The digital market of today continues to witness swift and vast expansions, with an increasing interest in tokenizing various types of assets through Non-Fungible Tokens or NFTs.

NFTs allow for innovators, developers or other digital market participants to tokenize all sorts of digital and non-digital assets and to expand further the popularity and scope of the metaverse.

An NFT, as a gamechanger in the digital economy, has the capacity to end all expenses of authenticating digital good’s ownership, and the potential to create countless opportunities of revenue generation for programmers, artists, painters, writers or creators. As the zeitgeist of today’s digital era, NFTs hold the power to build a new online community.

 What Are NFTs?

NFTs are digital tokens, serving as evidence or records of rights towards, or ownership of exclusive assets, primarily recorded on the cryptocurrency Ethereum’s blockchain. Like any other asset, NFTs provide owners the rights to buy, sell or trade their owned digital (or in some cases even physical) assets, as long as the assets are unique and non-fungible to the extent that they are not mutually exchangeable, unlike most cryptocurrencies.

This allows for the NFT market to mirror any real-world art market, where a single masterpiece values at a higher worth than multiple copies. NFTs may be used in acquisition of audio or video files, digital art, games or gaming characters, songs or music, images, photos, memes, tweets, tickets, or essentially any other digital, or physical asset.

Once the NFT is logged onto the blockchain, all subsequent transactions pertaining to that NFT get automatically recorded on the blockchain, providing owners with an authentic and accessible record which can neither be forged nor deleted.

The fungibility of an item, an asset or a currency means that it is easily replaceable or exchangeable with an exactly similar asset; for instance, all Euros, Dollars or Rupees, pieces of paper that hold a value, hold the same value as other notes of the same denomination, and hence two different 50 Euro notes can be exchanged and interchanged with one another and both would be for the holders of the notes.

The notes, therefore, are fungible, and one note of a particular denomination does not hold greater or lesser value than another of the same denomination. Such is not the case with NFTs, and no two NFTs, even of the same underlying assets, are equal to one another.

And hence, they are characterized as ‘non-fungible’, and are valued for their uniqueness and the non-existence of a replacement. Whereas non-fungibility may not be of much consequence in the real world; no one person, friend or pet can ever be the equal of another, in the digital world, where copying and mass-production of a digital asset is far easier to transpire, the ability of the blockchain to maintain non-fungibility of NFTs is an achievement which has led to its heightening success.

The availability of digital assets on the internet, and the ability to generate multiple copies was tackled by NFTs, designed on the Ethereum blockchain to resolve all issues arising from third-party involvements and moving from a centralized system to a decentralized and undisputed ownership of an asset.

A blockchain is essentially a digital ledger which distributes information across the network to all its users on trades and transactions incorporated into it, and automatically updates all future actions carried out in reference to it.

It is a system near impossible to hack or to cheat (unless a party has access to 51% or more of the total network resource) and hence, the information available on the blockchain is reliable, without chances of forgery or unwarranted changes.

An NFT, once transacted, is logged into the blockchain, hence making it available and unchangeable forever. An NFT is hosted on the blockchain as a “smart contract” with metadata, traceable through its unique transaction ID which provides the particular characteristics of an NFT, and is customizable.

It allows for a particular NFT to fuse in with other NFTs in the metaverse marketplace, an interface which have been programmed on the blockchain where sale and purchase of NFTs takes place, through their token standards.

The transaction IDs most commonly used for NFTs are the ERC-721 and ERC-1155: ERC-721 is a standard which represents uniqueness and exclusive ownership, whereas ERC-1155 allows for fungible copies or versions of the asset to be generated, in order to assist content generation.

Important NFT Statistics to Keep in Mind:

Unique Wallets Trading in NFT per Week, April 2021-2022, Credit: Dune

• The total expenditure of Crypto in the NFT marketplace in the year 2021 amounted to $ 41 Billion.
• “The Merge” is the most valuable NFT till date, amounting to $91.8 Million.
• The trading volume of NFT saw exponential growth in 2021, with a rise of 704% within different quarters of the same year.
• More than 50% of NFT transactions are below $200.
• Countries with the highest number of NFT transactions and owners are all in Asia: Phillipines (32%), Thailand (27%) Malaysia (24%), UAE (23%) and Vietnam (17%) of the population.
• Nigeria is expected to have the highest growth in NFT transaction, a 21.7% growth from 13.7% of the population to 35.3%.

NFTs and The Revolving Legal Issues Around Them:

NFTs may have gained traction in the digital economy, the legal sphere, however, is yet to catch up to the metaverse: NFTs, as of now, stand unregulated by the legal frameworks of most jurisdictions across the globe, and as such, raise multiple legal and policy concerns.

