Blockchain: An Overview of NFTs and the Legal Implications

Written by: Deborah Enyone Oni

Hilton Top Solicitors

Published: 21 July, 2022.

 

Introduction

The digital world is constantly transforming and has witnessed great improvements and addition over the years, one of the most recent being the technology of Non-Fungible Tokens (NFTs). It is important that we embrace this change and get ahead of it so as to be able to harness the potentials that it offers for our good as it will change our lives and business operations moving forward.

The blockchain networks and NFTs play a very important role in the ongoing transformation in the global economy and shows that it is here to stay. As such, having knowledge about it, is important so as to know where and how you can best leverage it.

The following discussion offers an overview of NFTs and Metaverse in relation to the blockchain, the role of NFTs in the Metaverse and how it would play out in the future.

This will help educate people about the NFT technology, address some bugging questions such as whether NFT is part of the metaverse? Which I’ve been asked on several occasions.

Meaning of NFTs, Blockchain and Metaverse

There is no single definition yet, that captures the representation of all types of NFTs, which is because NFTs are not tied to a specific technology and are applicable in a lot of business models and use cases. Notwithstanding the above, we will attempt to capture some representations about NFTs so as to give us an idea about the technology.

• NFTs are the assets of such nature that one part or quantity cannot be used to replace another part or quantity in paying debt or settling an account.
• NFTs are a special type of cryptographic token which can be used to represent unique property on a blockchain.
• NFT is a digital asset that secures the ownership of the asset with the help of a blockchain network.
• NFTs are a new class of digital assets, which are unique, indivisible, scarce and immutable.
• They help in representing the ownership of digital and physical assets on the blockchain. Starting from digital artwork to the gaming industry, NFTs are making a huge impact everywhere. 
• ●       NFT is a type of cryptocurrency that is derived by the smart contracts of Ethereum.
• Drawing from the recent example of a law firm that built its own NFTs, we can say, NFTs can be referred also to the digital representation of right to services of an individual or firm.

Blockchain

The meaning of blockchain is not new to a large number of people, but by way of reiteration, we will consider it briefly.

• Blockchain is a digital database, a secure peer-to-peer network that puts the safety of transactions in the limelight. 
• It uses cryptography to chain blocks into a growing list of records which is

locked by a cryptographic harsh or   string of characters that uniquely

identifies a set of data, to the previous block. This design makes it very difficult to alter transaction data stored in blockchain.

Metaverse

• Metaverse can be defined as a digital environment that runs on the blockchain, with technologies such as Virtual and Augmented reality as the major component providers.
• It is a virtual reality-based world which fosters unlimited virtual social interactions.
• It is used to describe the combination of the virtual reality and mixed reality worlds accessed through a browser or headset, which allows people to have real time interactions and experiences across distances.
• The space is still forming with gaps to be filled and opportunities to be explored.

Relationship Between Blockchain, NFTs and Metaverse

• Blockchain is the digital ledger that underpins cryptocurrencies such as Ethereum, and as such is a crucial technology for creating NFTs.
• The Blockchain technology helps to audit the transaction of the NFTs in the Metaverse by helping to keep to keep track of it. It offers interoperability between the assets.
• Blockchain provides an ideal decentralized environment for the virtual online world.
• The NFTs and blockchain technology makes it possible to hold and protect the ownership of an asset on the blockchain technology.
• NFTs can help in building the metaverse.
• The NFTs and Metaverse are both related to digital assets and how value is given to them.
• The Metaverse allows creators to exhibit digital forms of art and property by providing a digital environment, While the NFTs will be in charge of pricing that content with proof of ownership.

The Role of NFTs in the Metaverse

The NFTs can perform the following roles in the Metaverse:

• NFTs technology allows individuals to have entire ownership of digital assets such as audio, video, images and real estate within the Metaverse.
• NFTs allow individuals to sell or buy items and transfer them to the Metaverse or over the Internet.
• NFTs could help in gaining exclusive access to enter the location in Metaverse alongside allowing access to others.
• the smart contract functionalities in the NFT could also help in selling real estate on the metaverse.

History of NFTs

The first time NFTs was used was traced to 2014, when Anil Dash, a software entrepreneur, and Kevin McCoy , a digital artist, created Quantum, a colour-changing pixelated octagon. The first fully-fledged NFT project was created and presented at DEVCON  just three months after the Ethereum Blockchain was founded.

