Any creative endeavour is in theory capable of being tokenised or “NFT’d”. Record prices are being reached for the sale of non-fungible tokens (NFTs). But what are NFTs? How are they created? Why are they so valuable? What does the buyer own? What rights do they confer? And why should IP lawyers care?
Here we unravel some of the mystery surrounding NFTs and provide an insight into the intellectual property opportunities and pitfalls that a business should be aware of. While we write from an English law perspective, many of the considerations have a broader reach.
NFTs have been around since as early as 2012. They gained popularity in the crypto community in 2017 when a company, Dapper Labs, started selling NFTs linked to unique digital cat cartoons known as CryptoKitties and people went crazy for these cute digital kitties.
More recently, as we explain elsewhere (see NFTs’ nifty copyright issues), record prices are being reached for NFTs linked to different underlying assets. For example:
- Beeple’s digital art work, Everydays: The First 5,000 Days sold for a record US$69 million by Christie’s auction house.
- Twitter’s CEO, Jack Dorsey, auctioned an NFT of his first-ever tweet, “just setting up my twttr”, which sold for over US$2.9 million.
- NBA Top Shot crossed the US$500 million mark, making it the biggest NFT marketplace as at the date of publication.
What are NFTs? And why are they being sold for so much money?
What is an NFT?
NFTs are blockchain-based units of value or “tokens”, with a unique ID linked to an underlying asset. The most commonly used blockchain for an NFT is the Etherium blockchain, but NFTs are also held on other blockchains.
NFTs are composed of software code in the form of a so-called "smart contract”. It is the smart contract that contains details of the underlying digital or physical asset(s) to which the NFT relates, and also the rules and rights that attach to the NFT (for example, a rule that the original creator of the NFT gets paid a percentage of any subsequent resale value).
The value in an NFT is derived from it being “non-fungible”, meaning that the token cannot be replaced with an identical token (giving its inherent scarcity). This is in contrast to the fungible nature of crypto-currency or government-issued fiat currency, where each unit of the currency is identical in value and therefore interchangeable with each other unit of the currency.
The easiest way to understand an NFT is by using an analogy of a limited edition print of an artwork. In the physical world, an artist would sign the physical print and include a print number (for example, one of five). The artist’s signature and the print number are not the artwork but a means of authenticating the artwork.
In the NFT world, on the other hand, an NFT:
- Represents the digital form of the artist’s signature and the print number that is associated with the underlying asset.
- Is linked to the underlying asset by:
- The digital work; or
- Virtue of a copy of the underlying asset having been encoded in the NFT (which is not very common); or
- The NFT containing a code that links to, or can be used to identify, the digital copy of the artwork or the underlying asset (which is the more common). This is known as “hashing” (to which we will return below).
To quote Valuable, the company that minted (i.e. created) the NFT of Jack Dorsey’s first tweet:
Owning any digital content can be a financial investment, hold sentimental value, and create a relationship between collector and creator. Like an autograph on a baseball card, the NFT itself is the creator's autograph on the content, making it scarce, unique, and valuable.
For more information about NFTs in general, see our publication, Anatomy of an NFT.
I’m an IP lawyer: why does this concern me?
NFTs present opportunities and risks for businesses. These can be grouped into the following categories, which we will explore below:
- The monetisation of your business’s intellectual property rights.
- The risk that your business’s intellectual property rights will be misused.
Monetisation of IP: sale of the NFT
The obvious way that an NFT can be monetised is by selling it to a third party. However, for the buyer, the reality of purchasing an NFT is often not as straightforward as purchasing a physical asset. While the owner of an NFT can prove it owns the NFT, it does not necessarily own anything more than that.
An NFT is essentially metadata about an asset which is added to a blockchain. This means that, while an asset is used to encode the NFT to make a unique representation of that asset, the NFT is not usually - unless there are terms to the contrary in the smart contract encoded in the NFT or in any associated terms of sale - the actual asset itself.
To continue the analogy of the limited edition print of an artwork - if a collector owns a physical limited edition print, the collector would own the physical print itself but would not usually own any proprietary rights in the original artwork. This is an important distinction which is being missed by much of the media coverage of NFTs. Such coverage tends incorrectly to suggest that ownership of an NFT amounts to some form of ownership of the underlying asset.
