Your NFT Playbook – Technology – United States – Mondaq News Alerts

your nft playbook technology united states mondaq news alerts

Your NFT Playbook – Technology – United States – Mondaq News Alerts

United States: Your NFT Playbook

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Overview

The buzz surrounding non-fungible tokens (NFTs) reached a fever
pitch with the US$69 million sale of an NFT by digital artist
Beeple in March 2021. While artwork has remained the predominant
use of NFTs – and generated a good deal of media hype along the way
? companies across a variety of industries are coming up with new
and innovative use cases for NFTs – and turning to our
multidisciplinary global team for guidance in the uncharted
territory surrounding these digital assets.

First: What Is an NFT?

NFTs are unique tokens based on blockchain technology. Unlike
cryptocurrency tokens such as bitcoin, which are fungible, NFTs are
digitally unique – no two NFTs are alike. The unique nature of
NFTs, as well as the security and other advantageous features of
blockchain technology, provide a number of unique benefits,
including:

  • Verification of ownership and authenticity
  • Driving of value of digital assets through scarcity
  • Built-in smart contracts for re-sale royalties for artists and
    other NFT creators
  • Decentralization of digital asset ownership, management and
    transfers (in other words, independence from large platforms)

Lifecycle of an NFT

In order to advise your business on the legal issues and
third-party relationships that arise out of NFT deals, it is vital
to understand the lifecycle of NFTs:

  • The underlying work is created (or, it may be
    pre-existing)
  • The NFT is “minted” on the blockchain
  • The underlying work is hosted on a secure site or NFT
    marketplace, or is available as a virtual item on a third-party
    platform (gaming, social, etc.)
  • The NFT may be sold on or through a public or private
    marketplace, third-party platform or in a peer-to-peer
    transaction
  • The NFT may be resold

An important distinction to keep in mind is that the underlying
work that is represented or referenced by the NFT exists off the
blockchain and completely separate from the NFT. The underlying
work may be commissioned or created by the owner like a traditional
artwork might be, or it might be a pre-existing work/asset of the
owner. Once created, the underlying work is hosted or is usable or
viewable to the owner in a marketplace or gallery, on a secure
hosting site that the NFT “calls to” or on a third-party
platform (e.g., social or gaming).

The underlying work can be as simple as a JPEG image, a GIF, or
a sound file, (e.g., MP4), but use cases are expanding and becoming
increasingly sophisticated. Some noteworthy examples include a
conversant, AI-powered female avatar; Snapchat filters and other
virtual items for use in AR environments and games; virtual horses
(that can be raced, betted on and bred); sports and event tickets;
and even physical goods, such as luxury apparel sneakers and
personal protective masks.

Who Is Involved? Addressing Third-party Risks in NFT Deals

Depending on the specifics of an NFT offering, “drop”,
or deal, a number of services and third parties will be involved in
the process. The owner will likely have a direct business and
contractual relationship to the extent any of the below parties are
involved and must address the legal issues arising out of such
relationships. Though not exhaustive, a checklist of stakeholders
might include the following, and certain parties may serve multiple
roles, depending on the nature of the arrangement:

  • Creator of the underlying work, virtual item or event
    ticket
  • Creator/Minter of the NFT
  • Host of underlying work (e.g., hosting service)
  • Marketplace (public or private) and third-party platforms
    (gaming, social, AR)
  • Primary (and secondary) purchasers of the NFT
  • Agency (e.g., to aid in the promotional/marketing aspects if
    the NFT is promotional in nature)
  • Blockchain wallet (to effectuate the transfer)
  • KYC/AML provider (to address Know Your Customer/anti-money
    laundering obligations and risks; some blockchain wallets provide
    this)
  • Carbon offset organization (to address carbon offset due to the
    energy expended, which is often a part of NFT deals for PR and
    other purposes)

Additional Legal Issues to Consider

Third-party intellectual property rights – As
with the creation of any digital assets, the owner should have a
clearance process with respect to patent, trademark, copyright and
other IP rights to ensure that it has the right to utilize the
underlying work in the manner contemplated by an NFT deal.
Organizations investing in novel use cases should consider
landscape searches and freedom-to-operate opinions, particularly
when it relates to physical goods, a space where companies appear
to be seeking patent protection. NFT marketplaces and organizations
hosting works or virtual items in a gallery, website or platform
should also take advantage of available safe harbor programs (e.g.,
DMCA in the US and the E-Commerce Directive and its local
implementing provisions in the UK) and implement compliant
procedures pursuant to the same.

Securities and other regulation – There is
uncertainty as to whether an NFT in certain use cases would be
considered a security under US securities laws. Given the
blockchain-based nature of NFTs and the corresponding regulation of
cryptocurrency, the potential speculation associated with certain
NFT assets, and allowance for future royalties to be built into
smart contracts, there are aspects of NFTs and their offerings that
may subject them to securities regulations in the US and abroad.
Businesses engaging in the offering and sale of NFTs should pay
attention to updates and guidance from regulators on this
issue.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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