Non-fungible tokens (NFTs) have existed since 2017, but in March 2021 they became a household word. In the following weeks a number of issues came to light, which may suggest that the future of NFTs will not live up to the initial hype.

An NFT is a digital property existing on a secure network of computer systems that records its sale on a blockchain (digital ledger) to give buyers proof of authenticity or “non-fungibility.” Non-fungibility distinguishes NFTs from digital properties such as bitcoin that are interchangeable or “fungible.” Although NFTs are often discussed in the context of the method of payment – cryptocurrency – more accurately they encompass a range of digital property, including visual art, videos and music, and the associated digital rights distinct from the method of payment. Digital rights allow individuals to access, use, create and publish digital media. Creative artists, technology innovators, sports leagues and celebrities are all using NFT platforms to reach new audiences and create lucrative revenue streams. Applications beyond the art world range from NBA TOP SHOT, which offers fans the opportunity to buy and collect highlight videos, to Twitter founder Jack Dorsey selling his first tweet from March 21, 2006.

In March 2021, Christie’s auctioned “a unique work in the history of digital art” that sold for $69.3 million. The piece was a collage of images, added to daily since 2007, by the artist known as Beeple. While there may also be physical copies of NFTs, Beeple’s work only exists digitally. The price tag captured the attention of the art and technology world, as well as casual observers outside the world of cryptocurrency, raising many questions about the copyright and contractual implications of NFTs.

In each instance, it is critical to appreciate that the subject of the NFT can be easily acquired elsewhere on the Internet. The unique value of NFTs is that they come with certificates of authenticity and an electronic trail inscribed on a blockchain that indicates ownership. Although the provenance of a work of art can be researched to determine its value (a concept debated in the art world for centuries), an NFT’s provenance is attached to the work itself. The blockchain essentially mirrors the value that is placed on an original work of art (as opposed to something that is mass produced like a poster). While digital images of cats (an early NFT phenomenon) may have no value to most observers, the same might be said of Andy Warhol’s Campbell’s Soup Cans. There are many posters of the work that are of little value, but there is a robust market for the few with his signature.

Many observers may question the value of NFTs, while other well-regarded multimillionaire visionaries see it as the future of art and commerce. Notably, the financial value of art has always been “in the eye of the beholder.” Moreover, even if the NFT bubble should burst, there are likely to be elements of the experience that will survive.

Four distinct positives of NFTs are the following: 1) the NFT cannot be edited or deleted, thus preserving its integrity; 2) the file can be viewed publicly giving broader access to the work; 3) the creator may establish a direct relationship with the repeat and new purchasers, eliminating the middleman, and 4) a vehicle is established for creators to share in the profits of subsequent sales of their art.

However, before these expectations can be fully achieved for all but the most unique, “first of its kind” offerings, certain legal questions will need to be resolved.

Copyright Ownership or License

The key question is how ownership is defined with regard to digital property, and particularly with regard to NFTs. Digital property includes data (the information stored and used by computers) as well as Internet accounts for email, shopping, social networking, gaming and business transactions. This digital property is governed by contracts and intellectual property rights in much the same way as in the physical world.

The purchase of an NFT does not confer the copyright in the work. This is also the case with a physical work of art, where the right to 1) reproduce the copyrighted work, 2) prepare derivate works based on the copyright, 3) distribute copies and 4) in the case of literary, musical, dramatic, choreographic and other audiovisual works, perform or display the copyrighted work publicly. While claims regarding NFT sales seem to blur this distinction, there is no reason to anticipate that the fundamentals of copyright law will shift in the NFT environment. Moreover, buyers tend to understand that what they are likely purchasing is merely a license to display or transfer the work. It is also worth noting that fair use issues, as well as traditional concepts of the rights of joint owners and rights of publicity, will still apply to NFTs.

Moral Rights

It has been suggested that reproduction rights and intellectual property rights can be sold with the NFT. For example, following the publicity surrounding the burning of an original Banksy work on video, it was initially announced that the winning bidder of an NFT of a Jean-Michel Basquiat drawing would be offered the right to destroy the original, ostensibly to create more “exclusivity” for the NFT. Thankfully the Basquiat estate intervened, and the original work will not be destroyed, but this issue is certainly to resurface with other artists’ works.