To illustrate the above, it is worth considering Jack Dorsey’s tweet again. When Jack Dorsey sold his tweet, he auctioned it on the Valuables platform. Valuables characterise the purchase of an NFT as purchasing “an autographed certificate of the tweet” and make it clear in the terms of sale that any such purchase does not transfer the copyright in the tweet to the buyer.
Therefore, even though the buyer of Jack Dorsey’s tweet spent millions of dollars on the NFT, the buyer would not be able to use the tweet itself (e.g. by printing it on a shirt) without permission, as the copyright is still owned by Twitter and Jack Dorsey.
Those buying an NFT should carefully consider what they are getting when they purchase an NFT, as the ownership of an NFT does not automatically give rise to any ownership rights in the underlying asset.
Assigning intellectual property rights in an underlying asset
An NFT seller (assuming the NFT seller is also the owner of any intellectual property rights in the underlying asset) can, of course, transfer those intellectual property rights to the buyer.
However, to do so, the intellectual property must be assigned in writing. Without express written terms stating otherwise, either in the smart contract or elsewhere, this will not happen automatically on sale of an NFT.
Selling an NFT and the underlying asset
Although not commonplace, an NFT seller can sell both the NFT and the underlying asset together. The NFT can then be used as a digital proof of ownership. This raises two important considerations:
1) Ownership of the underlying asset
The purchaser of the NFT should check who owns the underlying asset. Typically, the sale of the NFT does not include sale of the underlying asset or any intellectual property rights that vest in it (see Buyer Beware, above).
However, there are certain examples where an NFT is in fact to be sold together with the underlying asset. One interesting example is Nike’s patent, obtained in in 2019, for a system called “CryptoKicks” where Nike could tokenise ownership of shoes by linking an NFT to a physical shoe. This system reportedly allows designers/businesses to have control over their shoe design - for example, by limiting the number of copies that can be produced. With the prevalence of fake trainers on the market, this provides an innovative way to combat counterfeiting. It also has the benefit of offering a limited edition product, engendering brand loyalty between brand owner and customer, and helps keeps the business current and relevant. To our knowledge, this system has not yet been launched by Nike but it is an interesting concept to be aware of in the retail sector.
The general approach of selling blockchain tokens with the underlying assets has, however, been used for years in the financial services sector, with a number of financial institutions using blockchain technology to trade regulated security tokens, where transactions are recorded on a blockchain (see our publication, Anatomy of an NFT).
2) Possession of the underlying asset
The purchaser of the NFT should also check who has possession of the underlying asset, particularly where the underlying asset is a digital file - for example, a digital piece of art.
As mentioned above (see What is an NFT?, above), an NFT is linked to the underlying asset, either by the digital work being encoded in the NFT (which is not very common) or by the NFT containing a code that links to, or can be used to identify, the digital copy of the artwork (which is the more common).
In the latter scenario, the NFT will typically contain what is known as a “hash” of the digital file. The hash is produced by applying a cryptographic mathematical function to a digital file to get an alpha-numeric string of characters, which acts as a unique identifier of the original file.
The hash value is used to authenticate that the NFT relates to that digital file. It is not possible to reverse engineer the digital file from the hash, so the hash in the NFT does not give the purchaser of the NFT the ability to possess the digital file that the NFT relates to. The purchaser will still separately need a copy of the digital file in addition to the NFT.
The purchaser should consider:
- Where the digital file will be stored and who will be responsible for maintaining it. In some cases, the digital file is hosted online and the NFT would then contain a URI or URL that points to the webpage where the digital file is hosted.
- What assurances it has that the digital file is going to continue to be hosted on that webpage, and that the file that is hosted there is not going to be altered. This should be included in the terms of sale of the NFT and/or the smart contract encoded in the NFT.
Licensing of intellectual property rights in the underlying asset
A more common approach is for an NFT seller and IP rights owner to license use of the intellectual property rights in the underlying asset to the purchaser of the NFT for certain purposes.
Such licence should be set out in the smart contract or in a separate agreement between the NFT seller and purchaser. The purchaser’s use of the underlying asset can be as open or restrictive as the rights owner chooses.
For example, the licence for CrytoKitties permits the owner of the NFT to commercialise the “kitty”, provided that such commercial use does not result in earnings of more than US$100,000 per year. In contrast, the licence for NBA TopShots grants the owner of the “moments” a licence to “use, copy, and display” that moment, but does not permit the owner to “reproduce, distribute, or otherwise commercialise” the moment.
