NFT’s Explained: The Intellectual Property Implications of Licencing Digital Assets Through Blockchain

On 11 March 2021, digital artist Beeple sold a Non-Fungible Token (NFT) of his artwork for $69 million USD.[1] According to Christie’s, the auction house behind the sale, Beeple, is now among the top three most valuable living artists.[2] But what is an NFT? And what has the purchaser actually bought?

An introduction to NFTs

An NFT is a unit of data on a digital ledger called a blockchain. A blockchain is a list of records or “blocks” containing encrypted information about the previous block, including a timestamp and transaction data. That data is, in theory, immutable. The blockchain is distributed through the internet on a peer-to-peer network to blockchain users, referred to as nodes. Each node adheres to a protocol for internode communication. This has the effect of totally decentralising the storage of the blockchain and makes editing the ledger impossible because each node is coded to cross-check and authenticate each block in the chain. The cryptographic securitisation of the blockchain is a significant factor in why the technology has enjoyed its rapid rise to prominence as the backbone of various digital currencies (like Bitcoin and Ethereum). The Hedge Fund Research’s Blockchain Composite Index recorded that on average crypto-currency hedge funds gained 194% in 2020 and 48% in January 2021 alone. [3] Even more staggering, according to Forbes, within less than three months, the combined market cap of major NFT projects in 2021 has increased by 1,785%.[4]

Unlike crypto-currencies, NFTs are unique, and as such, are not interchangeable. It is this quality that has led to the use of NFTs as a means to commodify digital creations, such as digital art, video games, and music files. An NFT is created by uploading a file, such as an artwork, to an NFT auction market, such as KnownOrigin, Rarible, or OpenSea. The market then creates a hash of the file, which is recorded on the blockchain as an NFT. The NFT can then be bought and resold on the digital market with crypto-currency.

Buying an NFT

In its most basic form, an NFT’s relationship to digital media is similar to the relationship between a certificate of title and real property. In that respect, an NFT is not the digital asset itself, but an electronic record representing ownership of rights in relation to the asset. Thus, just like Land Services SA keeps certificates of title and a record of property ownership in South Australia, the blockchain will maintain a record of ownership and authorship of the NFT.

However, owning an NFT does not necessarily mean that you own the asset underlying the NFT. NFTs typically have associated smart contracts which govern the use of a given asset and the respective rights granted to the NFT owner. The extent of the rights granted by the NFT is a matter for the owner of the intellectual property in the asset. As such, contracts for the sale of NFTs and the variance between them tend to resemble commercial licencing contracts more closely than contracts for real property.

Without an express term in the contract, the NFT owner does not acquire a right to reproduce, make derivative works of, perform, display or distribute copies of the underlying asset. These activities remain the exclusive domain of the owner of the copyright.

Below are two examples of how NFTs have been used so far:

  1. The NBA has sold NFTs of particular highlights they call ‘moments’ on its own proprietary blockchain.[5] The associated NFT contracts grant licences to the owner of the ‘moments’ for the “use, copy, and display” of the asset solely for “personal, non-commercial use” or “as part of a third-party website or application”.
  2. On 5 March 2021, Kings of Leon became the first band to release an album as an NFT.[6] The contract for that album provides that the owner has a right to display the art and included merchandise, but only for personal purposes, and expressly prohibits the album’s use in third-party products or within movies and other media.

Why not just licence?

As can be seen from the above, NFT contracts share very similar terms to that of standard licencing agreement – so why use NFTs? One major reason to use NFTs is that they allow for new avenues of commodification. For example, the NBA ‘moments’ (referenced above) are widely available video files that can be accessed on YouTube or a host of other websites. As the owner of the intellectual property in the videos, the NBA can commodify it by making licences in respect of the video available for purchase. This generates an additional income stream for the NBA and allows fans to “own” a collectable item – trading cards for the digital age.

From another perspective, while traditionally, artists who create physical art would be able to hand over tangible, non-replicable property at the point of sale, the purchase of digital art is constrained by the inability to verify the purchase of infinitely replicable art. NFTs go some way to resolving that problem by creating a means to verify the owner (or owner of a licence) of a digital asset. Additionally, a smart contract can be written into the NFT itself, which can guarantee certain rights in respect of the digital asset in perpetuity. For example, the NFT may guarantee that a portion of any subsequent sale is paid to the original NFT creator.

IP implications

NFTs are still very much a new use of blockchain technology, and there remains significant uncertainty around the practicalities of their use as an alternative to traditional licensing arrangements for digital assets.

One significant issue that has not been widely addressed is the enormous potential for creators to have their work converted into an NFT (or ‘tokenised’) without their permission. In that circumstance, traditional copyright laws will likely apply to allow the copyright owners to pursue an action in damages and a remedy in equity for an account of profits. However, where traditional breaches of copyright tend to have a limited chain of affected people, the owner, the breaching party and (in some cases) the third party purchaser, the consequence of the emerging market for trading NFTs could result in repeated on-selling by purchasers, creating a massive flow-on effect.

While the law may provide a means to claim damages for breach of copyright, blockchain transactions are anonymous and irreversible; without proper verification measures being taken, actually locating a perpetrator may prove impossible. Some platforms have implemented steps in an attempt to combat this issue, including through manual verification. For example, marketplace SuperRare requires that artists seeking to sell their work on its platform submit an application form with their name, email, selection of artworks and social network presence.[7] While not foolproof, this is at least a positive step in ensuring that purchasers receive authentic assets from people who own the appropriate rights.

The creation of enforceable contracts which attach to NFTs is another complex issue, particularly given the anonymity of crypto-currency transactions. This is notwithstanding the uncertainty as to the application of current laws surrounding when alterations can be made to licenced assets and at what point alterations are so substantial that they constitute the creation of a new asset. Additionally, the implications of how the blockchain itself would be affected in these instances remains completely untested.

Lastly, it is currently unclear how NFTs will account for moral rights in the creation of digital assets. For example, how co-contributors to works or derivative works will be credited with authorship.

Conclusion

As with any new technology, the law is often faced with the complicated task of playing catch-up. While this is not ideal and leads to significant uncertainty for early adopters, it is often impossible for the law to stay ahead of innovation. Given the explosion of NFTs in the past six months, we consider that the potential for exploitation is severe. Therefore, we strongly recommend seeking legal advice if you are planning to enter the NFT sphere.


[1] https://www.nytimes.com/2021/03/11/arts/design/nft-auction-christies-beeple.html

[2] https://www.businessinsider.com.au/art-auction-nft-beeple-top-selling-most-expensive-sale-millions-2021-3

[3] https://www.hedgeweek.com/2021/02/12/295867/cryptocurrency-hedge-funds-stratospheric-rise-continues-more-managers-join

[4] https://www.forbes.com/sites/youngjoseph/2021/03/29/nft-market-rages-on-nfts-market-cap-grow-1785-in-2021-as-demand-explodes/?sh=29a5575f7fdc

[5] https://www.cnbc.com/2021/02/28/230-million-dollars-spent-on-nba-top-shot.html

[6] https://www.rollingstone.com/pro/news/kings-of-leon-when-you-see-yourself-album-nft-crypto-1135192/

[7] https://superrare.co/about

For more information, please contact:
Sandy Donaldson

Sandy Donaldson
Consultant
p.  +61 8 8124 1954
e.  Email me

This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied upon as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Should you wish to discuss any matter raised in this report, or what it means for you, your business or your clients' businesses, please feel free to contact us.

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