Explore the sea of NFT
- A US-Legal Perspective
An NFT [1] is a digital asset that can stand for real-world objects, such as art, music, photos or videos, items in the games, and even books. They can be minted, bought, and sold on a certain marketplace. You might wonder what would be the difference between the NFT and cryptocurrency: that is, one of its remarkable properties is that it is actually a unique unit of data stored on a digital ledger that is not interchangeable (Trautman, 2021). However, it is still a mystery whether we should treat NFT as a commodity or a new item to be defined in this new decentralized world, and how we can apply those existing US Laws to identify its corresponding properties in order to regulate NFT market behavior, thus maintaining the blockchain ecology.
Figure 1: What are NFTs?
How to distinguish between ownership and underlying intellectual property rights in NFT?
Unique Ownership
Owning an NFT is similar to owning a photograph of a basketball player stuck in the room, thus it is natural to consider that only one person can own an NFT. However, in the real life, it is difficult to determine whether the owner of that photograph would own underlying intellectual property rights, for example, making copies, printing, or creating other derivative works if he/she actually obtained that NFT from a transaction (Bain et al., 2021). From this point of view, we propose that they have the right to own, sell, lend, or otherwise transfer the NFT itself, nonetheless, they don’t have the right to make or sell copies of the digital art, to transfer the copyright in the work, or to create derivative works based on the original, unless a “written” copyright transfer is done (We will further talk about the copyright transfer in Part 2).
Ownership and Underlying Intellectual Property Rights
The ownership [2] of NFT as a unique digital asset against ownership of the actual content that the NFT is connected to requires clear discrimination. In other words, an NFT is minted and created to represent the work of art or other productions behind, but it does not mean that any subsequent buyer and owner of the NFT would automatically own other underlying intellectual property [3] rights, among which the copyright is especially dominant. When someone purchases an NFT linked to several contents, they do not directly mean to purchase the underlying intellectual property rights (Mahmood, 2021).
NFT is nothing but a non-fungible unique cryptographic token. Under Section 14 of the Copyright Act, “a copyright owner has certain exclusive rights to reproduce, prepare adaptations of a work, perform, display, and distribute the copyrighted works in public”. According to this article, we would claim that for any original works, the author should own the copyright, except that the author is hired to make these contents, and there are other contracts signed by the two sides to note the belonging of the copyright explicitly. And in the general case, there is a common sense that the purchase behavior itself does not mean to transfer all copyright to the buyers (Stim, 2019). If the NFT owner is explicitly permitted by the seller that some of the intellectual property rights are transferred, the NFT owner is not allowed to make use of the elements in the creative work adhered to the NFT and create copies in order to distribute in any form to the public.
If you are still confused about how these different concepts relate or differ, here is a vivid example for you to understand:
The NFT of the American celebrity basketball player LeBron James’ dunk video was released as the limited-edition digital collectors that are sold on the “Top Shot” market. It turns out that the card describing a dunk can sell with lots of money, but NBA still reserves the copyright to the original video, as well as any future reproduction of the video rights. Therefore, for the owner of the NBA NFT, it is possible to display the image in a certain way but still must not change the video moments captured in your NFT or sell anything related to your NFT without the prior consent of the NBA. Commodities are used for any commercial purpose. In addition, all license terms set by the owner of the underlying intellectual property rights shall be complied with (Young, 2021).
Figure 2: Intellectual Property
In order to avoid being stuck in potential trouble caused by misunderstanding or neglect, developers ought to overcome these shortcomings since these can be mitigated with either the technology itself or through suitable wordings in the Assignment/license/intellectual property transfer smart contracts associated with the NFT. That is to say, if there is a mechanism within the NFT platform to create custom made smart contracts that could draw the line as to the originality of the assets, the rights conferred, royalties, if any, etc., then the problems associated with the market regarding intellectual property infringement associated with the sale of NFTs could be brought down. In addition, the introduction of necessary demarcation of rights and liabilities for a creative art buyer with implications of the potential creation of NFT would help the buyer sell the work in an NFT marketplace in the future.
Now that we have a clear understanding of how the differences between ownership and intellectual property look, we are also curious about if someone misunderstood their relationship, how will copyfraud and infringement have an impact on the blockchain ecology?
How to avoid copyfraud and improve the transparency and legitimacy of NFT assets transfer?
