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The curious rise of NFT's and related legal issues

Posted by Steve Vondran | Jun 14, 2021 | 0 Comments

Attorney Steve® - NFT Copyright Law - Overview of Non-Fungible Tokens (NFT's)

NFT copyright attorney

What are NFTs?

Non-Fungible Tokens, or NFTs, are digital files verified on a blockchain. NFTs can represent almost any property that is in digital format. NFT's are essentially virtual certificates of authenticity. NFTs are immutable, meaning historical records of transactions cannot be changed. The blockchain ledger tracks all sales and re-sales of the tokens.

In recent months, NFTs have risen in popularity. It is now seen as a source of revenue for artists and companies alike that can no longer be ignored.  This article will delve into how NFTs are created and what artists, photographers, and other creative folks need to know.  As an initial overview, let's see what Wikipedia has to say:

"A non-fungible token (NFT) is a unit of data stored on a digital ledger, called a blockchain, that certifies a digital asset to be unique and therefore not interchangeable.[1] NFTs can be used to represent items such as photos, videos, audio, and other types of digital files. Access to any copy of the original file, however, is not restricted to the buyer of the NFT. While copies of these digital items are available for anyone to obtain, NFTs are tracked on blockchains to provide the owner with a proof of ownership that is separate from copyright."

What types of digital works can be the subject of a NFT?

Just about anything that can be digitized can be the subject of a NFT.  This includes things like:

  • Photos
  • Memes
  • Illustrations
  • Trading cards (ex. sports cards)
  • Videos
  • Film
  • Tweets (see Valuables website - where Twitter founder sold his first tweet as an NFT for 2.9 million dollars)
  • Music
  • Ringtones
  • Virtual products / virtual worlds
  • Fine art
  • Domain names
  • "Crypto collectibles"

You can find all kinds of examples of things that have been converted (or "minted') into NFT's.  Literally, this is wide-open and limited only by the imagination.  There are many online marketplaces that sell different types of NFT's (see some examples below), and even large auction houses like Christies are getting into the NFT auction space.

What are some of the potential legal issues?

Any time you have new technologies, you have new legal issues that can often challenge the application of existing law.  For example, some of the key legal questions I think we are going to see are:

  1. Does the NFT creator have all the rights necessary to mint the NFT (ex. do they own all of the content that comprises the NFT, all publicity rights if they are using images of real people, all the releases or permissions that they need).  If not, what are the creators selling (aside from a potential of a lawsuit when third party claim rights to the minted NFT)?
  2. Can a NFT creator rely on fair use in creating their unique digital property?
  3. If the creator is using celebrity name, image and likeness (ex. in selling a sports collectible), do they have a celebrity release or license?  
  4. Can you copyright register the NFT?
  5. What is the buyer actually purchasing when they acquire an NFT?  Is there an obligation to pay future royalties?
  6. How is an NFT advertised for sale?  Is there really the value the creator, online marketplace or online marketplace is touting that the NFT has?  (potential for claims of false advertisement)
  7. Can one NFT infringe another?
  8. What if the buyer of an NFT resells and there are issues over the royalty due the original creator?
  9. What happens if a dispute arises?  Is there counsel experienced and knowledgeable in the area of NFT dispute resolution?
  10. Are NFT's subject to DMCA takedowns?  What if the takedown is done in bad faith?
  11. What is the ERC721 standard (which defines how NFT's can be transferred and created on the Etherium blickhain)
  12. What if their is a breach of the digital certificate of authenticity that comes with an NFT?

These are some of the initial issues I see as a copyright attorney.  There are undoubtedly many other issues that will arise.

How to Mint an NFT (basic overview)

Let's take a look at how to "mint" or create NFT.

There are currently three major minting apps:

(1) OpenSea

(2) Rarible

and

(3) Mintable

These sites can vary in scope and operation.

GENERAL OVERVIEW

To "mint" an NFT, a creator first needs to create a MetaMask (or their are other wallets such as Trustwallet, Dapper, MyEtherWallet, Coinbase, Bitski, Wallet Connect, Authereum or any other of the multiple options) Ethereum-based wallet.  One who wishes to mint an NFT must sign up for one of these apps (using the Ethereum-based wallet that they have already created).  

