NFTs: Opportunities and Legal Issues

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WHAT ARE NFTS?

NFTs are cryptocurrency-based digital assets that are usually created on the Ethereum blockchain and are freely tradable. They are typically used to establish ownership of virtual (or even physical) assets, although their specific rights vary. Whereas cryptocurrencies and most financial securities are fungible, NFTs are unique (in that they are not mutually interchangeable in the same way that cryptocurrency usually is), although the underlying asset represented by the NFT may not be.

WHO IS THE OWNER?

When a purchaser acquires an NFT on a work of art, he or she basically acquires a non-exclusive license to certain intellectual property rights. This can include the maximum number of copies that can be sold, the amount of royalty payments, and so on. A smart contract is used to issue this license. Once a smart contract is developed, it gets minted on the blockchain as a token, i.e., the NFT. A critical point to keep in mind is that once minted, the NFT is exceedingly impossible to alter or edit.

As a result, the contract’s licensing conditions must be foolproof, but more crucially, worldwide acceptable. Copyright rules differ by nation, and a license that appears to be foolproof may not be so outside the place of origin. Additionally, while the phrases ‘buy’ and ‘license’ are sometimes used interchangeably, it is critical to note that while you are acquiring the NFT, you are not purchasing the work itself. There may be a transfer of ownership of digital art but not of copyright.

It is only a license to utilize the product in accordance with the licensing terms specified in the NFT’s smart contract. This is comparable to the buying of a painting. The artist retains ownership of the picture. While the painting’s ownership may change multiple times, the owner’s copyright is never transferred. The premise is that the NFT functions as an emblem on the goods, imprinting and verifying ownership via the blockchain. There can be no doubt about who owns the copyright, and the author is entitled to royalties whenever the license is invoked by licensees.

LEGALITIES

1. DEFINING THE SCOPE OF NFTS

Critically, issuers must be transparent about the rights they are “selling” via the NFT. These may involve certifying ownership of an item, granting a license to utilize intellectual property rights (IPR), or even contractual rights, such as the right to acquire or use a certain asset (whether digital or virtual), or to get access to advantages. Clarity up front will help the issuer avoid granting unwanted rights and avoiding potential disputes by customers alleging misrepresentation of the rights on offer.

Similarly, the purchaser of an NFT must be aware of what they are purchasing. For instance, if the NFT has smart contract capabilities, this will be encoded into it and may not be visible at first glance. Due diligence on the side of the purchaser is required to ascertain the rights and liabilities acquired, particularly if they may have an effect on the present or future value of the NFT and underlying asset.

What an NFT symbolizes, how much revenue is expected from its sale, and even whether it is capable of fractional ownership are all determined mainly by the commercial justification for issuing the NFT. For instance, if the value of an NFT or underlying asset is derived from its scarcity, the issuer may wish to restrict fractionalization (and must guarantee that it can enforce such restrictions), and purchasers may seek assurances in this regard.

However, if the NFT or underlying asset is valuable, fractionalization of the NFT (without splitting the underlying asset) may offer up investment options to individuals who would not be able to purchase them otherwise. These considerations will also influence the text of any sales terms or smart contracts, as well as the appropriate legal framework.

CDFA announces NFTs and Metaverse programme
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2. RIGHTS TO INTELLECTUAL PROPERTY

Issuers will wish to exercise strict control over buyers’ usage of any intellectual property linked with an NFT. At first look, selling a claim to a unique piece of work may appear to be the same as assigning copyright. However, the issuer normally retains copyright and other intellectual property rights, while the buyer is allowed the right to exhibit the underlying product. Care must be taken in determining how and if IPR is licensed through the sale and subsequent transfer of the NFT, in order to safeguard the issuer’s valuable brand (including effective remedies if their IPR is misused).

What an NFT purchaser owns is determined by the code or smart contract inherent in the NFT (or the terms of sale in a traditional contract format). For example, NFT producers may establish an NFT to automate the payment of royalties or commissions on any resale of the tokens. Payments might be automated using a smart contract embedded in the NFT, with the issuer able to follow resales via the blockchain on which the NFT is stored.

3. FINANCIAL REGULATION

Businesses must determine if their NFT is a regulated investment, security, or payment instrument and/or whether selling it for sale, or providing associated services like as custody or exchange, constitutes a regulated activity for regulatory reasons. Although NFTs are not (yet) officially regulated, they may trigger regional and international legal requirements if they display features of other regulated investment units. To avoid being classified as a security token or cryptocurrency, issuers will need to show the non-fungibility of any NFT they sell.

4. DATA PROTECTION

Because the selling of NFTs is unlikely to entail the revelation or exchange of sensitive personal data, compliance with privacy regulations will be irrelevant. However, the security of data and,

more broadly, NFT transactions will be crucial. Technical teams will need to decide on the security and data-sharing protocols to use, as well as which blockchain system to implement (most typically Ethereum). Additionally, adequate technological arrangements must be in place to assure the long-term viability of NFTs and, more importantly, whatever digital assets they represent.

5. CONTRACTUAL

Issuers frequently use the assistance of a third-party technology supplier to “mint” NFTs. The “minting” agreement must explicitly explain the provider’s duties and provide guarantees that intellectual property and confidential information will be appropriately secured (particularly as NFT projects can be commercially sensitive).

Due to the fact that cryptocurrency money will be required to “mint” NFTs, organisations should consider acquiring an enterprise-grade cryptocurrency wallet. Thorough vendor due diligence will be required to guarantee that enough security is provided in the event of wallet theft or misuse. Along with any agreement with technology partners, the terms under which NFTs are sold to purchasers must be explicitly defined.

CONCLUSION

Inevitably, some practical interaction between NFTs and copyright will occur, although the majority of disagreements will be resolved at the platform level. The market is already functioning as a gatekeeper, preventing potential infringement by supporting the establishment of a platform for producers to sell their tokens. Nonetheless, the market’s structure and the incentive for high profits indicate that the NFT field is likely to create a significant number of copyright conflicts. Given that this is the early stages of a potentially revolutionary technology, it will be interesting to observe how ownership disputes and claims evolve.


Edited by:  Khushi Thakur

Published by: Aditya Negi

Sahiti Annam
Sahiti Annam
Sahiti is a Law student pursuing BBA.LLB at Symbiosis International University, Pune. She also holds a Diploma in International Business laws & Indian Corporate Laws. Her primary interest areas are Bankruptcy Laws, Company laws, Blockchain & Data Protection Laws, Banking Laws, and Laws relating to Intellectual Property Rights. Having been a professional lawn tennis player and an avid sports enthusiast, she is capable of handling her wins and losses well. Her adaptability makes her an excellent team player.

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