NFTs came to the limelight through Cryptokitties, a game which allowed players to buy and breed limited-edition of virtual cats. This made game developers to adopt NFTs in a big way to allow gamers to win in-game items such as digital shield, swords, or similar prizes and other game collectibles.

NFTs got into mainstream in 2021 as several animal collections including Bored Ape Yacht club, Cool Cats and Pudgy Penguins spiked in price.

What prompted the popularity of NFTs was the sale of a collage composed of 5,000 digital pieces, auctioned by Christie’s on March 11, 2021, for a remarkable US$69 million. Mike Winkelmann, an artist known as Beeple, created this piece of digital art, made an NFT of it and offered it for sale with the bidding which started at $100, and the rest of the auctioning process transformed it into a historical event.

Beeple’s collage, Everydays: The First 5000 Days, sold at Christie’s. Image: Beeple

What’s the value of NFTs

It is believed that the hype about NFTs is aided by celebrity endorsements and social media hype. An NFT is worth what someone is willing to pay for it, which can be a lot, if the NFT is made by a famous artist and the buyer is a wealthy collector. The rise in NFTs has also been fueled by people’s appetite for collectibles, even non-tangible ones like the iconic GIF Nyan Cat being sold as a piece of Art, Twitter’s founder transforming the first tweet into an NFT and putting it up for sale, profile pictures or “meet-and-greets” with celebrities and/or content creators. With that in mind, many unique services, content and certification can be branded or added to an NFT.

Most NFT applications to date have been driven by content creators, such as digital artists, musicians or media producers which was once considered impossible.

The Benefits of NFTs

NFTs have some benefits which includes:

• Proof of ownership: NFTs allow artists to prove that they are the original authors of the creative works.
• Accurate record of ownership: By transferring the NFTs through a blockchain, it is now possible to automatically generate an accurate record of ownership, at a lower cost, maintaining a clean chain of title.
• The rise of NFTs and blockchain technology has helped content creators to protect and monetize their digital content that had been easily copied and Shared prior to this time.
• Traceability: The Blockchain technology helps in tracing the digital asset which is a digital certificate of ownership representing the purchase of a digital asset

Gamers are rewarded for playing games through elements like the play and earn which had been viewed by gamers as economic freedom.

• NFTs help to boost Virtual Events, helping to eliminate trust and the issue of buying counterfeit tickets.
• NFTs could be used in airdropping branded merchandise or special access privileges to followers.
• NFTs help in driving the efficiency of fan engagement.
• NFTs could introduce interoperability outside the metaverse with infrastructure supporting the features of location-based engagement and augmented reality.

 NFT USE CASES

While questions remain about some NFT use cases, there is undeniably a fast-growing interest in the technology that is hard to ignore. NFTs present opportunities for issuers and acquirers/investors across various sectors. Besides gaming, NFTs are frequently used to sell a wide range of virtual collectibles Such as:

Art

The art business which has been around for a very long time has adopted the concept of NFTs. In traditional times, the artworks were sold in auction houses to the buyers. The middlemen fees in the traditional mode of sales of artwork created some strains. Adopting the concept of NFT development is a very strategic move which enables the conversion of the artworks into digital copies and mints them into NFTs via marketplaces.

Music

At present, NFTs are being adopted as music at a large scale as musicians are converting their music into NFTs.

Sports

The sports industries have entered the digital space by trading their assets like trading cards, sports card, achievements and other things. These assets are transformed into NFTs and placed in various marketplaces. The most notable NFT marketplace is the NBA Top Shot; this marketplace trades NBA-related NFTs on the Flow blockchain.

Gaming

Gaming industries are utilizing the effectiveness of the NFT concepts at a high rate and creating various new projects in a short period of time. The working of an NFT game is dependent on the trading factor of the game. Every in-game asset is represented by NFTs and they are traded over various secondary marketplaces. The concept of play to earn which allows users to farm or collect crypto and NFTs that can be sold on the market is a novel one.

Marketing

The growth of NFTs is very extensive and businesses are adopting this technology at a rapid rate creating a necessity for marketing services. NFT marketing promotes NFT projects and brings in a wide range of users. Engaging the right marketing services will help create great awareness and great sale for your NFT project.

Some NFTs marketing services include, Social Media Marketing, Email marketing, Content Marketing, Influencer Marketing and Search Engine Optimization.

NFTs Marketplace

The marketplace is a decentralized platform where NFT trading takes place. NFT marketplace has been the core of the NFT technology ever since its inception. An example is Decentraland.

