Introduction to Non-Fungible Tokens and their potential applications in the media and entertainment industry

Non-fungible tokens (“NFTs”) have been dominating technology columns in the media lately. Items that would previously not have been considered traditionally ‘marketable’ or high value are now being sold for eye-watering sums. For example, a digital artwork by Beeple sold for US$69 million, a token of Jack Dorsey’s first tweet sold for US$2.9 million, a token of a GIF of the ‘Nyan Cat’ created a decade ago was auctioned for US$590,000, and a NFT representing Tim Berners-Lee’s original source code for the world wide web was recently sold for US$5.4 million. NFTs have also meandered into the music, sport and fashion industries among others.

In this first article in a series of posts, we provide a high level overview to NFTs and some of the key legal issues arising from their unique nature. Subsequent posts will take a closer look at these and a variety of other key legal and regulatory considerations when applying existing concepts and regimes to NFTs and their underlying technology.

 What are NFTs?

An NFT is a ‘token’ or cryptoasset which represents an object (e.g. art, music, collectible, etc) and is stored on a blockchain. Unlike cryptocurrencies, these tokens are described as ‘non-fungible’ because they are unique and are not replaceable or interchangeable with others of their kind. The immutable nature of these tokens is the key to their success as a reliable form of authentication of original work in the digital world, where anyone can create, share, download and reproduce a piece of digital content (often at no cost).

In order to grasp fully the concept of NFTs, it is important to understand the underlying technology. In simple terms, a token is a string of numbers and letters which may represent a physical or digital asset. Tokens are stored on a blockchain (i.e. a distributed ledger – see our previous article on blockchain technology for more information), which provides an immutable, time-stamped record of transactions, therefore when NFTs are transferred to other users on a blockchain, this transaction is permanently recorded. Transfers of NFTs take place using code referred to as smart contracts (i.e. instructions in a coding language which are automatically executable on the blockchain ledger): these enable automated fund and NFT transfers from one digital wallet to another. Smart contract code can also be used to automate commission (or royalty) payments to the creators of the underlying work upon subsequent sales.

 What do you own when you own an NFT?

An NFT is a representation of an underlying asset, not the asset itself, therefore owning an NFT means one can claim ownership over the token however it does not, by itself, result in ownership of the underlying asset. As such NFTs do not automatically confer copyright in any creative work represented by the NFT, unless otherwise agreed between the creator of the NFT and the first purchaser.

Holding an NFT does not necessarily restrain others from creating or accessing copies of the underlying work. For example, thousands of copies of the Nyan Cat GIF are available on the internet for anyone to access, download, store and reproduce. An NFT is only a unique tokenised representation of the underlying work with a demonstrable transaction history. However, as blockchain technology further improves some NFTs may embed the underlying digital asset itself which could potentially prevent reproduction and counterfeiting of digital content.

The terms and conditions applicable to the sale of an NFT can always be recorded in a separate contract so as to clarify the parties’ respective rights and obligations in connection with the sale. Some marketplaces like Foundation and SuperRare have clarified the rights that users receive by purchasing NFTs on their platforms; generally they provide that NFT holders do not own the creative work itself. Dapper Labs has also made the NFT license for its venture ‘Cryptokitties’ available for “any NFT project” to use.

 Are NFT transactions legal and enforceable?

Whether NFTs constitute ‘property’ under relevant laws will impact (for example) the legal validity and enforceability of their transfer, their treatment if fraud/theft occurs and the ability to grant security over the NFT. The UK Jurisdiction Taskforce (“UKJT”) in its Legal Statement on Cryptoassets and Smart Contracts has found no bar, at least in principle, to cryptoassets being recognised as property and English courts have been willing to treat them as such (at least when issuing injunctions, see our reports on AA v. Persons Unknown and Ion Science v. Persons Unknown). However, the status of these assets in many other jurisdictions is more uncertain.

The legal status of smart contracts in the UK remains the subject of debate. The UKJT Statement suggests that smart contracts are capable of having contractual force, but a further consultation is being carried out by the Law Commission and this position remains to be tested in the English courts. Transactions executed solely on the basis of a smart contract may therefore raise questions of enforceability, jurisdiction of courts, contractual interpretation and remediation in the event of a dispute.

If an NFT is purchased with cryptocurrency, it is also worth considering whether such cryptocurrency constitutes valid consideration in the relevant jurisdiction for the purposes of contract formation as only a few jurisdictions recognise crypto currencies as legal tender (for example Australia, Japan and Switzerland), while in other countries such as China they are still illegal.

