Innovators and current market participants are developing new strategies to tokenize assets. These innovators are also broadening how to utilize tokens as the global economy transitions more to the digital realm. NFTs, or “nonfungible tokens”, are freely tradable digital assets typically people can create on the Ethereum blockchain. A blockchain is a recognized record demonstrating ownership of an item obtained through the NFT, much like a digital deed. With the rise of NFTs, there has also been a rise in NFT legal issues.
This article will describe the recent increase in NFT legal issues and how it may affect people’s use, purchase, and sale of NFTs.
Why are NFTs important?
NFTs provide proof of ownership of digital (or even tangible) rights. However, the special rights that come with NFTs differ. NFTs are distinct in that they are not interchangeable among themselves in the same way that cryptocurrencies typically are. This is the case even though the underlying asset the NFT represents may not be. In contrast, cryptocurrencies and the majority of financial securities are fungible. NFT legal issues arise mainly because of the complexity of ownership of NFTs.
What exactly is an NFT?
An NFT is, in essence, not what you physically purchased. Instead, it serves as evidence of your transaction. For example, suppose you buy the Mona Lisa painting. If you purchased the Mona Lisa painting, you own the painting and can do as you see fit with your purchase. However, if you do not wish to hang the painting or let an art museum display the artwork, you may want proof that you own the original Mona Lisa painting. An NFT will show everyone that you are the rightful owner.
What laws regulate NFTs?
Although the laws do not explicitly regulate NFTs now, existing laws and regulations will eventually apply to the use of NFTs. With the application of rules and regulations, any business involved in issuing, trading, or exchanging NFTs can expect commercial and NFT legal issues to arise. Our lawyers can help you avoid these legal issues before they affect your business.
NFT Legal Issues
The rights the issuer is selling with the NFT must be clear. Without explicitly stating who owns what, issues can arise as to who the rightful owner of the digital asset is. NFT legal issues are common, specifically because 1) people may not own the rights to what they are selling, and 2) the rights being sold are not clear.
Rights to Use
Common types of NFT legal issues that can arise are around who can use the NFT for commercial purposes. For example, a right to receive or use a particular item (whether digital or virtual) could be a contractual right. To obtain access benefits or a license could be a contractual right as well. These all pertain to intellectual property rights (IPR).
Clarity up front will help the issuer avoid reneging on unanticipated rights. This can help the parties avoid potential disputes from buyers who claim the seller misrepresented the rights sold.
Determining What the Buyer is Purchasing
An NFT buyer needs to be aware of what they are buying. The buyer must complete due diligence to ascertain the rights and liabilities they are buying. This due diligence is especially important if the rights could affect the present or future value of the NFT and the underlying asset. Without this due diligence, NFT legal issues are inevitable.
Current NFT Legal Issues
The current legal and regulatory framework does not support digital assets like NFTs. However, as investors, financial services, and fintech firms, as well as other commercial interests, investigate this area, a few critical challenges have come to light.
As the NFT market continues to evolve, potential NFT legal issues continue to evolve and arise as well. Tokenization may violate several US laws including those governing:
- Licensing
- Securities
- Anti-money laundering
- Sanctions
- Intellectual property
- Gambling
Be sure to consult with an experienced cryptocurrency lawyer to help ensure you are not violating any laws.
Intellectual Property Rights
Generally, the NFT seller establishes the rights accompanying an NFT. Many of the NFTs currently on the market include assets that support them produced by individuals who hold intellectual property rights in them. Those owners can choose what rights to provide the NFT buyer.
Many people may not understand the legal limitations pertaining to copyrighted works. This could result in infringement liability.
You may be held responsible for infringing third parties’ intellectual property if you mint an NFT for a digital asset containing another person’s IP. This can include:
- Artwork
- Music
- Video clips
- Trademarks
- Other copyrighted work
Without a license, you will not be able to create an NFT with any IP owned by someone else. You do not have the right to provide the buyer of your token any rights if you do not have the necessary rights to the intellectual property used in your NFT.
Trademark and Copyright Considerations
One common question clients ask is: “Can I obtain the copyright associated with purchasing an NFT?”
The answer is not necessarily. It is essential to understand the specifics of the smart contract that grants the buyer rights to the digital asset. Buying a physical artwork, even while the buyer has obtained the right to display and resell the piece, does not immediately transfer ownership of the copyright.
How can I gain the rights to sell the NFT?
Unless the author gives the copyright to the buyer, it belongs to the creator. In other words, even though the buyer now owns the NFT, they may not have the legal right to reproduce the related artwork and sell it as their own.
Anti-Money Laundering
People are occassionally using NFTs, especially those of high value, to aid in money laundering. The U.S. Department of the Treasury released a study covering various topics, including the dangers of financial crimes concerning digital art and NFTs. The study discovered that the high-value art market has several intrinsic characteristics that could make it susceptible to various financial crimes.
The Anti-Money Laundering (AML) Act has broadened to include dealers of antiques and works of art. Though NFTs are not the same as an antiquity, the Anti-Money Laundering Act extended the Bank Secrecy Act to apply to trading art pieces.