Few laws are directly associated with the creation, use or transfer of NFTs, and though their sale and purchase is perfectly legal, the rights and other legal implications attached with them can raise multiple legal concerns. Some of these concerns include:

Ownership Rights or Licensing Claims:  It is imperative for issuers, buyers or sellers of NFTs to ensure what specific rights are being provided or sold to the buyer of the NFT, and whether the ownership of the digital asset also includes the Intellectual Property license of the asset, or whether such license is retained by the asset creator.

Such clarifications are required in advance of the purchase, in order to avoid messy legal claims in the future pertaining to various commercial or non-commercial claims over the asset.

Communications between the parties should be clear on the extent of the buyer’s “ownership” of the asset, and any limitations which may be attached with the rights to receive, use or gain any benefits from of the assets.

IP Or Copyright Matters: Issuance of NFTs which include an asset, or a part of that content for which a trademark or a license is owned by another, any misstated issuance of ownership, or unwarranted use of such asset could let to third-party copyright infringement.

Moreover, a buyer who does not have the license of the content cannot transfer such a right to any future transfers, hence giving rise to any number of future lawsuits from the original copyright owner of the content or asset.

Data Protection and Privacy Laws: Most data protection laws provide the users with the option of choosing to amend or erase their data from the system, this however is functionally impossible under the blockchain technology which does not allow for data to be altered or deleted.

Hence, NFTs and any related personal data logged into blockchains have the potential to violate data protection laws under the legal frameworks of most jurisdictions.

Money-Laundering: There lies an underlying issue with NFTs where exceptionally large sums of laundered money may be used for the purchase of digital assets as a way to hide it from authorities.

It has been suspected that money laundering and terrorist financing may be carried out through the digital art world, giving rise to financial crimes.

Insider Trading: Corporations in the business of generating, as well as the digital marketplaces selling NFTs are in much need of adopting NFT insider trading policies in order to ensure no illegal or unfair activities are conducted within the companies and marketplaces.

Such policies should be strict with regards to sharing any confidential information with outside parties, and it should be illegal to purchase NFTs based on such confidential and private information.

Taxation of NFTs: Considering the large amount of money used in purchase of NFTs, it is concerning that NFTs, similar to other cryptocurrencies, are not taxed.

The laws are ill-equipped to deal with NFT taxation, and it is unclear which taxation boxes NFTs may fall into, hence placing them for now in a taxation black hole, highlighting the cracks in taxation laws.

Property Laws: NFTs show ownership of property, and hence it is important to be aware of exactly which jurisdiction would govern the property right claims of the owner towards the asset.

Generally, under property law, the situation and location of the asset is considered in determining which laws of property would apply; as NFTs showcase ownership of unique copies of the content, rather than the original content itself.

Actions From Legislators: EU And Abroad:

Despite the evident need for laws and regulations to manage NFTs, little efforts have come to fruition, especially in the case of the European Union (EU). EU’s draft Regulation on Market Cryptoassets (MICA) till date excludes NFT from its scope, despite continued efforts from the European Parliament.

As per Article 4(2) of the Regulation Bill, issuers of “crypto-assets that are unique and non-fungible” need not register for them under the Regulation, nor do the Rules currently apply to them.

It is advertised yet and again that the scope is to be extended to NFTs, who would need to act within the framework of the Regulation, however, such amendments have yet to take place which include non-fungible and unique crypto-assets within its ambit.

Though the European Parliament, as well as the lawmakers are in favor of including NFTs within the Regulation, it seems that the national governments are not too keen on this notion. Nevertheless, as the Bill has reached its final stages, and is expected to be passed soon, the fate of NFTs and NFT issuers stands awaited.

As for efforts abroad, the Executive Order on Ensuring Responsible Development of Digital Assets, which was published by the White House on March 9, 2022, in order to assist governmental reports on study of NFTs and ways to regulate it.

such steps are required due to the “advances in digital and distributed ledger technology for financial services have led to dramatic growth in markets for digital assets, with profound implications for the protection of consumers, investors, and businesses, including data privacy and security; financial stability and systemic risk; crime; national security; the ability to exercise human rights; financial inclusion and equity; and energy demand and climate change.” Moreover, draft legislation has also been in works, however, as of et, NFTs are unregulated in USA as well till such a time when the legislation is passed.

Conclusion:

Despite the constant rise in NFTs since the last year, an analysis of its framework highlights the potential legal issues that currently are, or in future might arise from the growing popularity of NFTs.

It is imperative, therefore, that the legal frameworks be equipped with the necessary tools to proficiently regulate the metaverse.

Till then, the duty largely falls upon the actors involved in the NFT transactions to safeguard themselves on their own from legal claims, by employing rigorous due diligence and being meticulous in their contracts concerning purchase of NFTs.

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About Author:-  Mr. Khawaja is an International Technology Lawyer based in Düsseldorf and managing partner of KLA Germany. He is known for providing robust solution with pragmatic approach on topics related to IT law, GDPR, Arbitration, IP, Startups, Investment and International Trade.