Legal implications of the looming NFT boom

The crypto boom and headlines about high-value sales of digital art and music via non-fungible tokens (NFTs) – one-of-a-kind digital assets stored on the blockchain – has led to an explosion in interest by the international art sector. NFTs look set to emerge as a pivotal technology in the UK – and businesses must be aware of the legal implications.

How do NFTs work?

NFTs use the same blockchain technology that underpins cryptocurrencies. However, unlike Bitcoin or Ethereum, they are not interchangeable, due to the unique identification code and metadata distinguishing one NFT from another. 

NFTs may include “smart contracts”, which are software code that executes automatically and sets the rules associated with an NFT – in some cases providing significant benefits to NFT creators. Smart contracts – which the Law Commission recently concluded are compatible within the existing English law framework – have capacity to specify limitations on NFT use by a buyer, provide royalty payments from resale transactions, and prove legal ownership. Once the smart contract code is written, it is permanently minted into an evidentiary token on a blockchain. 

While many people associate NFTs with digital collectables, use cases are appearing across a wide number of sectors. When Kings of Leon recently released a new album as an NFT, it showcased the technology's utility. Six of their NFTs provide lifetime tickets for their shows, while the others have a five percent royalty payment attached the artists receive each time the NFT is resold. NFTs are digital tokens evidencing ownership, relying on blockchain technology as immutable proof: as we move towards Web3, the technology has the potential to overhaul how individuals and companies interact with one another.

Minted? Legal ramifications of NFTs 

Whilst the prospects for NFTs are exciting, some issues are not yet fully resolved. Resale rights, for example, can presently only be assured when the NFT is resold via the same platform. An automatic royalty for the original creator would fall away if moved to a wallet or sold on via different platform. 

Creating (as known as “minting”) an NFT requires significant energy and, in a world where we need to reduce carbon emissions, a solution to this needs to be found. The NFT may not have any intrinsic value – its value is related to the link it has to the digital asset. In some cases, there is a link to a separate asset, and this can create value, depending on the nature of the real-world asset. 

There is a difference between the IP rights in the NFT, simply a piece of code “pointing” to an asset and the IP rights in the asset itself, so it is important to view them as two separate issues. Typically, a buyer will take ownership of the token, but not the IP in the asset, which will remain with the creator. Some argue it must be made clear to buyers what they are actually taking ownership of.

A complex question is whether a third party’s IP rights are infringed when a creator mints someone else’s work. There is no quick answer, but the determining factor would be the type of asset – and the rights granted to the person who is proposing to mint the asset. A similar issue is how a new buyer can be sure the creator did not infringe a third party’s IP when the NFT was minted – and what would happen if that third party brought a claim.

Conclusion

NFTs can contain legal rights within a smart contract – and sometimes disputes can arise in relation to this. A blockchain network is decentralised – stored across many computers in different jurisdictions – meaning it will not always be clear which laws apply, highlighting the importance of building clear legal terms into the smart contract.

The introduction of NFTs has the potential to influence a transition to a more digital world, not only for content creators, but also for users as diverse as governments and sports clubs. At Walker Morris, we talk to our clients about ticketing and how the use of NFTs can prevent counterfeiting or give token holders enhanced social experiences. However, the NFT market is still in its infancy, and as infrastructure continues to evolve at pace, so will the legal and regulatory aspects.  

Sally Mewies is head of the technology & digital group at Walker Morris: walkermorris.co.uk

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