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Non – Fungible Tokens (NFTs) – The collectibles of the future

What is an NFT?

An NFT is a digital asset that represents real-world objects like art, music, in-game items, and videos. They are bought and sold online, frequently with cryptocurrency through designated platforms as Opensea, and they are generally encoded with the same underlying technology as many other cryptocurrencies. Although they have been around since 2014, NFTs are gaining notoriety now because they are becoming an increasingly popular way to buy and sell digital artwork.

NFTs are also generally one of a kind and have unique identifying codes. This is in stark contrast to most digital creations, which are almost always infinite in supply. But many NFTs, at least in these early days, have been digital creations that already exist in some form elsewhere, like iconic video clips from NBA games or securitised versions of digital art that is already existing on Instagram.

For instance, famous digital artist Mike Winklemann, with the alias name “Beeple” created a combination of 5,000 daily drawings to produce possibly the most famous NFT at the moment, which was sold at Christie’s auction house for a record-breaking $69.3 million.

Anyone can view the individual images or even the entire collage of images on the internet for free. So why are people willing to spend millions on something they could easily screenshot or download? The answer is simple, an NFT allows the buyer to own the original item since it contains built-in authentication which serves as proof of ownership. Collectors, value those digital rights almost more than the item itself.

NFTs Vs Cryptocurrencies

NFT stands for non-fungible token. It is generally developed using the same kind of cryptography as cryptocurrencies, like Bitcoin or Ethereum, but here is where the similarity ends.

Fiat money and cryptocurrencies in general are “fungible,” meaning they can be traded or exchanged for one another. They are also equal in value where one dollar is always worth another dollar as well as one Bitcoin is always equal to another Bitcoin. Crypto’s fungibility makes it a trusted means of conducting transactions on the blockchain.

NFTs are completely different. Each has a digital signature that makes it impossible for NFTs to be exchanged for or equal to one another and this is the reason why they are classified as non-fungible. For example, one NBA top shot clip is not equal to Beeple’s artwork merely because they are both NFTs.

How does an NFT works?

NFTs exist on the blockchain, which is a distributed public ledger that records transactions. Specifically, NFTs are typically held on the Ethereum blockchain, although other blockchains support them as well.

An NFT is created, or “minted” from digital objects that represent both tangible and intangible items, including:

  • Art
  • GIFs
  • Videos and sports highlights
  • Collectibles
  • Virtual avatars and video game skins
  • Designer sneakers
  • Music

It is worth mentioning that Twitter co-founder Jack Dorsey sold for a charitable cause his first ever tweet as an NFT for more than $2.9 million. Essentially, NFTs are like physical collectors’ items but instead of getting an actual oil painting to hang on the wall, the collector purchases a digital file, safeguarding an exclusive ownership right. NFTs’ unique cryptographic data makes it easy to verify their ownership and transfer tokens between owners. The owner or creator can also store specific information inside them. For instance, artists can sign their artwork by including their signature in the metadata of an NFT.

The unique business opportunities for artists and content creators – The use of NFTs

Blockchain technology and NFTs provide artists and content creators a unique opportunity to increase their wealth. For example, artists no longer have to rely on galleries or auction houses to sell their art. Instead, the artist can sell it directly to the consumer as an NFT, where it generates even more profits than the traditional selling method. In addition, artists can benefit from royalty payments, as they are able to receive a percentage from the sale every time their piece of art is sold to a new owner. This is an attractive feature as artists generally do not receive future proceeds after their art is first sold at an auction or gallery.

Legal Challenges

Smart Contracts & E – signatures

The purchase of an NFT, essentially a contract between a buyer and a seller, is broadly a part of a sequence of pioneering processes in the contract-making field. The proprietary transfer of the digital certificate of ownership is obtained using the so called “smart contract technology”, which is a self-executing transfer of a digital asset using blockchain protocol, predominantly on Ethereum. Smart contracts, in general, are computer codes programmed accordingly to execute certain actions when predetermined circumstances are already in place. Similar to the traditional contracts, the terms of a smart contract are still the foundation of the contractual relationship between the buyer and the seller. Therefore, the terms of the smart contract will, inter alia, define the Intellectual Property rights of each party.

