NFT's: worth your time and (crypto)money?

NFTs are changing the way we think about art — and investors are starting to notice. Christie’s recently sold a digital artwork by an artist named “Beeple” for $ 69,3 million USD. Now, a former auction executive teamed up with cryptocurrency experts to purchase the 2005 Banksy painting “Love Is in the Air” for 12.9 million USD and plans to sell off 10,000 pieces of it as NFTs[1]. Applications for interested buyers started December 13, 2021. Also in Belgium, visual artist Musketon has sold a number of highly detailed vector graphics with an aggregate value of more than 1 million USD[2].

NFT issuances are growing rapidly globally and have the potential to open up new business channels and revenue streams for digital artists, brands and famous sports figures to reach their fanbase, audiences and customer community, while at the same time enabling them to monetize their digital or physical assets.

With this blogpost we endeavor to explain how this phenomenon works from a legal perspective and want to briefly highlight some of the commercial opportunities, legal uncertainties and risks related thereto.

What are NFTs?

An NFT is a non-fungible token that consists of metadata and usually includes an URL-link to a unique digital version of an underlying digital (e.g. video, image or other digital content) or physical (e.g. sculpture, paining or other tangibles) asset. As it is encoded using distributed ledger technology or DLT (e.g. blockchain), it can be considered as a of certificate of authenticity and/or a proof of title to such digital version of an asset.

“Non-fungible” means that it is unique in nature (contrary to e.g. units of a cryptocurrency, which are indistinguishable from one another and interchangeable). Each (tradable) NFT is accompanied by software code in the form of a smart contract on DLT indicating a transfer of title, and the applicable terms and conditions. Once it is ‘minted’ (i.e. it’s encoded as a data file on DLT), the NFT cannot be deleted or edited, can be viewed publicly and enables transparent tracking of title and transactional history.

Commercial value of NFTs

The valuation of an NFT is tied to its uniqueness. While in the world of digital assets (such as digital artwork), copies can be made that cannot be distinguished from the original work, an NFT, through the abovementioned characteristics, has the ability to prove a unique title to and authenticity of the asset it represents. Its terms and conditions can also ensure the initial creator of a percentage of the transaction proceeds in each subsequent sale of the NFT, thereby creating automatic royalty collection as a payment model.

To be clear, minting or tokenizing an image does not prevent further downloads of copies on the internet if that image is generally available on the internet, but there is a difference between a person downloading a copy of an image and a person owning the only original image.[3] NFTs are a new narrative of owning things, and scarcity drives up the price.

While NFT are mostly linked to digital assets, also physical assets (e.g. luxury goods or artwork, such as the Banksy painting) have the potential to be minted in one or a finite number of NFTs, thereby increasing liquidity and at the same time ensuring provenance.

In general, NFTs can thus enable the efficient commercialization of unique assets that are difficult to sell or prove title to, and even offer the ability to fractionalize the ownership of an underlying asset.

Legal value of minting copyrightable works

From a legal perspective, three scenarios should be distinguished when minting copyrightable works:

  1. The NFT creator is the owner of (a sufficient license to) the copyright on the work -
  2. Work that is not copyright protected anymore –
  3. NFT holder did not receive the consent of the copyright owner to create an NFT –

In this case, there is no copyright issue when creating an NFT of the work. The smart contract incorporated in the NFT can outline the means of exploitation of the copyrights, automatic royalty payments to the owner of the copyright, the sales price and the maximum number of replicas of the digital creative work that can be sold.

A work is only protected by copyright until 70 years following the death of its author. After such term, it becomes part of the public domain. Just as everyone has the right to enjoy works in the public domain, anyone has the right to create NFTs of these works. While an NFT is ‘unique’, it does not prevent others to mint the same work, and the minting itself does not give the NFT holder any rights to the underlying work (which is why websites guaranteeing the authenticity of the underlying work are popping up cfr. infra). In case of physical works, you can mint Botticelli’s “Birth of Venus”, but it does not make you the owner of the painting, nor can you prevent thousands of other minters to do the same.

Creation of an NFT constitutes an act reserved for the copyright owner if it is considered as a (i) communication to the public or (ii) an act of reproduction, but this qualification is the subject of debate.

As creating an NFT does not entail a copy of the work as such, but only the creation of a ‘tokenized version’, it could be argued that it does not constitute an act of reproduction. On the other hand, if the work to which the NFT relates is not generally accessible (as opposed to giving a public URL, where the minter could reasonably assume the content was posted with the consent of the copyright owner), this could give be considered a copyright infringement.

