The recent report that Sotheby’s has had over $100 million in Non-Fungible Token (NFT) sales year to date is raising questions among Creators and Collectors about what are NFTs, what role NFTs play, and will play, in the art market and whether Creators and Collectors should jump onboard the NFT bandwagon. Those who create and collect art can try to just ignore the impact of NFTs but they cannot ignore how NFTs fit into the current Intellectual Property (IP) rights which protects both Creators and Collectors. There are great opportunities and great risks for Creators and Collectors in this market today. To assess these risks and opportunities, it is necessary to understand what NFTs are, and are not, and the role IP plays.
What is an NFT?
A Non-Fungible Token, or NFT is a digital collectible that is a unique, non-reproducible, digital code representing a digital file. It is analogous to a paid invoice for a painting – it is not the painting, it does not guarantee the authenticity of the painting, it does not convey the ownership of the painting, but it does describe a transaction and points the way towards finding out about the ownership of the painting.
NFTs are created when a digital file is uploaded to a third party NFT platform or distribution network. Since the digital file is too large to easily be handled on such platforms, an NFT or Hash, is created as a marker to stand in for the digital file. The Hash points the way to the URL where the digital file is located. This Hash – a digital ID in essence, is what is unique about each NFT. When an NFT is transacted, this is what people buy and sell, and where the transaction is recorded. This process of identification of the URL for the digital file is called the “smart contract.” The process of creating this digital ID, or NFT, is called Minting. So, the original owner of the digital file, mints a new NFT when uploading a digital file onto an NFT platform.
Once minted, neither the NFT nor the digital file that it points to can be altered, hence the name “non-fungible.” If there is a change, the digital ID will reflect that change. When sold, the buyer of an NFT acquires the ability to execute the smart contract that points to the URL of the digital file. The buyer does not, however, acquire any ownership rights to the underlying asset (digital or otherwise) and may not even get the right to display, reproduce or use the digital file unless that is explicitly stated in the smart contract. Additionally, the buyer may, if the NFT is sold at a later date, owe a percentage of the transaction price to the Creator. The NFT is no guarantee of the authenticity of the digital file or the underlying asset: it only can tell you the provenance of that specific digital file to which it points.
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NFTs and Intellectual Property Rights
Intellectual Property (IP) are those rights that the Creator has over the “creations of their mind.” They are created when the work is created. There is no need to register or mark the work. These rights include the exclusive right to own, display, use and reproduce the work. Those rights can be transferred from the Creator to others by legal contracts, either before or after the creation of the work. So, someone creating a design for their employer is a Creator; but, if the terms of employment require, they have already given up their IP rights.
IP rights, and especially copyrights, are hard to enforce for digital assets. Digital assets are simple to reproduce and easy to display, but it is hard to identify which is the original work. The result is that the Creator often rapidly loses control over the rights to the digital file once it enters the digital marketplace.
The benefit of an NFT is that the smart contract can be structured so that the Creator retains control over the use, display, resale and reproduction of this specific version of the digital file. Additionally, the Creator can add resale rights, so that a percentage of each “downstream” transaction accrues to the Creator. For the Creator, the NFT goes some way toward curing some of the risks of digital assets in today’s marketplace.
For buyers, there remains the need for due diligence when purchasing NFTs. Just because there is an NFT, there is no guarantee that the “Creator” has any rights to either the digital file or the underlying asset. So, an NFT of a forgery is a valid NFT of fraudulent work. The third-party hosting platforms have procedures to remove fraudulent NFTs; and, in the Terms of Service, these procedures and rights of Creators are spelled out. This means that it is important to actually read the Terms of Service before buying an NFT.
The Terms of Service will also describe how the purchase of an NFT actually effects the IP rights of the Creators. Just buying an NFT does not convey any rights to display, use or reproduce the digital file unless it is specifically described as doing so. When buying an NFT, check:
- What are your rights to use, display and reproduce the digital file?
- What is the Seller’s representation of ownership of rights over the digital file?
- How volatile is the NFT, and what happens if the underlying asset is no longer available?
- What are the dispute resolution procedures?
- What are the terms of any indemnification?
- What does the buyer and the third-party platform disclaim?
Like the art market, the NFT market is driven by emotion. Owning a one-of-a-kind asset, even a digital asset, has many willing buyers and willing sellers. Since this is a new frontier in the digital marketplace for many Creators and Collectors, it is important to understand what NFTs are, and are not, as well as how the Digital Marketplace continues to evolve its relationship with Intellectual property rights.