Part of creating the wallet is to create a Passphrase.  This consists of 12 words that will become your passphrase to your wallet.  You need to keep this in a safe place and not share it with ANYONE for any reason.  If you lose this you can lose everything in your account.  Some people put this in a safety deposit box to highlight the important of keeping this secure.

Next step is to upload the artwork into the application.

Once the artwork is uploaded, the creator will want to include background information about the artist's creative history, along with any interesting facts about the artist and the NFT itself. NFT collectors want to know why the artist's work will have value to them. Telling a good story is key to creating interest needed to generate a sale, and hopefully, a bidding war.

Once these steps are completed, the NFT is ready to be minted.

The app will have a “Mint NFT” button that the creator should click.

The creator's Ethereum-based wallet will then prompt the creator to “sign” the creation.

Doing this links the creator to that particular NFT forever and ensures that the creator will always be listed as the original artist and be the one to whom royalties are due on secondary transactions (ex. if the NFT buyer wants to turn around and re-sell, will a commission or royalty be due to the original creator)?

The final step is for the minter to approve the “gas fee.” Gas fees are the cost of minting an NFT on the Ethereum blockchain.

OFFERING FOR SALE

Once the creator accepts and approves these fees, the process is complete, and the only thing left to do is wait for the platform to officially mint the NFT. Once the transaction is confirmed by the platform, the creator has successfully minted an NFT and will forever be listed on the blockchain ledger as the sole original owner of that NFT.

Once the NFT is minted, it can be auctioned on an NFT marketplace or offline auction houses like Christies (see .  The high bidder is essentially buying a "token" and certificate of authenticity and an accepted offer gets minted on the Etherium blockchain.  The blockchain serves as a digital ledger (documenting all transactions and serving as a "digital chain of title" report).

Smart Contracts and Resale Royalty Rights

Smart contracts are an important part of ensuring that NFT creators are paid their due royalty fees on the intellectually property that they rightfully own. These smart contracts are coded to automatically execute agreements or parts of agreements. The smart contract can constitute the entire agreement or can serve as a complement to a traditional contract. A smart contract is coded to automatically perform a specific task upon the occurrence of a certain triggering event. These contracts can currently only perform basic tasks, such as transferring bitcoin from one wallet to another.

NFT Royalties

Most NFTs are minted as ERC-721 tokens (aka the ERC721 standard). The way these tokens operate is that after the initial sale, the original artist sees no royalty on secondary sales.

Some platforms are trying to remedy this issue and allow artists to see royalties on secondary sales of the NFTs they mint. One new NFT platform, Zora, allows artists to set a “creator share” which is a royalty percentage they will be due on all future sales of the NFT. This creator share is automatically paid through the use of smart contracts and is auditable on Ethereum to ensure that creators are getting paid the royalties that are due to them.

One major problem with Zora's platform is that the smart contract does not trigger if a subsequent sale is made on a secondary market. The royalty will only be automatically paid if the secondary sale is made on the Zora platform.

Current United States law does not recognize resale rights with recourse for unpaid royalties, as the UK and EU do, so this makes it tough for NFT creators to be made whole when their royalties do not get paid. Smart contracts are one possible solution to this problem.

This creates an issue over auditing rights.

Intellectual Property Rights of NFTs

When an NFT is sold, all copyright rights remain with the original creator, except the right to re-sell that individual token. The creator may choose to specifically assign certain copyright rights (i.e., public performance, right of reproduction) when making the initial sale, but this must be specified in the contract of sale.

The purchaser of an NFT typically only receives the right to use the underlying copyrighted material associated with the NFT for personal use.

NFT in the News

NBA TopShot

Recently, the NBA partnered with Dapper Labs (“Dapper”) to develop a digital trading card system based in the blockchain called NBA Top Shot. The tokenized cards contain clips of memorable plays that a user can memorialize in their collection for a certain price. In just its first few months, NBA Top Shot generated over $230 million in revenue. Each digital “card” is minted as an NFT so unique cards can be quickly verified as authentic or as fake even if someone creates an identical copy.