 Are there any other issues and risks?

The fact that users can choose to remain anonymous/pseudonymous on a blockchain means that NFT transactions may pose additional risks from a compliance perspective and may also make it difficult to bring legal action or recover damages in the event of a dispute. Some trading platforms such as Nifty Gateway mitigate these risks by requiring users to provide documentation while creating an account on the platform, which could assist with identity verification as well as for compliance with anti-money laundering and economic sanctions rules.

The authenticity of the underlying work should also be verified – there have been instances reported of artists’ works being sold as NFTs without their permission. Marketplaces such as OpenSea have attempted to tackle this by building into their terms of service that content posted on the platform will not contain copyrighted material unless the user has permission to post the material and grant OpenSea a license over it. It has also designated a ‘copyright agent’ to deal with infringement complaints, and has reserved the right to remove content from the platform.

Smart contracts may also present practical difficulties which users ought to be aware of, such as system vulnerabilities and code malfunctions. Some platforms like SuperRare disclaim responsibility for smart contract risks like bugs, timing errors, hacking, theft and changes to the blockchain’s protocol rules in their terms of service.

 Application in the media and entertainment industry

In a move to counter the abundancy and availability of media content on the internet, NFTs have the potential of (i) reintroducing scarcity into an industry where the presence of intermediaries means that creators often take little part in the profit sharing and (ii) generating new revenues from content catalogues owned by media companies or investors.

Musicians have been venturing into NFTs as a way to increase revenue streams after a halt of live music performances due to the pandemic. Kings of Leon was one of the first bands to release a new album as an NFT along with a moving digital album cover and an exclusive physical vinyl, they also enabled fans to purchase a super token which granted them a golden ticket to access VIP seats at concerts. Earlier this year, musician and artist Grimes also sold 10 digital artworks at auction to raise a total of around US$6 million. In addition to authenticity and traceability, NFTs enable artists to cut out expenses of intermediaries which could solve the issue of musicians struggling to profit from their work. As the technology is still in its infancy, fans have complained of the poor user experience when purchasing NFTs which often requires purchasing crypto-currencies on an exchange, creating and accessing different crypto wallets and incurring a host of third party fees along the way, often doubling the purchase price of the token. However, this innovation is seen by some as an opportunity to generate revenue for artists with a smaller yet loyal fan base who receive meagre revenues from streaming services.

The NBA has been using NFTs to monetise its content by setting up its “Top Shot” marketplace powered by Dapper Labs, where fans can buy packs of NFTs featuring key highlights during games. Like Pokemon cards, the purchasers do not know which moments are included in the pack, but they have the ability to sell the NFTs on a secondary marketplace where the most sought after highlights have sold for up to $200,000 dollars.

The film industry has also been buying into the NFT craze as some filmmakers intend on seizing the opportunity to raise money for new productions by selling digital collectibles (such as artwork or sections of the film’s score), to publicise the release of a movie or to boost awareness of an issue. For example, in March 2021, Adam Benzine released 10 limited edition copies of his 2015 documentary “Claude Lanzmann: Spectres of the Shoah” on Rarible for an initial selling price of 100 ETH (approx. $260,000) – to this day 9 copies have yet to receive bids. Around the same time, Nick Box, a filmmaker, released a unique edition of his feature length art horror film called “Elevator to Insanity” on Mintable, he also attached the VOD distribution rights to the token – however it did not receive bids. While NFTs may create new revenue streams for filmmakers, potentially bypassing studios and distribution companies for financial contributions, these have yet to appeal to NFT purchasers and attract as much enthusiasm as other NFT use cases previously described. It is thought that this lack of success may be a direct result of an issue with low storage space on the blockchain. Until recently, the blockchain could only accommodate smaller files resulting in shorter video clips such as NBA sporting highlights mentioned above. However, a collaboration between companies VideoCoin and Filecoin has resulted in a recent announcement that they have managed to solve this storage issue by creating enough file capacity to store 725 million 1080p high resolution film NFT files. With news of this technological development, it will be interesting to see whether NFTs in the film industry gain more traction.

In conclusion…

NFTs are undoubtedly attracting significant interest as a lucrative ‘investment’ opportunity or for their ability to generate new revenue streams for content creators or owners, which is why they already have been used across a wide variety of sectors. However, given the many legal and practical challenges, especially around legal enforceability, ownership and intellectual property rights, it is necessary to tread carefully when considering venturing into the NFT space.