Copyfraud and infringement of copyright:
From the last section, we notice that it is quite difficult to differentiate between ownership and other intellectual properties in the NFT, especially for ordinary people. Therefore, the minting and sale in the marketplace are vulnerable to ‘copyfraud’ [4] and the infringement [5] of the copyright of the basic work and moral rights. Copyfraud often occurs when a person mints an NFT of a public domain work, falsely claims to own the copyright. Similarly, if a person is not the author or copyright owner of the underlying assets for which copyright exists, casting NFTs and misrepresenting them as the author or copyright owner of the work may infringe copyright and moral rights (Lewis et al., 2021).
We have seen an instance of works in the public domain from the Rijksmuseum in Amsterdam that were turned into an NFT. Another one is about a 12-year-old programmer named Benyamin Ahmed who launched his own NFT project. His 3,350 computer-generated “Weird Whales” almost instantly sold out for 3 ETH each ($6,000). However, while this hype took place, one user found that the artwork “pixel whale” seemed to be copied directly from another project, using pixel images from four years ago (Schmalfeld, 2021). However, we are still not clear whether the artwork “Weird Whales” project improperly makes use of others’ intellectual property rights, since that base image may have been placed in the public domain and the original artist may have announced explicit permission for anyone to use.
“Copyfraud, as the term is used in this Article, refers to claiming falsely a copyright in a public domain work. These false copyright claims, which are often accompanied by threatened litigation for reproducing a work without the putative “owner’s” permission, result in users seeking licenses and paying fees to reproduce works that are free for everyone to use, or altering their creative projects to excise the uncopyrighted material.”(Jason Mazzone, 2006)
Figure 3: Copyfraud
Meanwhile, we are also seeing some artists start complaining about social media that their works were being minted into NFTs without their permission. It turns out that the physical asset is not on the blockchain, but the token itself has been in. This means that access to this item depends on whether the site hosting is online or not. When the seller of the NFT is not the true holder of the copyright, the problems of copyfraud and copyright infringement raise. At the same time, similar issues happen in stock image libraries, where their terms may require anyone uploading images to have the necessary copyrights, but anyone who has access to high-resolution images that are attractive to others can still try your luck and submit this image to profit from any sales (Golowczynski, 2021).
Why does the infringement issue show up? Let’s delve into the loophole behind NFT: One advantage to purchasing an NFT is that all authentication is done on the blockchain. As long as the buyer is eligible to confirm that the original selling account can be successfully linked to the artist, then no matter how many rounds this item has been in the transaction, the buyer can still verify whether the purchased piece is authentic (Schmalfeld, 2021). However, what the blockchain does not explicitly inform the buyer is whether the piece of work is simply a copy of one’s intellectual property or not. Thus, we would assert that constructing a centralized administrative mechanism for identifying the public domain/true owners, like storing copyright into government-leading databases, might be a resolution to contain the copyfraud/infringement of copyright.
The legitimacy of NFT assets transfer
Some platforms offer to build in copyright elements into the sale, such as copyright transfer; Mintable for example includes a tick-box that allows the person minting a work to “Transfer Copyright”. (Guadamuz, 2021)
Figure 4: Copyright Transfer interface in Mintable(an NFT market shop)
With regards to the transfer of copyright, Copyright Law of the United States establishes copyright assignment as requiring that “any or all of the copyright owner’s exclusive rights, or parts of those rights, can be transferred. The transfer, however, generally must be made in writing and signed by the owner of the rights conveyed or the owner’s authorized agent.” In the widest sense, an assignment of copyright means that the ownership of work will be transferred to the assignee, and they can therefore do with the work as they want.
So you might ask whether the design of the Copyright Transfer Interface is applicable and legitimate?
With regards to the use of a tick box to generate a copyright assignment, this could be akin to what is known as a click-wrap agreement, namely legal documents that are usually entered into by the click of a button. This is a widely accepted practice, and there is substantial case law accepting the use of “I Agree” click buttons. It would appear that as long as it is clear that the party is willing to make a copyright assignment according to what they “say and do”, then the ticking of a box, the filling of a form, and the signing of a token electronically could all be taken together to evidence the existence of an assignment.