All secondary peer-to-peer sales occur on the NBA Top Shot platform so Dapper and the NBA are able to collect a royalty on every transaction.

Dapper licenses the clips from the NBA and then Dapper mints the NFTs. Typically, there is only one NFT for a particular highlight, so if one clip becomes in high demand, the prices in the secondary market can skyrocket. The most expensive clip sold so far was a Lebron James dunk against the Sacramento Kings from the 2019-20 season. The NFT sold for a whopping $208,000!

As with anything, things are worth what people are willing to pay for them. The purchasers of the most expensive NFTs believe that these NFTs will be a sound investment and will appreciate in value over time. Whether that will be the case remains to be seen.

Emily Ratajkowski NFT

Recently, Emily Ratajkowski sold an NFT of a photo of herself in front of a “painting” by Richard Prince. Here is a depiction of the NFT at issue:

The painting is of an Instagram photo Ratajkowski posted herself, containing comments by a few people, including Prince himself. This single NFT brought to light a myriad of copyright issues.

Ratajkowski owns the physical copy of the background painting, but probably not the right to digitally reproduce it. The foreground photo of Ratajkowski in her apartment is likely owned by the photographer or by Ratajkowski herself. The Prince painting is a print of a Ratajkowski (@emrata) Instagram post featuring a photo from a shoot she did for Sports Illustrated. All three of Prince, Ratajkowski, and Sports Illustrated likely own some copyright rights in this painting.

The Instagram post also contains Ratajkowski's profile photo in the top left. She likely owns the copyright to this photo. The painting also contains comments written by other viewers of the Instagram photo who may own a copyright in their words if there is something minimally creative about them.

Ratajkowski's primary motivation in minting this NFT was to “troll” Prince, an artist known for transforming other artists' work in minor ways and profiting off it. She was attempting to give him a taste of his own medicine, so to speak.

Going forward, Ratajkowski will receive a royalty every time this NFT is sold. Whether she will be sued by any of these potential copyright holders in the underlying material remains to be seen. This recent example illustrates the many copyright considerations any minter of an NFT must be aware of.

Banksy and the Injective Protocol NFT

Another recent example of copyright issues associated with the sale of NFTs can be seen in an NFT minted and sold by blockchain company Injective Protocol (“Injective”). Injective bought a piece called “Morons” by famous artist Banksy for $95,000. Injective then filmed a video of someone burning the piece of art and minted that video as an NFT. Injective then turned around and sold this NFT for $380,000, netting themselves a large profit. This potentially violates Banksy's moral rights as an artist and it remains to be seen whether he will be seeking any legal remedy.

This is potentially analogous to another recent case where the court ruled that there was a breach of copyright rights. Dann Thorleifsson and Arne Leivsgard, Faroe Islands watchmakers, purchased a painting by artist Tal R for $90,000. Thorleifsson and Leivsgard intended to cut up the actual canvas and use those pieces of canvas as the material for 200-300 designer watch faces to retail at $1,470 apiece. The court ruled that this constituted modifying the artist's work without his permission, and thus violating his copyright.

Problems and Considerations with NFTS

What many do not realize about NFTs is the massive impact they have on the environment. Most NFT sales are based in the cryptocurrency Ethereum. Each of these transactions requires a lot of energy. The average Ethereum transaction requires 35 kWh of energy, or 6.1 more kWh than the average American home uses per day.

NFT transactions are even worse. A single NFT transaction can include hundreds of these Ethereum transactions.

Proof of Stake v. Proof of Work

There are two “consensus mechanisms” used to confirm transactions on the blockchain without needing a third party: Proof of Stake and Proof of Work.

Ethereum currently operates on a proof-of-work system, which means that verification of a transaction requires someone in the network to solve a cryptographic algorithm using computational power to confirm that a new block in the blockchain is valid. These algorithms require an incredible amount of energy to solve, exacerbating the environmental impact problem.

One alternative that can help solve this problem is Ethereum 2.0. Ethereum 2.0 operates on a proof-of-stake system. In this system, users of a particular blockchain must stake a certain amount of coins from that particular chain, which are then frozen. Among all users that stake coins for this purpose, a verifier is chosen randomly. The theory behind this system is that those with a large stake in the blockchain will have a large incentive to properly validate transactions and keep hackers out of the network for fear of losing their entire stake.

