The meteoric rise of the NFT and its trail of uncertainties

The topic of the non-fungible token, or NFT, hit the mainstream news when Christie’s sold a Beeple artwork for USD 69m [1]. In reality – or should I say, in virtual reality –, the sale was not of the artwork itself but of its tokenized form, called an NFT.

The NFT is a convenient device and, for laymen like yours truly, the logical result of the intersection between digitalization, on the one hand, and distributed ledger technology (DLT, of which the blockchain is an emanation), on the other hand.

Indeed, we have been witnessing a transition from physical objects existing purely in their “real” world physical form to their duplication in the digital realm, much like you and me, as individuals, also exist online through IP addresses, usernames, and in some cases digital/electronic identity [2].

In addition to that trend, DLT offers a resilient (read tamper-proof) means to store information. For all the noise and frenzy surrounding its existence and market adoption [3; 4], DLT does seem set to change the ways in which we transact. In particular, because it gives us a way to do something extremely simple, yet practically difficult: confirm facts. For instance, DLT could – maybe should… or not? see below – be used to run a land registry, an intellectual property rights database and so on and so forth.

The tokenization process allows, among other things, to represent an object on a blockchain. The existence of this token will remain limited to the blockchain on which it is recorded. Conversely, this blockchain will record all this token’s “life” events, such as its birth, change of hands, etc. Many tokens are deemed “fungible”, such as a crypto-currency coin, in that one item is equivalent to any other item of the same. The NFT, though, is intended to be different. The NFT is not a fungible asset as it is the tokenized form of a specific item, a one-of-a-kind.

As an aside, the extent to which the notion of fungible goods under the law applies to the same extent in the DLT/NFT area is currently anyone’s guess. In particular, this is relevant from a securities standpoint. Indeed, many jurisdictions, including Switzerland [5], qualify certain tokens as securities, and securities are necessarily fungible (art. 3 lit. b Swiss Financial Services Act intermediated securities; see also art. 3 para. 1 Swiss federal Intermediated Securities Act which expressly notes that the underlying security must be fungible). Long story short: NFTs could be fungible securities. The least that can be said is the name may be misleading.

Be that as it may, the market has welcomed NFTs, as the introductory examples show. Moreover, IBM recently announced that it is looking into a system that would tokenize its patent portfolio into NFTs, thereby greatly facilitating the visibility and, hence, monetization of that patent portfolio [6]. Indeed, patents are one of the strongest intellectual property rights as they give the holder a form of de facto monopoly over the patented technology. One issue with patents is, however, the arguably tangled patent registers and the lack of clarity surrounding the patents in existence, which issue IBM is hoping to resolve.

Artists in particular are embracing the NFT. Indeed, (digital) artworks are protected by copyright. However, enforcing the artist’s copyright prerogatives in the digital realm is arduous because digital works can easily be duplicated (e.g. right click, save as). The NFT offers, conceptually at least if not legally, a solution to this duplication problem.

In any case, because the NFT is the result of digitalization, it probably remains a mere representation, a confirmation of something that occurred elsewhere. For instance, when an artist sells a digital artwork by means of an NFT auction, the NFT may be the simple confirmation that a sale occurred. Legally speaking, the NFT would be the proof of the artist having assigned or licensed – depending on the terms of the NFT sale – her copyright over her artwork to the buyer. This is reminiscent of the debate around smart contracts, where some would argue the smart contract is a pure technical device allowing the parties to a (real) contract to implement the terms of their agreement, while others would argue that the smart contract may very well be a contract in itself provided it embodies the legal requirements (e.g. offer and acceptance) [for a reference, see 7]. In the case of the NFT however, the issue is further muddied by the fact that the underlying work often only exists in virtual form, meaning that there is no true original version but only a potentially infinite number of identical copies.

In that respect, another noteworthy development concerns the risks currently surrounding NFTs. Despite the assurances of DLT, tamper-proof does not mean that capable individuals cannot find loopholes and workarounds. For instance, an individual, going by the moniker of “Monsieur Personne”, appears to have found such a work-around [8]. He supposedly has succeeded, through a rework of the smart contract underlying the NFT’s creation and transaction, to reallocate ownership of artworks tokenized in an NFT. The result is an attribution of an NFT that seems valid from the blockchain’s perspective, but is factually inaccurate. More specifically, through a process called “sleepminting”, a third party could create an NFT and allocate it to, for instance, the artist who created the tokenized artwork; this third party would then sell for a pretty penny this NFT to a gullible buyer. The NFT would therefore reference the correct artist, but the transaction would be – at best – deceptive. This appears to be the result not of a DLT flaw but of the perhaps overly simplistic smart contract at stake, namely ERC-721 (hey, who said contract drafting was easy?!).

All the above makes one wonder how to apply the laws to such set-ups. In addition to the question surrounding securities and the fungible nature of tokens, a key consideration around NFTs pertains to copyright law. Namely, what is the artist/copyright holder actually doing when she auctions off an NFT on her work? Does the NFT allow us to imply that there is an assignment (read sale with transfer of title) of all intellectual property rights, or is only one copy being conveyed, or is it a license, or nothing at all? Probably much of the answer to this lies in the terms associated with the NFT. Let us not, then, forget to read the small print. But that is not all, as it seems unlikely that the NFT could transform what is merely a digital copy among a potentially infinite number of digital copies into a “true” and “original” copy, like the unique artworks we see in museums. It would therefore indeed seem that the artist is actually not transferring as many rights (especially ownership) as she actually intended to, as the NFT can simply not accommodate all those rights.

And anyway, by the time you are done reading this, the NFT may already be a thing of the past, a mere blip on the screen, or not. Stay tuned.