A Complete Guide on NFT from a lawyer's POV
Non-fungible tokens are relatively new in the market and not a lot of legal implications regarding them have not been reported yet. However, the transactions being conducted through NFTs are rising dramatically in amount, running in thousands of dollars, which makes blockchain lawyers concerned about how very strict regulations soon may arise. So here are the rights that the original artists, vendors, marketplaces, and purchasers should keep in mind while dealing with NFTs in order to avoid any legal complications in the future.
NFTs have not reached mass hysteria until recently despite ERC-721 tokens being created in approximately 2017. Recently the tokens have generated unprecedented levels of revenue. The millions of dollars generated by NFTs have also generated life-changing money for a lot of the retail public, thus it is important for crypto lawyers to give their opinions on the matter and potentially provide some helpful guidance. In this article, we will explore the legal implications of such transactions, and what are the things that you will need to consider whilst dealing with NFTs.
What is an NFT and how does it work?
An NFT is a Non-Fungible Token. This means it is a token that cannot be stacked with other tokens nor would it be divisible as opposed to fungible tokens where they can be added together or divided. For example, tokenized gold can be added together (1 gram of gold plus 1 gram of gold equals 2 grams of gold) or divided (1 gram of gold divided by 2 equals 0.5 grams of gold). If you try to add 2 diamonds together you will have 2 distinct diamonds and if you try to divide a diamond you don’t have 0.5 of a diamond you again have 2 different diamonds. These non-fungible tokens are commonly described as NFTs.
NFTs are commonly used to tokenise collectables or artwork like paintings or digital art, however, the capabilities of NFTs expand to a whole range of Non-Fungible Assets such as music albums, contracts, Intellectual Property and precious stones. A registry of who possesses what, similar to cryptocurrencies, is maintained on a blockchain public ledger. The advantage of such digital storage is that the data will be secured by the security the technology offers while keeping an automatic and immutable track of each registration, transaction, and ownership. Retaining professional blockchain lawyers can help to create the legal ecosystem required to release NFTs, for example allowing an artist to distribute intellectual property rights via an anonymous marketplace.
Guide to NFTs from blockchain lawyers’ POV:
NFTs are relatively new and there are not a lot of legal regulations regarding them yet. However, crypto lawyers expect them to arise soon enough, given the high rate at which they are becoming popular and a large amount of money ordinary people are making by using them. From the blockchain lawyers’ points of view, there are a number of rights associated with NFTs that the original artists, vendors, marketplaces, as well as purchasers, should be aware of in order to avoid any legal complications that may arise later:
Generally, an NFT will not constitute security however it is highly dependent on what the NFT represents or is tied to. For example, if the NFT provides a profit share in a company there is a high possibility the token holder will be considered to be holding the security. However, if the NFT simply represents a right to a piece of art it generally won’t fall under the definition of security thus will not be considered a security. Some commentary compares NFTs with ICOs (Initial Coin Offerings) and in a way they are similar as they both use Blockchain technology however we cannot draw a conclusion about their legal regulations or securities status from a generalized perspective, we will need to do a bespoke analysis of each individual token and NFT. As previously mentioned, an NFT representing ownership to a non-fungible asset is highly unlikely to be considered a security or security offering. However, NFTs in the following scenarios may be considered security tokens, and financial regulations will apply:
- NFTs that provide dividend in a Company;
- NFTs that provide voting rights or control in a company;
- NFTs that are sold with the purpose of funds being used to build a platform for the benefit of the NFT purchaser; and
- NFTs represent shares in a company or units in a trust structure.
Anti-money laundering and sanctions:
Cryptocurrency or tokens can be subject to Anti-money laundering (AML) regulations. Financial Action Task Force (FATF) provides international guidance on AML regulations and AUSTRAC is the AML regulator in Australia. In Australia, an NFT will generally not be considered a virtual or digital currency as they are a product and cannot be used as currency.
Thus, there is typically no aml requirements for NFTs. However, once again this is highly dependent on what the NFT actually represents. For example, if an NFT represents 20 gold bullions, the NFT will fall under AML regulation if and when retrieving the physical bullion. If you’d like further clarification a Cryptocurrency or Blockchain Lawyer will be able to help.
Anything created on the internet is vulnerable to hacking in some way or another. Even though NFTs are subject to the protections provided by blockchain technology, there still remains the rare possibility of an individual accessing your personal computer and stealing your private keys which store your NFTs. Or in the alternative, there may be a 51% attack on the relevant blockchain. However, the more decentralised the blockchain is the safer it is to operate on. Therefore, companies and individuals should prepare themselves by taking the proper precautionary measures.
Intellectual property right:
Intellectual property rights is one of the largest concerns surrounding the NFT space. This is because if someone creates an NFT it cannot be deleted unless burned. The only person that can burn it is the owner of the NFT. You may only own the intellectual property contained in an NFT if the original creator had the rights to distribute the Intellectual Property in the first place. Thus, you must be careful of where you purchase the NFT and where the NFT was created from otherwise you may receive a cease and setlist letter asking you to burn that relevant NFT.
NFTs can generate revenue for both the creator and the purchaser if legally structured correctly. That is why it is imperative that blockchain lawyers should be hired to draft bullet-proof contracts, terms and conditions and Intellectual Property Agreements that can neither be taken advantage of nor be disputed later.