Non-Fungible Tokens, or NFTs, are now going through a hype cycle similar to the one previously experienced in the blockchain/crypto sector during the initial coin offering craze. An NFT connected to a digital artwork sold at Christie’s auction for $69 million on March 11, 2021. There is a lively secondary market for some NFTs, which can swiftly increase prices after the original sale. Other NFTs, including one based on Jack Dorsey’s first Tweet, are selling for millions.

When the dust settles, NFTs will have some features that become commonplace as time goes on, just like any other hotly anticipated technological development. Still, some of the claims made about this new category of digital assets will turn out to be unreal.

What a customer indeed possesses when purchasing an NFT can be offered as one of the fundamental questions, especially for those focused on the legal issues raised by NFTs.

NFT : What is it?

Starting with Ethereum in late 2017 and now encompassing additional blockchains, several public blockchains have established a standard for generating tokens on their chains that, in contrast to conventional cryptocurrencies, are non-fungible. NFTs are distinct from Bitcoin or Ether, which can all be exchanged for one another.

Tokens on a blockchain are just pieces of software code with specialized functionality identifiable by a unique identifier, or “hash,” a lengthy string of numbers and letters. So a token is a chunk of digital information with pushable and pullable levers that have been preprogrammed. When it comes to cryptocurrency, these digital currencies can be traded with one another in the same way that real paper money is. For example, while each Bitcoin has a unique serial number, they are otherwise identical in trading.

NFTs can represent other distinctive assets online or in the real world because they are not fungible. For instance, an oil painting hanging on the wall of an art gallery could be represented by an NFT. NFTs can more frequently be linked to another digital asset by cryptographically linking the token with it.

The Issues With Ownership of Digital Assets

One problem jumped out above all others when I initially started writing and giving clients advice on leveraging blockchain technology in media and entertainment in early 2016: The discrepancy between how people thought the technology worked and how it operated.

For instance, many believed at the time that a blockchain could be used to deliver media assets, making it simple to move digital assets around like cryptocurrency. As ledgers for tracking transactions, blockchains are excellent, but they are lousy for storing or distributing digital assets of any magnitude. Mainly, the media asset files are too big.

This implies that the file—whether a picture, a movie, an eBook, or anything else—must “live” somewhere else for digital media assets. On a blockchain, the asset can be recorded permanently and securely. That record can be cryptographically “linked” to the item wherever it resides off-chain, but they do not coexist. Consider how a library operates: There is a card catalog that lists the books’ locations and the dates they are checked out, but the books are stored separately on shelves.

After deletion of the underlying digital asset modified on the platform where it is hosted, this could potentially lead to problems. (To address this, distinct international networks have been developed to store digital assets in a decentralized, permanent manner, such as the Interplanetary File System (IPFS)—these files can then be linked to a blockchain record with more excellent permanence.) As a result, it’s crucial always to consider where the underlying content is stored when examining any blockchain-based system incorporating media content, including NFTs.

“Double Spend” and the first sale

Even identical books will have tiny differences between two copies. Differences in how they are bound, how the color appears, and the printing quality, even though physical items are not fungible. Digital media, in contrast, have the potential for unlimited replication and meaningful variation.

We, therefore, have the copyright “first sale” doctrine in the physical world, which states that an imitation of a piece of art that has been physically manifested is purchased and sold in a secondary market without the original author having any control over the secondary sales. We separate the intangible work of art or writing protected by copyright law from the tangible copy, so the owner of the physical copy loses all interest in the underlying copyright for the work.

Given how simple it is to copy digital files, American courts have refused to recognize the “digital first sale” doctrine. As a result, media files are essentially treated as fungible under copyright law, and there is no unique digital media asset that can be purchased and sold on a secondary market.

The problem of limitless replications of digital assets in the digital currency domain is known as the “double-spend” problem. Since a digital dollar is merely a unique identifier (a collection of letters, numbers, or symbols), there is nothing to prevent someone from replicating it and distributing it to several recipients. How can we ensure that a digital currency unit delivered from one person to another isn’t also sent to another?

The blockchain ledger, shared in a decentralized manner among computers around the world but not under anyone’s control, is how Bitcoin addressed this issue by adding a third transaction ledger above and above the accounts maintained by each party to a transaction (or their banks). Bitcoin avoids monetary double-spending by establishing this public ledger.

Several years ago, we initially discussed how blockchain technology might be able to resolve the first sale/double-spend dilemma because of its capacity for cryptographically tracking objects. The growth of the NFT standard has given this query new life.

The (Partial) Rescue of NFTs

Since NFTs are digital tokens, just like the cryptocurrencies on which they are based, they may be purchased and traded on the open market. Beyond some of the astounding initial selling prices we’ve seen, NFTs have recently gained popularity because many of them have gone to trade for higher prices in secondary sales. But it’s crucial to keep in mind that nothing about NFTs alters the fact that their underlying asset always exists “off-chain,” just as books in a library are found on the shelves, not tied to their library cards.