Thus, it allows a more personalized realization of transferring all or part of the copyright in the smart contract. First of all, we should be aware that, when it comes to copyright, we’re actually talking about multiple rights. It includes the right of reproducing, selling, licensing, or otherwise transferring the copyright of the original work, as well as making derivative works.
Here is an example for Music Contracts:
“With respect to music minted into an NFT, you could draft the associated smart contract with provisions that provide performance rights only to the purchaser of the NFT while retaining all other rights for the artist, who could then sell one of those other rights (such as the synch rights) to a different purchaser of a separate NFT. The open nature of the blockchain means it is relatively easy to track these various rights as they pass from party to party and makes tracking any associated royalty streams relatively easy compared to current standards” (Barsky, 2021).
But what does “in writing” and “signed” mean exactly to ensure its legitimacy?
It is accepted widely that electronic documents can be used to conduct contracts. Although the ESIGN Act is a federal law, if all parties to the contract use electronic documents and sign electronically, electronic signatures and records will be legally recognized. It is also equivalent to what the General Rule of Validity has stressed, that “No contract, signature, or record shall be denied legal effect solely because it is in electronic form”. This means that in practical terms there is a wide range of types of signatures being accepted as valid by the courts. While existing rules are broad and inclusive to various electronic formats, it’s not yet clear if this could include the type of cryptographic signature that is used to sign an NFT. Also, the formal validity of smart contracts as contracts is still in heated debate. However, there has been a recent consultation by the UK Jurisdiction Taskforce looking specifically at cryptographic assets such as tokens, and they believe that there is no reason to believe that private-key signatures would not be classed as electronic signatures for any legal purpose. The recognition of NFT assets transfer acting as valid forms of transferring rights represents the general trends.
Still, there is nothing stopping an author from using both an NFT to transfer ownership of a digital asset electronically, while writing a document in natural language and with a physical signature to ensure the buyer that there has been a proper transfer of rights. This is the preferred solution of some platforms that are offering copyright transfer as part of their services. The platform Hup Life is planning to include what they call a “second layer NFT” which will comply with copyright formalities in order to “transfer a full bundle of rights.
Transparency, Privacy, and Anonymity: NFT’s advantages and implications
Transparency
What differentiates the NFT marketplace from the real-world art market? Or what is the merit of NFT that the latter one does not possess, which puts all of us into a frenzy nowadays? The transparency of NFTs is the answer we are increasingly hearing to those questions recently. On one hand, the “physical” art world is largely based on the opacity of art transaction information. The past auction house sales are the only reliable public evidence that sets the estimate of value for artworks. Conversely, NFTs are transparent in the sense that no one is capable of manipulating the record of ownership or copying a new NFT. To a certain extent, the transparency associated with the Ethereum blockchain and digital art allows us to track every transaction, which is a key element in the field of innovative art.
For example, if you trace down the transaction of the one digital art collector NFT called @4156 buying the work “Death Dip” by the artist XCOPY on the SuperRare platform for the sum of 1,735,000 dollars, then at that moment the balance of the digital wallets is approximately 769.55 ETH ($1,667,741) in that of the artist and 301.31 ETH ($653,757) (Concas, 2021). With their wallet address, it is easy to further track the subsequent input and output transactions.
Figure 5: An NFT marketplace touting its transparency
Privacy and Anonymity
Even though it seems that blockchain, smart contracts, and NFT have solved some problems in the current popular centralized data collection application model, they are not able to adequately solve these problems if the context and situation of the application are considered. (Cornelius, 2021).
Traditional Internet Companies depend on centralized intermediaries to verify personal data. For example, Google utilizes an authentication service to verify user data and offers protection policies to ensure user privacy. In comparison, NFTs transactions manifest great advantages. NFTs transactions can be made directly between buyer and seller using smart contracts where personal information is directly shared with third parties. Using blockchain technology, creating identity mechanisms becomes possible for verifying and collecting necessary data in a decentralized manner, without ever sharing it directly with counterparties. Thus, NFTs guarantee user anonymity by storing personal data into non-fungible tokens that interact directly with smart contracts.