Fortunately, the legal framework for such practices has long existed with the European Union (“EU”) where it provides to the EU businesses electronic signature solutions even though such solutions were not commonly used until today. In particular, EU has adopted Regulation No. 910/2014 on the Electronic Identification and Trust Services for Electronic Transactions in the Internal Market which has established, inter alia, a comprehensive legal framework for electronic signatures. The legal framework provides three types of e-signatures with the most advanced of them requiring a qualified creation signature device. The national law 55(I)/2018 on electronic identification and related issues states, inter alia, that the third type of electronic signature has the equivalent judicial value of a handwritten signature.

Therefore, NFT project owners need to put appropriate terms in place in order to protect their business interests including provisions that address warranties, Intellectual Property rights, liabilities as well as the applicable governing law and dispute resolutions mechanisms.

Intellectual Property Rights – Ownership of Asset

People from different backgrounds are dealing with NFTs and the majority are not familiar with the legal restrictions relating to copyright rights which may lead to potential infringements. The owner of an NFT acquires ownership rights of the digital asset he purchases, and this is classified as a token in his electronic token wallet. A clarification is needed due to the fact that interested buyers that will purchase anything from a physical marketplace can earn the ownership rights only but not any copyright or reproduction rights, which remain with the seller, unless agreed otherwise by the NFT issuer on the terms and conditions of the contract.

Personal Data Protection – GDPR

Some data protection laws give individuals the right to the erasure of their personal data, but the immutable nature of the blockchain technology poses an obstacle to the execution of such rights. Data protection laws also provide to individuals in some instances the right to rectify inaccuracies in their personal data, and blockchain technology might make this right functionally impossible to exercise. As such, NFTs that contain personal information might violate data protection laws.

One of the main principles of the General Data Protection Regulation 2016/679 (“GDPR”) is that the process of personal data requires either the consent of the data subject or a legal basis (Art.6 GDPR). The data of the users, that are being processed, are usually under a pseudonym and thus there should still be GDPR compliance. The consent of the parties in a smart contract-based transaction, such as an NFT purchase, is granted following sufficient prior awareness of the procession and exposure of the data after the initial acceptance. The data subject cannot track the process of its data nor acknowledge beforehand the handling of it, especially if the process is the minimum required by law, in line with the range of the consent.

The decentralized form of a public blockchain, with no entity as a “data controller”, elevated every user in the network of computers of the blockchain as a controller. The cryptographic and multifaceted environment, in which NFTs are encrypted and purchased, is still legally underdeveloped and personal data protection regulations have not been updated. Proposals regarding the technical specifications of the token’s blueprint, which is basically the design of the purchasable token, have advocated for the incorporation of the relevant legal requirements into the architecture of an NFT or cryptocurrency.

Data Storage and Hosting

An NFT and the digital asset it represents are typically stored separately. The NFT is stored on the blockchain and contains information on where the digital asset is located. The NFT is connected to the digital asset via a link. However, if the digital asset is deleted or the server hosting it fails or otherwise goes offline, the link will break and the NFT that remains will be worthless because it would no longer be associated with the digital asset and there is no way to back up the NFT. Since the NFT is unique and cannot be replaced, the NFT purchaser might be left without any remedy. Based on the use of the specific NFT, this can result in business interruptions, regulatory record keeping violations, and loss of data. It is highly advisable for NFT providers to minimise their platforms’ vulnerability to cyberattacks and take preventive measures ensuring buyers’ protection.

Royalties

Coded NFTs Smart contracts allow the distribution of funds for the payment of royalties to the creator each time the work is resold. However, these automated resale royalty payments might not occur unless the NFT is resold through the same platform. EU law does not recognise resale rights relating to creative works, so the law provides no recourse for unpaid resale royalties in the EU.

Conclusion

The introduction of NFTs has the potential to strongly influence a transition to a more digital world. NFTs are making it possible for creators to infuse physical properties like rarity, uniqueness, and proof of ownership to digital assets. They have encouraged new methods and means of monetisation of items that were previously lost to the depths of the internet. The NFT world is still emerging, however, significant infrastructure will likely continue to be built in the form of intermediaries, tokenization platforms, distribution channels, custodial solutions, and e-commerce integrations. As the NFTs’ market continues to evolve, so do the legal and regulatory issues.

Panayiotis A. Koussis – Author