NFTs are unique, effectively non-destructible tokens stored in the blockchain – a decentralized ledger system that uses computing resources to validate the holder of cryptographically unique data without reliance on a single source of truth such as a bank or government [further reading]. The NFT references a link to a resource – typically on the internet or in a game – where some content is available. An NFT has a single owner (which can be an entity), and generally NFT’s cannot be subdivided once they are created, though they can be transferred.
An NFT can represent anything – digital art, a book, a page from a movie script, a signature, a title document to a car or house or real estate, an in game “skin” or custom article, a representation of something in a virtual reality construct (currently being referred to as the metaverse), like clothing, shoes and so on. It can also link to something that is itself a representation of something tangible – for example, an NFT can link to a digital object that might be used in a game, as an avatar or in the metaverse, but that also is created tangibly (for example, this shoe created using artificial intelligence), or it can be an electronic representation of part of the notes to a very famous song. A decent list of many potential uses of NFTs is set out in this article 15 NFT Use Cases That Could Go Mainstream.
NFTs were originally born from a desire to find a way to establish the “provenance” (title) to digital art. See NFTs Weren’t Supposed to End Like This. As pointed out in that article, the blockchain cannot actually store the thing it points to – for example, an image – there is not enough space. It only has the space to really hold a link to that image. As NFT use becomes both widespread and also, referencing property that the NFT holder might not own, many legal issues are now coming to light.
Who owns an NFT and exactly what do they own?
A case filed a few days ago on February 1st is challenging the sale of the “very first NFT” by Sotheby’s for 1.47 million dollars. Free Holdings Inc. v McCoy et al., case number 1:22-cv-00881 (S.D.N.Y). In that case the Plaintiff claims that the sale of the NFT, which is apparently a copy of the original token the founder of NFT’s created, violated its ownership rights to the actual NFT, which it claims to have in its wallet.[1] The defendants have apparently asserted that the actual NFT (the digital token itself) was “removed” or “burned” from the Namecoin blockchain where it was created, and thus does not even exist. The plaintiff is claiming that the original owner allowed the token to “expire” and it somehow renewed that token and placed it in its wallet.
This case presents a novel issue . . . what does “title” to an NFT really mean? The NFT itself is represented solely electronically (a token stored in a blockchain), and only functions electronically – once retrieved, it points to a resource on the internet and identifies the person holding the token as the true owner of … what? That link? The actual resource that is at that link? Is a picture of the token framed as art actually the NFT (and who owns the token itself, the text string)? That token is publicly viewable by anyone – the blockchain just limits how it can be transferred, and identifies the NFT holder as at least someone who has digital rights to the link. Is the token itself a copyright? We may get some guidance in the Free Holdings case.
A person who purchases an NFT should be aware that they are only really purchasing a public and decentralized proof system that establishes that they are the owner of the token, because that token is in their wallet. The actual thing displayed at that resource location probably is under copyright protection, and the owner of the copyright is probably not transferring ALL of the rights to the copyright in whatever that resource depicts. However, there is probably at least an implied license to publicly display whatever the NFT points to on the internet (or in a game, or the metaverse, or wherever that content can be displayed). The result is very similar to the result when someone buys a physical painting or art object. While they have title to that thing (the tangible thing, the painting) – in the absence of a very specific agreement, they do not own the copyright represented by that thing.
What rights must a person who creates an NFT have to the underlying content or server?
Those are very good questions. Could I create an NFT to any URL on the internet (i.e. to any picture that is publicly viewable) and sell that? Do I have to be the “owner” of that image or have any license to it? Do I have to control the web server that serves that image upon a request? What disclosures do I have to make to a purchaser of the NFT as to what rights they are receiving, whether I am the copyright holder of the image, or that I control the server? Does the contract imply I will perpetually, until the end of time, maintain that server and that resource location? What happens if I go bankrupt, or the blockchain service I used goes bankrupt, or the server company? Can multiple NFTs be sold that point to the same resource? Does the NFT platform owe a duty of due diligence to verify rights in the underlying resource? There is nothing built into the NFT or blockchain system that requires unique resource links. Even if an NFT provider limited links to be unique, other NFT providers need not respect that prior link and can create NFTs in their blockchain, pointing to the same resource.