However, the anonymity features of NFTs also bring about regulation problems, such as nefarious money laundering issues. Because digital art is both newer and more subjective in pricing because collectors and financiers are struggling with a series of new issues that revolve around the value of the artwork if it can never be actually viewed or stored. This creates a perfect environment for crime because dealers and sellers can determine the value of a work and compare prices with little historical background. Therefore, it is an excellent cover for money laundering, adding more confidentiality to an already challenging market, where location, identity, and source of funds are usually kept secret. Criminals could “clean” dirty money by generating an anonymous NFT, selling it on the blockchain, and purchasing it from himself or herself from an anonymous digital wallet with illicit funds. The money would be regarded as legitimate funds from the sale of the artwork. It seems that using illegal cash to buy NFTs from yourself is a simple way to transfer funds while claiming that these funds are used for legitimate art purchases and tax avoidance in the process (Young, 2021). Due to anonymity, high-value transactions, and limited global regulatory issues, art transactions have historically been vulnerable to crime. What to expect from the regulation side is that AMLA enacted provisions, “study the potential expansion of requirements to persons engaged in the art trade,” which may include NFTs. In addition, the Financial Action Task Force (FATF) [6], a money laundering and terrorist financing regulatory agency, has issued new guidelines for its so-called “virtual assets” and related risks. (Woloszynski, 2021)
How can royalties be defined and integrated into the asset transfer to incentivize artists’ creation and increase liquidity?
What are NFT royalties?
Every time your original NFT is sold on the market, NFT royalties [7] will provide you with a percentage of the sale price. NFT royalties are permanent and will be automatically implemented by smart contracts. For the majority of the markets, a royalty percentage can be personalized, and 5–10% is commonly regarded as standard royalties (Gomezz, 2021).
Figure 6: Royalties
But you may wonder whether there is a difference between other traditional royalty payments and that in the NFT market.
NFT royalties are automatically paid to the author in the second sale. They are encoded into smart contracts on the blockchain. Every time a second sale occurs, the smart contract will ensure that the terms of the NFT are fulfilled. If royalties are specified, part of the profits will go to the artist who created them (Gomezz, 2021). The prerequisite for generating NFT is that it must be specifically identified in the articles. Whenever the smart contract terms are written clearly, the remaining will be processed automatically. Although traditionally after the first sale, artists or creators cannot track subsequent transactions of their works (Chernichaw et al., 2021). Once they sell their work, all their income will come from that work. No matter how the reputation has increased in the future, they cannot get any other benefits sold before. On the other hand, if they wait for the right time, buyers of their works can regret and further sell the same work at a higher price. This resulted in artists being unable to get a cent from subsequent sales, no matter how high their prices were. Therefore, the common concept of artists is that of poor or hungry artists. NFT brings the opportunity to completely change this situation. Artists can get a permanent fair share of their work.
Why are NFT royalties important?
NFT royalties are a quite easy way and a good opportunity for artists, composers, and other original content creators to profit from their original work, and this might be quite difficult to happen in the traditional item in real-life (Chernichaw et al., 2021). NFT is actually a way to democratize payment. Now, based on popularity, celebrities can get paid as easily as sports superstars. They also benefit from the secondary sale of their works, which is fair. Another cool thing about NFT is that the tokens can be sold, but the basic copyright still belongs to the creator. Authors now can even separate the intellectual properties into different segments and thus sell a certain percentage to potential buyers.
Since NFT Royalties develop a new function that whenever one NFT is resold, according to the presets of smart contract, part of the royalties will follow the flow to send back to the creation (intellectual property owners). However, there is still a grey area that there is no mechanism/law to regulate how royalties will be distributed among creators, owners, and other intermediaries, and whether this distribution is solely determined by the smart contract, and whether the content of this smart contract conforms to the existing laws in royalties, intellectual properties.
Figure 7: NFT Royalties: Clearly Explained
How does the value or the function differ in different types of products, like patents, technology, books, or creative arts in terms of privacy, copyright, and ownership?
This brings us to the first question: How to price an NFT?
First, it is quite challenging to value NFTs since there are few comparable assets, and at the same time, NFT has enabled the unbundling ownership applicable. In the past, it is difficult to define the ownership of multiple agents on the same property, however, a clear and transparent identification of the smart contract fully illustrates the properties and their corresponding value to determine the price of an NFT (Wil, 2021). In terms of pricing the NFT, here we summarize 6 features to be considered when determining its value:
The chain an NFT is minted on contributes to and secures, its value over time, and this is why NFTs minted on Ethereum are currently more valuable than NFTs minted elsewhere.