Furthermore, experts in antiques may possess liabilities to meet a variety of Anti-Money Laundering requirements. Enforcing agents may attempt to include NFTs trades by claiming that such transactions constitute the solicitation of antiquities and fall under the purview of the AML Act.
Gambling
If players pay for the opportunity to win an NFT, and the NFT may be freely traded on a secondary market, the NFT may be seen as a “thing of value.” If it s a thing of value, gambling laws may apply. Lootboxes and other chance-based gaming features have come under heightened scrutiny from gambling laws, and class action lawsuits have increased.
Often, their terms of service only offer a license to use the in-game cash and game objects in the game. They ban the sale, transfer, or exchange of outside items on their platform. Therefore, many traditional game producers have won gambling claims brought against them.
What do courts say?
Courts have often determined that these in-game currencies and items are not a thing of value for gambling purposes. This justification might not hold for NFTs since game developers emphasize the actual ownership and ability to sell cryptocurrencies and NFTs through secondary marketplaces. This is one of the reasons that many blockchain-based games use more play-to-earn or user-generated content business models rather than systems that depend on luck.
Ownership/License Rights
One of the main issues with NFTs is ownership and license rights. Typically, the buyer owns the token. Yet they can only attain a license to the asset represented by the token. Copyright for the investment will remain with its creator. Different licensing conditions may be used, ranging from limited commercialization rights to personal and noncommercial rights.
The license terms and marketing materials should accurately and concisely describe the rights the seller is granting to the buyer. Inaccurate marketing that, for instance, implies a purchaser “owns” an asset to which they have a restricted license could result in several legal claims and other problems.
License agreements should clearly define rights and what a buyer is and is not permitted to do with their purchase. It is also essential to ensure affirmative acceptance to have a valid contract.
Securities Law
Most NFTs with a single owner and only one unique asset are unlikely to be securities. However, under certain circumstances, they might. If an NFT possesses security-like characteristics or otherwise satisfies the Howey test, such as when money or another kind of compensation is invested with a reasonable expectation that gains will result from others’ efforts, then the NFT may be subject to U.S. securities legislation.
How does the Howey test apply to NFTs?
A case-by-case Howey analysis is essential for understanding whether a specific NFT is a security. However, based on the specifics, NFTs might violate securities laws in the following situations:
- “NFTs represent presales of digital assets intended for use on a platform that is not yet built, and the proceeds of the sale are used to construct the platform;
- There is “pooling” or “fractionalization” of digital assets (e.g., art where artists pool assets and share revenues and where multiple NFTs represent fractional ownership of an asset by numerous investors);
- NFTs represent a license to a digital asset (e.g., a song) and a share of the revenue from the purchase (e.g., a percentage of sales).”
NFT Lawsuits
NFTs are worth money and disputes over money result in lawsuits. As a result, NFT lawsuits are increasing in frequency. In most NFT litigation, the legal issues center around who owns the IP of the NFT.
Since NFTs are so new, the legal questions they raise are just now developing and put to the test in the courts. Critical NFT lawsuits are currently pending in the courts, such as Nike, Miramax, Lil Yachty, Hermes, etc.
More people file lawsuits to defend their intellectual property rights as NFTs gain popularity. All intellectual property owners should be aware of the precedent that cases like this are making in this quickly evolving industry. These lawsuits may also have an impact on your rights. Additionally, if you intend to purchase NFTs, make sure you know what you are buying to avoid violating the rights of anyone else.
Frequently Asked Questions
Do current laws protect NFTs?
As mentioned, the laws do not explicitly apply to NFTs right now. However, theoretically, lawmakers can “tether” NFTs to a legal right. The right to own one copy of the creative work and the right to make copies and produce derivative works of the original creative work are two different rights at stake here.
What is the controversy with NFTs?
The legal industry has seen a rise in reports of so-called “NFT theft.” People are stealing creators’ work, minting them as an NFT, and even selling them to customers who believe they are getting the real thing. This rise has coincided with the NFTs’ increasing popularity. NFTs are supposed to provide authenticity and proof of ownership by being on the blockchain. Therefore, this legal ground is difficult to navigate based on ownership issues, IP infringement issues, and securities laws issues.
Can someone sue you for using their NFT?
You risk having someone sue you for using an NFT improperly or other intellectual property connected to an NFT. Ensure you are not using someone else’s work if you are an NFT author. Similarly, if you are an NFT holder, avoid using your NFT in any way that would contravene the rules.
Is it a crime to screenshot NFT?
It’s against the law to screenshot an NFT and sell it or pass it off as your own creation. It violates established copyright laws and discredits the NFT’s original inventor.
Is copying NFTs or NFT art illegal?
While most NFTs are not copyrighted themselves, some NFTs violate copyright laws by employing works of art that someone has from artists or well-known pieces. If the underlying work is copyrighted, you must obtain a license or permission to use the work in order to copy or sell an NFT with that copyrighted work. Copyright infringement may also occur if you copy these works for NFT marketing purposes.