Ethereum 2.0 uses significantly less energy than Ethereum and a transition to Ethereum 2.0 as the main blockchain base for NFT transactions would have an enormous positive impact on the environment.

Conclusion

NFTs are potentially the next great wave that many companies and individuals may want to investigate and take advantage of.  Or, it could simply be a trend (but I don't think so, just like trading baseball cards, as long as you have buyers and sellers there is a marketplace).  Only time will tell.  But with so many different blockchain marketplaces popping up, it will certainly be interesting to see where this all goes.

Regardless, they have become so mainstream that it is no longer prudent business to ignore them and there could be some incredible business opportunities that will present themselves going forward. Business owners and artists should educate themselves NOW on what NFTs are and how they can be beneficial to them to keep pace with competitors or to create new markets for their digital goods. For now, it looks like NFTs are here to stay and early adopters will be rewarded as such.

This blog is written by Justin DeLuca, University of Arizona law student with contributions from Steve Vondran, Esq.

If you need a  blockchain lawyer for an NFT legal issue contact us at (877) 276-5084.

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Sources:

https://fstoppers.com/originals/nfts-are-causing-global-ecological-disaster-im-not-exaggerating-557465

https://www.bitdegree.org/crypto/tutorials/proof-of-work-vs-proof-of-stake

https://www.coinbase.com/learn/crypto-basics/what-is-proof-of-work-or-proof-of-stake?utm_source=google_search_nb&utm_medium=cpc&utm_campaign=9943088770&utm_content=127915792732&utm_term=&utm_creative=523247202125&cb_device=c&cb_placement=&cb_country=us&cb_city=open&cb_language=en_us&gclid=Cj0KCQjwnueFBhChARIsAPu3YkQ4DOzvKUHbQ_CzXkUJrV2UrYmpHU2HlyUIJEGAwtEt3lDvOVv3D8saAkFhEALw_wcB

https://www.theverge.com/2021/4/24/22399790/emily-ratajkowski-nft-christies-copyright-nightmare-richard-prince

https://www.artsy.net/news/artsy-editorial-danish-court-ruled-tal-painting-cut-watch-faces

https://www.theartnewspaper.com/analysis/but-is-it-legal-the-baffling-world-of-nft-copyright-and-ownership-questions

https://corpgov.law.harvard.edu/2018/05/26/an-introduction-to-smart-contracts-and-their-potential-and-inherent-limitations/

https://www.schoenherr.eu/content/formulating-a-smart-contract-and-minting-an-nft/

https://consensys.net/blog/blockchain-explained/can-nfts-crack-royalties-and-give-more-value-to-artists

https://www.jdsupra.com/legalnews/the-rise-of-nfts-opportunities-and-9565689/#:~:text=Royalties%3A%20Smart%20contracts%20written%20into,resold%20through%20the%20same%20platform

https://www.cnbc.com/2021/02/28/230-million-dollars-spent-on-nba-top-shot.html

https://hoopshype.com/lists/most-expensive-nba-top-shot-moments/

https://help.foundation.app/en/articles/4742869-a-complete-guide-to-minting-an-nft#:~:text=You%20can%20start%20the%20process,video%20file%20in%20MP4%20format

About the Author

Steve Vondran

Thank you for viewing our blogs, videos and podcasts. As noted, all information on this website is Attorney Advertising. Decisions to hire an attorney should never be based on advertising alone. Any past results discussed herein do not guarantee or predict any future results. All blogs are written by Steve Vondran, Esq. unless otherwise indicated. Our firm handles a wide variety of intellectual property and entertainment law cases from music and video law, Youtube disputes, DMCA litigation, copyright infringement cases involving software licensing disputes (ex. BSA, SIIA, Siemens, Autodesk, Vero, CNC, VB Conversion and others), torrent internet file-sharing (Strike 3 and Malibu Media), California right of publicity, TV Signal Piracy, and many other types of IP, piracy, technology, and social media disputes. Call us at (877) 276-5084. AZ Bar Lic. #025911 CA. Bar Lic. #232337

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