It turns out that it is more valuable than Off-chain since the former one enables the metadata to be incorporated into the token, in order to make it last forever.
3. Creator and community’s fame and reputation.
Naturally, the more popular the creator, the bigger the community, the more valuable the NFT is — and this dynamic is basically true for any market.
4. Scarcity and authenticity go hand-in-hand with scarcity.
Any party purchasing an NFT should conduct due diligence of scarcity and authenticity. For a low transaction fee, anyone can create an NFT, with a number of copies, that purports to represent something important, but these NFTs have no authenticity or scarcity, and thus have low value.
5. Release Pace.
It is important to figure out the production pace of a given kind of NFT. With a simple example, one provider that offers unlimited mints of an NFT at 0.1 is generally not as attractive as one that is committed to minting only 50 NFTs, even with a limited supply.
6. Richness, related to additional features of an NFT.
More and more visual NFTs are now minted with accompanying audio. Compared to a plain old NFT, it offers users a richer artistic experience, which adds to its value to a large extent.
Here are also several examples of Value Transfer to NFT: In May 2021, The £70,000 artwork, called Morons, was destroyed and made into a non-fungible token. According to the buyer Injective Protocol, this behavior is intended to be the first trial where a physical piece is turned into a digital one. And the idea is that “by removing the physical piece from existence and only having the NFT, we can ensure that the NFT, due to the smart contract ability of the blockchain, will ensure that no one can alter the piece and it is the true piece that exists in the world. By doing this, the value of the physical piece will then be moved onto the NFT” (Shaw, 2021). Later, its NFT is minted in Ethereum, and its value increases sharply in the Decentralized Artwork Gallery.
Figure 8: NFT’s Street
Later, in August 2021, a Macroeconomist is heading to make it happen that the physical value of a diamond can be transferred to NFT after it is destroyed in the physical world. This experiment is still in progress, and we can see in the OpenSea that its value now is far above the floor price, and it has increased by over 1000%.
To help understand why this transfer can still sustain the value of the original destroyed one, we can make a comparable example here, in terms of a physical asset, it has value because of two functions (LizerbramLaw, 2021):
- Physical utilities function
- Asset function as a Store-of-Value (SoV) [8]
An NFT can serve the role as an SoV because it’s able to satisfy 3 basic criteria for something to qualify as an “asset”:
- Durability;
- Limit on supply;
- Social agreement.
After the transfer behavior takes place, we have to recalculate its price by following steps:
- Find the price of the corresponding physical asset
- Subtract the values of its physical features
- Add the values of digital-asset features of the NFT, such as programmability, low maintenance, security, trackable, ownership verifiable, etc.
From the example above, we figure out that there is a great distinction between NFT and other physical assets. To be more specific, for the physical assets, the NFT smart contract has to be aligned with the legal contract associated with the physical assets in reality to avoid confusion.
Another Outlook on Book NFT
From Buyer’s Perspective:
Understand digital copies of books available on Amazon as an example and comparative study with NFT. For the e-book you bought on Amazon or other centralized e-book shelves, As long as Amazon is existed and agrees to continue to provide it, you can own it. If Amazon crashes tomorrow, that book will disappear with other platforms. From this perspective, NFT has more in common with printed books-it is your property, full stop. It will not disappear due to the whim of outside parties. In fact, with NFT, you not only own one copy, but you also own a specific copy of a series of copies. But what buyers on earth can get after the transaction on the Book NFT Platform?
(1) the NFT itself (which can be re-sold);
(2) the ebook file redemption code;
(3) an optional print copy if they want it at no extra cost.
Platforms for selling Book NFT and in which segment you can sell
- two existing bookselling NFT Platform, one is Canonic, built upon Bitcoin Blockchain; and the other is WIP Publishing, minted to the Ethereum or MATIC blockchain, Polygon.
- Sell the cover art as an NFT
- Release the book in chapters sold as NFTs
- Sell the entire PDF manuscript
- Make a book trailer and mint the images
Figure 9: Canonic Website
Canonic is actually a great example but it only allows reviews from those who purchased the book, and Canonic’s service attempts to eliminate book-burning, similar to how service providers de-platform content creators based on their political views. WIP Publishing is designed to minimize fees and maximize returns for authors to fully motivate writers to produce more valuable content and materials, and at the same time, it allows the buyers to directly make payment in OpenSea conveniently.