Generative Arts

A generative NFT is a digital asset where the characteristics and signature features of the asset are programmed in smart contracts. This unique concept of NFT artworks has been enormous among the digital community. Examples are Artworks like cryptopunks, bored ape yacht club and lazy lions.

NFT Metaverse

Metaverse is a collective virtual shared space thatallows all types of digital activities.

Generally, it covers a set of techniques like augmented reality and the Internet to establish the virtual world. The concept stems from the last decades and has a great progress with the rapid development of blockchain. Buildings can be leased to others to earn the bond or raise rare pets and sell them to get the rewards. Primary blockchain-empowered projects are Decentraland, Cryptovoxels  Somnium Space, MegaCryptoPolis, and Sandbox.

Metaverse offers extremely versatile, scalable, and interoperable digital environments and most importantly blends innovative technologies with models of interaction between participants from individual and enterprise perspectives

Tech like WebVR is allowing virtual reality headset users to have meaningful interactions across the internet.

Lawyers and NFTs

On 25 October 2021, Stephenson Law  made news as the first law firm to launch its own NFT in a set of three, which serves as “crypto-art tokens that represent legal advice” that enables the purchase the right to redeem their NFT for “one hour of legal advice on the subjects of financial services Regulation, blockchain, and NFTs, along with the strategy, compliance, governance, and documentation necessary of such a new technology. One of the NFTs will entitle the purchaser to one-on-one access to Stephenson Law’s founder, Alice Stephenson.

Various controversies have arisen from these as some of the legal professionals accuse the firm of marketing gimmicks, a floodgate of potential money laundering undermining the integrity of the legal profession.

Challenges of NFTs

As it is with any innovation, the NFT is not without its own challenges as there are already pushbacks against the rise of NFTs. Plenty of works of questionable artistic value are being sold at hype-driven auctions. Artists’ works have allegedly been stolen and auctioned off as authentic. And many artists are concerned about the climate impact of art sales that rely on blockchain technology, which is notoriously inefficient by design.

Legal Implications of NFTs

NFTs like any other assets, are subject to legal implications with respect to governance, ownership, intellectual property rights, Data protection, fraudulent trading, theft and data security.

Governance/Regulation

NFTs also confronts barriers like strict management from Government just like other cryptocurrencies and on the other hand, the government is also confronted with questions on how to properly regulate this nascent technology with the corresponding market.

NFTs are not yet specifically regulated in any jurisdictions, if they exhibit characteristics of other regulated investment units, they may trigger national legal obligation.

These regulatory obligations range from “know your client” identification and verification and associated record-keeping and monitoring obligations and other compliance obligations under anti-money-laundering regulations, through sanctions regimes, to much more onerous requirements where securities regimes or other investment laws are triggered.

Anti-Money Laundering NFTs has led to the creation of separate laws, and one example is a class-action lawsuit filed in 2021. Currently, global regulations over art, digital assets, and antiquities, especially regarding anti-Money Laundering (AML), have extended.

NFTs confront legal and policy issues across a wide range of areas. Potential concerned areas cover commodities, cross-border transactions, KYC (Know Your Customer) data, etc. In some countries, such as Nigeria, Indian and China, the legal situation is strict for cryptocurrencies, and also for NFT sales.

The Nigerian Securities and Exchange Commission (SEC) on the 11^th May, 2022 issued  a document titled ”New Rules on Issuance, Offering Platforms, and Custody of Digital Assets” (the Rules).

The implication of the new rules by the Nigerian SEC are:

• Effort of the commission to regulate digital assets such as Bitcoin and NFTs.
• Legalizing digital assets in Nigeria.
• Classification of digital assets as securities.

Applicability of the Rules

The rules applies to all issuers seeking to raise capital through digital assets.

Coverage of the Rules

The Rules cover the following:

• Issuance of Digital Asset as Securities.
• Registration Requirement for Digital Assets Offering Platforms (DAOPs)
• Registration Requirements for Digital Assets Custodians (DACs)
• Virtual Assets Service Providers (VASPs)
• Digital Assets Exchange (DAX)

Several countries, such as Malta and France, are trying to implement suitable laws with the aim of regulating the service of digital assets.

Elsewhere, issues are resolved by using existing laws. They require buyers to follow complex or even contradictory terms. Therefore, undertaking due diligence is a necessity before investing in NFTs.

Taxation

IP related products (including arts, books, domain names, etc.) are treated as taxable property under the current legal framework in Nigeria. However, NFT-based sales stay out of this scope.

