Non-fungible tokens, or “NFTs” are taking the digital world by storm. Jack Dorsey, the founder of Twitter, recently sold an autographed tweet associated with an NFT for $2.9 million. Super Bowl champion Tom Brady just announced the launch of the NFT platform he has cofounded that will offer digital collectibles. Such popular use with highly appraised items begs the question – What actually is an NFT? And for those of us in the high-tech world, the further question – How do NFTs relate to intellectual property?
WHAT IS AN NFT
An NFT is a digital version of a certificate of authenticity (a token), secured and embedded in a blockchain. When an NFT is created, digital information including the creator’s name and other programmatic details such as the creator’s blockchain wallet address are linked to an underlying asset and stored in a blockchain (while the underlying asset might not be stored in the blockchain). Because NFTs are secured by a blockchain, no one can modify the record of ownership or copy/paste a new NFT into existence.
We discussed the blockchain technology in a previous article. An NFT is a special application of the blockchain technology directed to the management of unique digital assets. The most popular and leading NFT blockchain network, Ethereum, created a specification the ERC-721 standard in 2018 that provides a formal, unified interface especially suited for tracking and transferring digital art and other collectibles. For example, some of the events implemented under the standard include ownerOf() to find the owner of an NFT and Transfer() to change the ownership of an NFT. Such an interface can be captured in the corresponding smart contract. The ERC-721 standard specifically contemplates tracking not only virtual collectables, but also physical property (through a digital link).
Currently, there is no fool-proof way to prove that a creator of an NFT possesses rights to the underlying asset that is linked to the NFT. However, to authenticate the owner of the underlying asset of an NFT, some NFT marketplaces are providing “Proof of Authenticity” labels associated with for-sale NFTs. A “Proof of Authenticity” label appears as a sticker below a for-sale item description in the marketplace, similar to how platforms like Instagram and Twitter provide a “verified” badge for public figures and global brands. A “Proof of Authenticity” label means that the marketplace’s in-house curators can attest to the provenance of the work or that the artist is who they claim to be. In some cases, a marketplace issues a “Proof of Authenticity” label simply based on a personal attestation from the author of the underlying asset.
As such, NFTs provide a form of digital ownership, similar to what a deed is for physical property, and can represent images, audio, video, or anything else in the digital or physical domain. NFTs can be transferred or sold to other people, together with the associated rights in the underlying asset, as further discussed below.
As noted above, NFTs comprise smart contracts i.e., programs stored in a blockchain, that people interact with by communicating with the smart contracts and then receiving proof of interaction. While an NFT that operates on Ethereum is likely complying with the ERC-721 standard, the smart contract behind an NFT can be programmed in a variety of different ways to allow different approaches for people to interact with the NFT.
NFTs are ‘Non-fungible’ because each NFT is treated as a unique entity. NFTs can represent a one and only “original,” such as a unique work of art. In contrast, units of cryptocurrency that also resides in blockchains, such as Bitcoin or Ethereum, or even real fiat currency such as the U.S. Dollar are used in an interchangeable manner, or are “Fungible”.
NFTs are useful because their uniqueness and chain of ownership can be verified using a blockchain, they can be utilized across applications developed by different companies. Standardization made possible by ERC-721 and other specifications promoted by mainstream blockchain networks facilitates the ease of use and widens the scope of use. As a result, NFTs can now be traded easily through secondary markets. These phenomena open up a new world of possibilities for new use cases and business models.
HOW ARE NFTS ARE MANAGED
NFTs can be created on one of any number of public and private blockchain networks.
A popular NFT platform and marketplace running on the Ethereum blockchain network is OpenSea, which allows anyone to create NFTs. In a simple process, anyone looking to create an NFT will deposit some cryptocurrency such as Ethereum to pay for the creation of the NFT on an Ethereum blockchain, accept the platform terms of service, and start creating the NFT. Typically, payment in the form of cryptocurrency is accepted to facilitate all transactions within blockchain networks.
Creating the NFT can include uploading an image, video, or audio file, which is typically stored outside of a blockchain, and adding a name, owner, and description. As discussed above, this data is combined into a smart contract that is stored in a blockchain that represents and controls the NFT.
In the case of digital assets such as images or media files, the digital asset can be stored on the blockchain or referenced by a link such as a Uniform Resource Locator (URI). In the case of physical assets, the description needs to make it clear that the underlying asset is a physical work, such as including a serial number or another identifier of the physical work that can easily be digitized. Alternatively, physical assets can be digitized and an NFT can be created for digital version of the physical asset.
Additionally, through the incorporated smart contract, an NFT allows the creator of the NFT to decide whether they will collect a royalty for future resales of the NFT, potentially a powerful tool that would allow a creator to profit from any future sale of the NFT. For example, some NFTs have a feature that can be enabled that will pay a royalty fee to the creator of the NFT every time the NFT is sold or changes hands, making sure that if a work gets super popular and balloons in value, the creator see some of that benefit. For artists, NFTs provide an additional way to sell digital works that there otherwise might not be much of a market for. For buyers and collectors, NFTs provide an avenue to financially support artists.
The NFT could also be associated with other rules or conditions that govern the use of the associated asset in general. Various options currently exist on different platforms and additional options will undoubtedly be developed in the future. A detailed guide for entering the NFT marketplace can be found here.
INTELLECTUAL PROPERTY PREVIEW
It is important to note that ownership of an NFT does not necessarily convey ownership of the underlying asset or artistic work. Generally, a creator of an NFT decides the terms of the NFT and how ownership of the NFT relates to the underlying asset. Absent governing terms, the copyright of an underlying work that is represented by an NFT is not transferred to the NFT owner.
In practice, marketplaces that list NFTs are providing blanket copyright licenses for NFTs that are purchased through their marketplace. For example, the NBA Top Shop license grants the owner of an NFT a non-exclusive license “to use, copy, and display” the NFT solely for “personal, non-commercial use”.
Undoubtably, the rise of NFTs raise many legal questions such as how to verify that someone actually owns an underlying asset that is associated with an NFT, how to effectively attach terms and conditions to an NFT, and how to enforce such terms. In our second part of this series, we will take a closer look at NFT developments in the intellectual property space, including patents.
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