As a result, when a user purchases an NFT, they buy the token itself, not the digital asset to which the token is connected. No rights or obligations about the asset are immediately transferred due to the cryptographic link; this is the outcome of a contract between the buyer and seller.

The conditions of sale for each NFT will determine if further rights or even the transfer of ownership of a digital file of the digital asset are included in the purchase of the token as a matter of contract. The variety of rights that could result from the NFT is essentially limitless.

For instance, the NBA’s Top Shot collectibles program, which has generated over $400 million in sales of NFTs connected to certain film moments in NBA history, is one of the most popular contemporary uses of NFTs. Users who buy NFTs are given restricted permission to use, copy, and display the related photos and videos for private, non-commercial purposes only.

According to reports, the NFT that sold for $69 million at Christie’s auction contained certain display rights in the image. The artist reportedly promised to work with the buyer to make a physical display of the artwork possible. However, the artist still holds the copyright to the image and may also keep a copy of the digital file.

Most of these assets are available for viewing on the NFT sales platforms. Therefore anyone is free to take a screenshot or perhaps create a clone. Additionally, anyone may hold a copy of the underlying digital item in addition to the creator or original seller. Ownership of an NFT does not prohibit the third party from producing a duplicate of a digital asset that is connected to an NFT if they have access to it, similar to how a card catalog’s existence does not end others from reading books that are on the shelf or even prevent someone from stealing books from the stacks.

Information Inequality

Many people buying NFTs today might not be aware that they may be buying less than they think, just as many people, in the beginning, did not grasp how blockchain worked for media content. Buyers can misunderstand that when they acquire an NFT linked to underlying digital assets, they buy the investment rather than just the token.

The Non-Fungible Token entry on Wikipedia states that “[a]n NFT is created by uploading a file, such as an artwork, to an NFT auction market. This creates a copy of the file recorded on the digital ledger as an NFT, which can be bought with cryptocurrency and resold.” This is untrue; typically, only a cryptographic “hash” (identifier) will be connected to the token, and the files remain off-chain on the platform. Instead, a file copy is not typically maintained on the blockchain.

With this novel technology, it’s possible that some customers mistakenly believe they are acquiring a controlling right in the underlying work, even though it may be evident to the majority of customers that they do not acquire ownership of the copyright in the underlying novel when they buy a copy of a book. Even if they don’t, people think they are getting more rights to exploit the work than they are. Or they might think they’re buying a one-of-a-kind digital file when they’re not. It becomes crucial that users evaluate and comprehend the terms of the sale.

Another central myth that permeates the NFT market is that “smart contracts” are primarily used to encode the terms of sale. To a certain extent, this is accurate: The smart contract for a certain NFT specifies the fundamental conditions of purchase in terms of who receives what payment. This could, for instance, entail a requirement that the original creator or seller receive a cut of subsequent sales, a particular NFT characteristic that could be ground-breaking.

Although it’s unclear how many NFT sellers are using this option, NFTs can contain a link to off-chain information about the token that may include details on the rights that flow with the token. But this does not imply, for example, that the token’s functional code contains all of the selling terms.

For instance, if the seller included a clause prohibiting customers from exploiting the underlying digital art for commercial reasons, as long as the buyer and seller understood the governing terms, the restriction would probably be enforceable. However, the NFT smart contract itself cannot enforce that clause; instead, a seller must use conventional enforcement procedures (e.g., demand letters, litigation).

Also, read – How digital asset ownership is upsetting the traditional business paradigm via Web3

A Long Chain of Liability or Caveat Emptor?

It’s not entirely clear whether a user will be held later to have agreed to be bound by whatever conditions of sale are initially connected with the NFT simply because they bought an NFT. It can rely on what the customer saw and acknowledged when making the purchase.

Practically speaking, most NFT platforms currently include the terms of the sale in a licensing agreement that can be found on the platform itself. This ought to be adequate to ensure that the original seller and the first buyer initially have the same understanding. Will the terms be adequately communicated to subsequent buyers if NFTs are later exchanged off-platform in a secondary market? If not, has the agreement on the terms been reached?

Some initial sellers (and NFT platforms) may believe that all subsequent transactions are out of their control and that downstream sellers must inform potential buyers of the terms of the sale. However, it is not sure that the initial seller may assert that the enforcement of words is not the original seller’s issue if, for example, each subsequent sale includes payment of a percentage back to the seller.

Despite the haziness around these challenges, NFT sales are increasing in quantity and value. To ensure a robust and long-lasting market for NFTs in the future, sellers and buyers owe it to themselves to better comprehend the agreements they are forming.