Although few countries, such as the U.S. (internal revenue service, IRS), tax cryptocurrencies as property, most areas worldwide have not yet considered it.

An asset would be subject to legal regulations related to taxation. If you simply come up with a token. it isn’t considered a taxable action. Selling it is different. Such marketplaces as Rarible or OpenSea have their own taxes on trading NFTs.

Intellectual Property Rights

NFTs are here to stay and raise a lot of ownership questions relating to copyright law.

Creating an NFT of a work of art doesn’t grant its author or owner the underlying intellectual property rights. NFT holders need a license from the original creators to reproduce the original work. It’s crucial to understand the limits of what you’re getting for your money, even if it’s not obvious.

The creator of a work is the owner of the copyright, and can do what he/she wants with it.

When someone buys an NFT from the creator, they obtain ownership in the sense that it becomes their property since an NFT is a digital certificate of ownership representing the purchase of a digital asset, traceable on the Blockchain. But the NFT holder does not have any other rights to the work. This includes those rights offered under the copy right law such as the right of communication to the public (making the asset available to the world), Rights of Adaptation and Rights of reproduction.

But typically, copyright and other IP rights will be retained by the issuer, and the buyer will be granted a right to display the underlying asset. Care needs to be given to how and whether IP rights is licensed through the sale and subsequent transfer of the NFT. This should be particularly to ensure that the issuer’s valuable brand is protected.

Some creators, like Kings of Leon, restrict all commercial use of their work, allowing only personal consumption.

Data Protection

If we take the EU, as GDPR admits, in relation to every private information point there is a minimum of one legal individual against whom data subjects can enforce their rights (for example, rectifying or eliminating personal information).

In Nigeria Sec 3.1(13) of the Nigeria Data Protection Regulation (NDPR) makes similar provision as to the right of a data subject be notified by a data controller of the rectification of data and the right to the erasure of their personal data.

In the US, similar law also exists: users sometimes can fully delete their private information. This is granted by some data protection laws like California Consumer Privacy Act (CCPA) or the EU General Data Protection Regulation’s provisions.

Data Security

The security of data and NFT transactions more broadly will be paramount. Technical teams will need to consider which security and data-sharing standards, and which blockchain protocol (most commonly Ethereum), will be deployed. In addition, there will need to put appropriate technical arrangements in place to ensure the permanence of NFTs and, crucially, any digital assets they represent.

Recommendations

• With the various great opportunities associated with NFTs, comes a greater need for businesses to act carefully to avoid unintended regulatory implications and to protect their commercial interests. 

• Lawyers would need to help protect clients from deceptive NFT activity. Regulators would have to work with NFT platforms to increase consumer protection in NFT transactions. They should also work on creating a more comprehensive framework to regulate NFTs.
• Due to the rise in the value of NFTs, theft and impersonation have also been on the increase. 
• NFTs platform such as Open sea and Rarible which have lower barriers to entry  should not make the entry requirements so low that just any one can just register. Users must provide proof of national ID, bank account, and other verifications to participate on the platform.
• It is worthy of note that the lack of a centralized authority has proven to be a double-edged sword. It can be difficult, if not impossible, to hold any individual or entity accountable.  

Conclusion

2021 appears to be a landmark year for the popularity of and trading activity in NFTs. The NFT market is set to expand even greater, with talks and evolution of using NFT to preserve delicate art pieces, combatting luxury good counterfeits, proof of personal identity and proof of knowledge in education.

NFTs can be traded globally when operated on DLT platforms as this technology allows operating beyond borders. Therefore, it is necessary to consider their legal status and the different regulatory frameworks across multiple jurisdictions within which they may be subject to. However, the possibilities of NFTs and their underlying technology are not yet fully known, and may be boundless.

The future of NFTs may lie in complex business applications, since the most utilized nature of NFTs is providing authentication, providing proof of ownership and facilitating the transfer of ownership. Today there is yet to be a single definition that represents all types of NFTs while being technologically and business model independent. This could be a challenge given that NFTs are not tied to a specific technology and are applicable in a lot of business models and use cases.

 

About the Author:

Deborah Enyone Oni is the Managing Partner of Hilton Top Solicitors, a tech savvy law firm committed to delivering legal services through innovation and technology. Deborah is a Blockchain researcher, Educator and Consultant. She heads the Blockchain and Cryptocurrency unit of the firm. She is helping in building the women in the legal space who are technologically aware and empowered.

deborah@hiltontopsolicitors.com