Ironically, one of the advantages being touted for NFTs – the concept that artists might potentially have an ongoing revenue stream from each resale of their work – is also rooted in the concept of moral rights. This concept is not new. In fact, resale rights have their origins in the French law droit de suite, first enacted in 1920, which provides that French artists receive a royalty from the resale of their work. To date more than 60 countries have enacted some version of the resale right. The concept in the United States has been slow to gain acceptance, and the Copyright Office concluded in a 1992 report that there was not a sufficient economic or copyright policy justification to warrant a national law. Legislation in Congress, such as the Equity for Visual Artists Act of 2011, have stalled. To date California is the only state to recognize a resale right. The California Resale Royalty Act of 1976, Cal. Civ. Code § 986 provides:

[w]henever a work of fine art is sold and the seller resides in California or the sale takes place in California, the seller or the seller’s agent shall pay to the artist of such work of fine art or to such artist’s agent 5 percent of the amount of such sale. The right of the artist to receive an amount equal to 5 percent of the amount of such sale may be waived only by a contract in writing providing for an amount in excess of 5 percent of the amount of such sale. An artist may assign the right to collect the royalty payment provided by this section to another individual or entity.

Having a mechanism in place to track resales could jumpstart legislation in this regard, despite the fact that the current marketplace, where art is bought to be flipped for profit in a matter of days or even hours, will hopefully become a relic of 2021.

Smart Contracts and Resale Royalties

One of the more interesting features of NFTs is their use of smart contracts. Smart contracts are not actually contracts, but rather generally publicly accessible computer code that can monitor and enforce a legal agreement without further action. Smart contracts are said to be “self-executing.” Theoretically, such contracts cannot be altered and cannot be controlled by a third party once executed. Smart contracts can, for example, trigger royalty payments to the artist upon a resale or, in the physical world, the release of escrow funds in a real estate transaction or refunds due to objective events. But even with smart contracts there are significant downsides. In the real world, alterations and amendments are often necessary even with the most carefully drafted agreement. This is even more likely in a nascent industry such as NFTs. Additionally, traditional contracts often intentionally contain ambiguities, such as “best efforts” and “bona fide” language that is not possible in a smart contract where subjectivity is not built into the code.

Sale of Copyright Shares

There is a strong case for the proposition that much of the NFT marketplace is a fad that will die out as the “firsts,” such as the first tweet or the first NFT album, run their course and the market is saturated with NFTs of all ilks. One possible antidote to this burnout is the concept that, rather than selling the article itself on the Internet, the artist can sell the copyright interest in his/her work and therefore the rights to an ongoing royalty stream. There are many practical considerations to be addressed here, not the least of which is how the existing Performing Rights Organizations (PROs) can or will adapt to this new model.

Trademarks, Licensing and Branding

As noted, one advantage cited by artists is the fact that with NFTs they can reach their existing fans and establish new audiences without a middleman. This allure is also drawing major brands and businesses to test the NFT waters. As with any new distribution channel, there is already an influx of trademark applications and trademark licensing issues to resolve. Trademark holders may seek new registrations such as the NBA TOP SHOT application in Class 34, for

[p]roviding digital collectible services, namely, operating an online marketplace for transactions and registry services using blockchain-based software technology and smart contracts for digital collectibles featuring players, games, records, statistics, information, photos, images, game footage, highlights, and experiences in the field of basketball.

Luxury brands are already seeing advantages to NFTs because of the opportunity to prove the authenticity of their product. However, as with any new technology there are examples of trademark infringement, counterfeiting and unauthorized sales of copyrighted material. So let the buyer beware of fraudulent activity and the trademark holder be vigilant for new infringements that could tarnish their brand and their valuable relationship with their fans and purchasers.

Conclusion

Whether NFTs are a mere fad akin to digital trading cards or have a lasting impact on the creative and legal landscape, Lutzker & Lutzker will keep you updated on the trends and are available to help navigate the ever-changing world of art and commerce, as well as copyright licensing agreements that may be affected by NFTs.