From Author’s Perspective:
Compared to Traditional Publisher Publishing, such as Wiley, NFT book publishing actually gets rid of the intermediaries and further brings more financial profits to the authors themselves. This would in turn generate a stronger motivation for the writer to produce more valuable books and publishing materials with high quality. In addition, we notice that self-publishing platforms, such as Pressbooks, are available for authors who would like to publish their works as an open-source e-book or physical book, with ISBN and DOI numbers available, to guarantee authors’ intellectual property. However, for the NFT book, it can be foreseen that smart contracts designed in these platforms could not only enable authors to track whether there is any illegitimate use through decentralized blockchain and guarantee all the financial profits they deserve through on-chain transactions.
In addition, NFT also helps in getting rid of piracy and plagiarism. Every sale or purchase generates a data entry stored in blockchain technology, and every time the ownership of a book is transferred, it will be recorded in the blockchain, and royalties will be paid and collected systematically (Rolling State, 2021). Cryptocurrency and blockchain technology becomes all the more fun when you are able to remove your real-world identity from your wallet ID. NFTs for books could enable any author or publisher to receive compensation for their work while being completely anonymous (Upadhydy, 2021). And In the future, a secondary benefit is NFTs could allow the writers to monetize the secondhand book market, which further expands the monetization of the core product.
Conclusion
In this article, we explore the sea of NFT from a legal perspective, and this hopefully helps you to generate a holistic view of the current situation with this hot topic and implies several orientations for us to move forward to generate research questions related. The reason why we put a great number of efforts into the US-legal perspective is that we mainly focus on the marketplace who are the ones that get most involved, and clearly, the US is now a leading player. But in the meanwhile, we notice that there are more activities now emerging in European countries and China, and for example, MiCA is now heading to draft a proposal for the EU’s Proposed Markets in Crypto-Assets Regulation. Thus, we are also more than excited to see researchers, who are interested in, to do comparative studies in the future.
Project Lead: Prof. Luyao Zhang
Authors: Tianyu Wu, Jiarui Zhang
Acknowledgments:
Design: Austen Li
Executive Editors: Xinyu Tian
Chief Editor: Prof. Luyao Zhang
Relevant Materials
[1] NFT
A non-fungible token (NFT) is a unique and non-interchangeable unit of data stored on a digital ledger. NFTs can be used to represent easily-reproducible items such as photos, videos, audio, and other types of digital files as unique items, and use blockchain technology to establish a verified and public proof of ownership.
https://en.wikipedia.org/wiki/Non-fungible_token
[2] Ownership
Ownership is the legal right to use, possess, and give away a thing. Ownership can be tangible such as personal property and land, or it can be of intangible things such as intellectual property rights.
https://www.law.cornell.edu/wex/ownership
[3] Intellectual Property
Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more than others. The most well-known types are copyrights, patents, trademarks, and trade secrets.
https://en.wikipedia.org/wiki/Intellectual_property
[4] Copyfraud
A copyfraud is a false copyright claim by an individual or institution with respect to content that is in the public domain. Copyfraud also includes overreaching claims by publishers, museums, and others, as were a legitimate copyright owner knowingly, or with constructive knowledge, claims rights beyond what the law allows.
https://en.wikipedia.org/wiki/Copyfraud
[5] infringement
An infringement refers to the unauthorized use of a copyrighted or patented invention.
https://www.law.cornell.edu/wex/infringement
[6] Financial Action Task Force (FATF)
FATF is an intergovernmental organization founded in 1989 to develop policies to combat money laundering and has recently issued global, binding standards to prevent the misuse of virtual assets for money laundering and terrorist financing.
[7] Royalties
A royalty is a payment made by one party to another that owns a particular asset, for the right to ongoing use of that asset. Royalties are typically agreed upon as a percentage of gross or net revenues derived from the use of an asset or a fixed price per unit sold of an item of such, but there are also other modes and metrics of compensation.
https://en.wikipedia.org/wiki/Royalty_payment
[8] Store of Value (SoV)
A Store of Value (SoV) is any commodity or asset that would normally retain purchasing power into the future and is the function of the asset that can be saved, retrieved, and exchanged at a later time, and be predictably useful when retrieved.