital object. In the UK, it has become possible to trademark graphic marks such as graphic files, it will be possible to protect the intellectual property in the visual representation of an NFT. T
Other ways of protecting the creative process of an NFT are through the use of trade secrets and non-disclosure agreements.
What are the NFT legal grey areas?
Like any new concept, there are many challenging legal aspects to NFTs with which to grapple. The legislature and the judiciary in the UK have not yet had an opportunity to consider how the law would apply to specific scenarios. The natural course is for legal jurisprudence concerning these areas to develop with time. Some of the central grey areas are highlighted below:
What rights would accrue to an author where their work is tokenised without their permission?
In the case of a license holder over the original work, does this license also cover the right to create an NFT, or do they need to apply for a different kind of license to create tokens over the digital asset?
If the underlying digital asset disappears or changes its character, what kind of rights would an NFT holder claim and against whom should they claim?
In most jurisdictions where intellectual property can be challenged by invalidity or on originality, or where they require renewal, how would this practice hold against the use of NFTs, which in design are expected to persist indefinitely through a change of ownership?
What happens to the initial holder when the token is sold. Are his ownership rights wholly extinguished, or do NFTs create a hybrid of ownership rights that is yet to be tested in law?
But is it legal?
Conclusion
What is the future of NFTs' related law?
The law is more reactionary than proactive. It would be over-ambitious to expect that the law would answer all these complex and technical legal questions beforehand and in anticipation of the scenarios. As such, we expect that novel case law will continue developing as and when the courts are called upon to make determinations. Therefore, this is an area that needs specialised legal services.
We can work with you to help establish the necessary steps you must take to get authorised and be compliant with the FCA regulations, draft NFT contracts and digital asset eWallet payment and electronic payment corporations’ compliant terms, as well as prepare your general terms and conditions.
To obtain accurate advice about your business' legal compliance status and how we can help, please contact us on (020) 7305-7491 or at peter@pailsolicitors.co.uk, and we would be delighted to assist you.
The writer is an Internet and digital technologies + cryptocurrency law specialist, owner and principal solicitor at PAIL® Solicitors. Peter Adediran's specialist niche areas of practice are digital media business SMEs and IP, contentious and non-contentious. (Charge rates may vary)