Even if minting a copyrightable work in itself could possibly avoid copyright infringement, uploading the created digital version without consent of the copyright owner will most likely constitute an infringement to the right of communication to the public and reproduction.

Copyright protection for NFTs?

Another outstanding question is whether all NFTs can be protected by copyright. For example, CEO of Twitter, Jack Dorsey, famously minted and sold an NFT of his first tweet reading “just setting up my twttr”. First off, copyright protection in the EU requires “an expression of author’s own intellectual creation”, which means that it should reflect the author’s personality as an expression of his/her free and creative choices. Also, it should be expressed in a sufficiently precise and objective form.

While this tweet seems like a very general statement, the question is raised whether ‘minting’ or creating an NFT in itself qualifies as an artistic performance, comparing it to Marcel Duchamp’s Fountain (i.e. the artist that drew “R. Mutt” on an upside down urinal). The creative process there was described as transforming ordinary objects by separating them from their mundane context and presenting them as art, which reflect the character of the artist.

Some apply the same reasoning for NFTs, but only time will tell whether minting NFTs will be regarded as a new art form, qualifying for copyright protection.

Authenticity issues

While NFTs are unique, it should be noted that (i) several NFTs can be created based on the same underlying work and (ii) NFTs by themselves cannot guarantee the authenticity of the underlying work, since the underlying work itself is not stored in the NFT.

If the act of minting – and selling – in the future is not seen as reaching the standard of copyright protection (cfr. supra) it will be hard to prevent the creation of unauthorized NFTs, as any person can claim to own the underlying item in question (supra ‘Birth of Venus). Rectifying this authenticity issue of the underlying work on the other hand will not be solved in a technological manner, but rather through verification mechanisms by platforms, galleries and companies marketing these NFTs, which we already see happening.

Financial and regulatory aspects

It is important to note that artists or entrepreneurs endeavoring to mint assets, issue or market tokens or to build a business model on these principles, should properly investigate the possible legal consequences and conditions, and consult with specialized legal counsel, since the regulatory landscape is evolving and not yet (completely) adapted for this innovative phenomenon.

In the context of NFTs the following regulatory aspects should be highlighted, without providing a limitative overview:

1) The EU is currently in the process of negotiating a new regulation on crypto-assets, the Market in Crypto Assets (‘MiCA’) Regulation, and for the first time in the EU, it defines a crypto-asset as a “digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology”. On the one hand, the current draft of MiCA provides that issuers of “crypto-assets that are unique and non-fungible” do not need to publish or register a white-paper for them, so therefore, no rules about their functionality and reliability need to be set out in public. On the other hand, NFTs issuers will most likely still be required to comply with other obligations applying to all issuers of crypto-assets.[4]

2) On the aspect of money laundering, the Fifth Anti-Money Laundering Directive (‘AMLD5’) brings several new entities within the personal scope of the provisions on the prevention of money laundering and terrorist financing, e.g. art and antiques dealers. With respect to transactions in art works for an amount of EUR 10,000 or more – who will need to register with the FPS Economy – AMLD5 could thus impose registration obligations for NFT issuers as ‘art dealers’, in case transactions involving works of art surpass that amount;

3) Given the lack of specific legislation, it remains unclear what the tax implications of NFTs are. Without this, authorities will look at what regimes already exist, and which regime is most appropriate to fit in crypto assets. Another question that remains: which jurisdiction will get to claim the taxation?

4) Several marketplaces to buy and sell NFTs are popping up on the internet. Whether an NFT qualifies as a financial instrument (e.g. as shares, bonds, units in collective investment schemes, or derivatives) is currently not decided, but could trigger licensing requirements or other regulatory obligations.

Conclusion

The use and creation of NFTs has explosively increased in 2021. This rapidly growing market poses interesting commercial opportunities for entrepreneurs and artists, but various regulatory and IP protection challenges remain, and it is clear that authenticity verification will play a large role in the long term for the credibility and marketability of NFTs.

If you have any questions on NFTs, or any other legal technology issues, do not hesitate to contact Cresco’s Technology team!

[1] https://www.nytimes.com/2021/12/01/arts/design/banksy-nft-loic-gouzer-particle.html

[2] https://www.tijd.be/ondernemen/technologie/piek-van-cryptokunst-is-niet-ver-weg/10292443.html

[4] https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52020PC0593&from=EN ) Art. 13 en OV. 23