Most NFTs are sold using “smart contracts” – which are essentially a series of pre-made instructions in the blockchain that, when triggered, simply occur. See How smart contracts work. No human sees them, nor reviews them, approves them, or checks they were made or not made. The whole idea is that the blockchain system itself verifies the “transaction” occurred, without human involvement and without a centralized verification system (such as an intermediary bank, certificate signer, government title repository etc). They are not the proper place to agree to whatever license rights and obligations are connected to the underlying resource represented in an NFT. Even if they were, the smart contract process will not meet electronic signature requirements under UETA or ESIGN which are applicable in the US. Those terms would have to be in the underlying terms of service of the NFT provider and the NFT seller.
These issues will play out under traditional legal principles – in the author’s view predominantly under contract law (based on what the terms of service of the NFT provider and seller say), under advertising law – what disclosures must an NFT seller make to meet the requirements of advertising law – that the sale was induced by truthful, non-misleading and fair representations about the NFT?, under the law of publicity rights (use of a person’s likeness to sell a product or service), and of course finally under intellectual property law, principally copyright law.
On that last point, at least under US law, a question arises whether the Digital Millennium Copyright Act notice and take down provisions will apply to NFT transactions. For example, suppose person X sells an NFT to a linked resource at location Y, and was not the owner of the copyright of the image there. If the purchaser does nothing else (such as displaying that image embedded in a game or web page) – can the copyright owner force the NFT platform to take that down that link – assuming the copyright owner does not control that resource? Is that NFT itself a violation of 15 USC 1125(a), indicating a false association with the owner of the copyright (or perhaps implicitly stating the NFT owner owns the copyright?). Under certain cases in the US (e.g. Dastar), misrepresentation as to authorship is often not an actionable.
Are NFT providers liable for NFT sales that violate the rights of a third party?
Most third parties will not have agreed to the NFT provider’s terms of service, which undoubtedly will disclaim liability for any claims arising from acts of the NFT seller. If the third party’s rights are violated, can they sue the NFT provider? In the US, the NFT provider may have immunity under Section 230 of the Communications Decency Act if the NFT is “information provided by another information content provider”. But is it? The NFT provider actually creates the NFT and provides the functionality. However, the NFT owner is the person creating the information that is stored in the NFT.
Summary and some recommendations
There are more questions than answers today, however in any NFT sale transaction, at least the following should be closely reviewed:
- The terms of Service of the NFT Platform provider. A buyer will be agreeing to these terms. They are likely not favorable to the Buyer, and also likely not negotiable. As a result, the value of that NFT is highly dependent on the reputation and likelihood of that platform staying in business.
- The terms and conditions of the sale from the Seller. Does the Seller represent it has the IP rights to the resource? That they are unique? Will not be resold in a different NFT? Is their liability limited or remedy limited?
- Some diligence into the actual art/resource/item should be done – and this may be very difficult. There are no real regulations in this area (outside of general unfair and deceptive consumer protection laws) – so even finding the true author or owner of a work may be very difficult – even in the US where we sort of have a registration system. The less able a buyer is to verify the provenance of the underlying resource, the more strongly worded the representations, warranties and consequences of breach should be. In a worse case, an escrow should be set up so that some post transaction verification can occur before all, or at least some, of the actual transfer of the cryptocurrency occurs.
For more information, contact Mike Oliver or Kim Grimsley.
[1] – Etherscan defines a wallet as follows: “A wallet address is a publicly available address that allows its owner to receive funds from another party. To access the funds in an address, you must have its private key.” Link