July 27, 2022 - On Tuesday, July 26th, the LSTA hosted a webinar, Non-Fungible Tokens and the Gamification of the Markets, which was presented by Jones Day partners, Mark Rasmussen and Juan Antonio Solis. Non-fungible tokens or NFTs are part of the Web3 ecosystem which encompasses new technologies and is characterized by decentralized ownership or peer to peer transactions without an intermediary. There are two components of each NFT: (1) the NFT item is stored off a blockchain and (2) the NFT metadata is stored on a blockchain which points to the NFT stored off the blockchain and contains a unique token ID (although they can be created on any blockchain most are created using smart contracts on the Ethereum blockchain ).
NFTs may be accessed with a person’s digital wallet which stores his/her public and private keys. The public key is the address to which the NFT can be sent, and the private key is like a password which gives the owner the authority to transfer whatever asset has been sent to the public address. The NFT items may then be viewed within the wallet software
NFTs are “minted”/ recorded and transferred on a blockchain ledger. Almost anything can be represented by an NFT, including images, music, documents, and title to real and personal property. NFTs can be used to prove ownership of an asset that could be copied infinitely; they may also be used to track title to cars, homes, or luxury goods. This can be done by using a unique code such as a QR code, which is linked to the asset. For example, an expensive luxury handbag could have a QR code in it linked to an NFT that establishes the origin and authenticity of that handbag.
The uses of NFTs continue to grow and become more creative. For example, if you access the metaverse, you may want to “show off” and purchase clothes for your avatar and a house in which that avatar can host parties. The first digital NFT house, Mars House by Krista Kim, was sold for $500,000. Digital artwork is another example of a use case of NFTs. Beeple’s The First 5000 Days’ associated NFT sold for $69.3 million dollars in 2021. When an artist creates content, that artist has all the rights in that content, and thus when a person buys the associated NFT, they are typically buying the token itself not the digital asset linked to the token.
NFTs are also being used in gaming platforms. Draftkings, a digital collectibles ecosystem, offers daily sports fantasies, sports betting, and gambling services. In that NFT ecosystem, high profile sports athletes such as Simone Biles and Tom Brady have permitted NFTs to be created of their images, and these are then sold on the Draftkings marketplace.
NFTs are not linked simply to fun and games, however. Recently NFTs were used in the service of court papers. The first NFT “Temporary Restraining Order” was served after the service token was approved for use by the New York Supreme Court. After the court approved its use, the NFT TRO was served on the defendant by airdropping the TRO via an NFT to a user’s wallet which had been identified as the defendant’s wallet. The NFT included a hyperlink to the trial court’s order and papers upon which the TRO was based, and when the person clicked the link that was proof that the defendant had indeed accessed it and knew of the TRO. Perhaps this type of use may not have been anticipated a couple of years ago but demonstrates how varied the contexts of NFTs’ uses can be.
The speakers also dived into the legal framework of NFTs and the agencies responsible for regulating them, including the SEC, CFTC, and OFAC. Laws and regulations relating to securities, commodities, intellectual property, AML and sanctions are just some of the laws that are relevant to NFTs and their uses.
Securities regulatory considerations must always be considered, especially since the SEC recently expanded its enforcement unit and highlighted NFTs as an area it may look at more. Parties, therefore, must ask themselves at the outset: do the securities laws apply to the digital asset that is being offered, sold, or distributed? Is there an immediate consumptive use of the digital asset? How is the digital asset marketed? Is the market value of the digital asset supported by the issuer?
Although the Office of Foreign Assets Control does not specifically cover NFTs, because violations of sanctions carry strict liability, sellers of artwork should be particularly careful because it is not hard to see how a buyer of artwork could engage in money laundering.
The dearth of jurisprudence surrounding NFTs makes the new intellectual property cases involving NFTs even more fascinating. The interesting Miramax case touches on the classification of an NFT. In that case, which is currently being heard in the US District Court for the Central District of California, Quentin Tarantino, who believed that he had reserved the right to copy and distribute the Pulp Fiction screenplay, launched an NFT collection of digital images of handwritten sections of that screenplay and auctioned them on OpenSea, an NFT exchange. Miramax sued him for breach of contract and copyright infringement claiming Tarantino had no right to the screenplay. It will be interesting to see how that case progresses.
Finally, the speakers highlighted the cybersecurity and other risks to consumers of NFTs and explained “rugpulls”. Rug pulls are situations where people set up new businesses and offer NFTs for sale. Using social media to advertise the new project, they make promises to the public, and people buy the NFTs based on those promises. However, once paid, the companies then walk from the advertised projects and leave their NFTs investors with nothing.
Clearly this is an exciting new area that will continue to grow, but those willing to dabble in NFTs should educate themselves about the applicable laws and the many associated risks. Click here for the slides and replay.