In the absence of an express licence, under English law principles at least, a licence will be implied, but will probably be quite narrow. Depending on the circumstances, in the case of an NFT relating to a digital asset, the licence may be limited just to the right to use or display the underlying digital asset for personal use and for the purposes of re-sale of the NFT.
Monetisation of IP: Royalties on subsequent sale
NFTs open up a potential new revenue stream for asset owners, as it is possible to code an NFT’s smart contact to make a royalty payment automatically to the original NFT seller on each onward sale of the NFT. The royalties are normally paid as a percentage of the secondary purchase price, and open up the possibility of infinite revenue streams.
This aspect of NFTs is of particular interest to digital content creators within the gaming sector, where financial benefits to creators can incentivise game developers to record their ownership of in-game items and help to fuel in-game economies.
Misuse of IP
With all the opportunities that NFTs present for a business, there is also the inevitable opportunity for misuse of a business’s or brand owner’s intellectual property rights held in any underlying asset through minting of unauthorised NFTs.
This is new territory as, to our knowledge, these issues have not been tested in an English court yet.
Potential infringement: copyright
There are two main types of infringement that may arise as a result of the unauthorised minting of an NFT relating to a digital asset:
- Infringement of the reproduction right (i.e. the restriction against reproducing or copying copyright works).
- Infringement of the communication right (i.e. the restriction against communicating copyright works to a new public not originally envisaged by the copyright owner).
With respect to the reproduction right, if the NFT includes a digital copy of the asset, there is potential for this to amount to an unauthorised reproduction that may amount to infringement of copyright. However, in circumstances where there is no reproduction of the underlying asset in the creation of an NFT, there is arguably no infringement.
With respect to the communication right, the minting of an NFT linked to an underlying asset is arguably a different act from that of making the asset available in a new forum. On the other hand, if the NFT does include a digital copy of the asset, the act of minting the asset may well amount to a communication to a new public that was not envisaged by the copyright holder.
At the moment there appear to be more questions (and arguments on each side) than there are answers. Where this lands will ultimately depend on the individual facts of each case and also any policy drivers that a court takes into account.
Potential infringement: trade marks
Trade mark infringement may arise where an unauthorised party mints an NFT linked to the underlying asset, without the asset owner’s permission, and advertises, offers for sale and/or sells the NFT using the asset owner’s registered trade marks.
The key question to consider here is whether the business owns registered trade marks that cover NFTs or similar goods/services. If it does, then there may be a relatively straightforward case for trade mark infringement under trade mark law – that is to say:
- The same mark is being used as the asset owner’s registered trade mark for identical goods or services; or
- The same or similar mark is being used as the asset owner’s registered trade mark in relation to the same or similar goods, giving rise to a likelihood of confusion.
However, even if the asset owner does not hold any trade marks for relevant goods/services, this does not signal the end: it may be possible, in certain circumstances, to argue that use of the same or similar mark for dissimilar goods takes unfair advantage of the reputation of the asset owner’s registered trade mark and therefore amounts to infringement.
Again, we will need to wait and see what direction a court takes on this.
There are certain steps that a business can take to monitor and enforce its intellectual property rights. These include:
- Watching NFT marketplaces. The business may have watch notices in place that it could extend to key marketplaces.
- Take action where appropriate. This may include steps vis-à-vis:
- Minters who do not have authorisation to mint an NFT linked to the business’s underlying asset.
- Marketplaces where NFTs are available for sale (issuing take down notices and requesting details of prolific unauthorised minters so that steps can be taken directly).
- Purchasers of NFTs insofar as the purchaser of the NFT is not acting in accordance with the smart contract (or any other contract) and/or are infringing the business’s rights, which may give rise to claims for breach of contract and/or IP rights infringement.
- Train staff. Staff should be trained that unlicensed use of IP – be that in an NFT or otherwise – is not permitted.
NFTs present numerous opportunities and potential risks for businesses. Clear delineation of what is permitted and what is not with respect to IP rights should be set out in the terms of sale of the NFT and/or the smart contract encoded in the NFT, which will best allow a business to control its IP as well as to monetise it.
There should also be appropriate oversight of use of a business’s IP by third parties (be that buyers of an NFT or third parties) and steps taken where appropriate. Clearly there are many issues to navigate and ultimately how the law evolves remains to be seen.