Clifford Chance
NFTs – An Introduction and Some Key Intellectual Property Considerations
According to nonfungible.com, the global non-fungible token (NFT) market was estimated to be worth around $16.8 billion in 2021. Demand for NFTs is expected to continue to grow as a host of brands, including the likes of Nike, Coca-Cola, McDonald's, Gucci and Clinique, seek to capitalise on the NFT explosion.
In this article, we explore some of the key intellectual property considerations relating to NFTs.
What is an NFT?
An NFT is a digital record, the uniqueness and ownership of which is verified using distributed ledger technology (DLT). Pursuant to a recent interlocutory order, the English High Court recognised that there is at least a realistic arguable case that NFTs may be treated as 'legal property' as a matter of English law.1
The most prevalent DLT used in connection with NFTs to date has been the 'layer 1' blockchain technology, Ethereum (although other 'layer 1' blockchain technologies, such Solana, are being increasingly used). The native token or 'coin' (cryptocurrency) of the Ethereum blockchain is Ether (or ETH), which is 'fungible' as each ETH coin is interchangeable and indistinguishable.
Each time a transaction is processed on the Ethereum blockchain, a transaction fee (known as 'gas') is payable in ETH. Due to the increasing number of transactions being processed on the Ethereum blockchain, 'gas' fees can be extremely expensive. To reduce those fees and speed up transaction processing times, certain 'layer 2' solutions or protocols are built on top of the Ethereum blockchain, which usually adopt their own separate fungible 'token'.
Polygon is such an example of a layer 2 solution built on the Ethereum blockchain, which has an alternative token to ETH, called MATIC. As with the Ethereum blockchain, each time a transaction is processed on the Polygon platform 'gas' fees are payable in MATIC.
In January 2018, the ERC-721 token standard was introduced for NFTs to operate within the Ethereum ecosystem. This new standard introduced the concept of 'non-fungible' tokens. Each such NFT represents a non-interchangeable unit of data which is identified by a unique token ID e.g. Bored Ape Yacht Club (BAYC) token ID #9055 (thought to be owned by American rapper, Eminem).
Another key feature of the ERC-721 token standard is that each NFT may be linked with certain metadata, including, for example, digital images (so called 'profile picture' or 'PFP' NFTs), digital media (such as music or videos), or written data (such as a book). The metadata itself, however, is not generally stored on the blockchain in connection with Ethereum-based NFTs. This is primarily due to the expense of storing digital data on the Ethereum blockchain. Instead, a Uniform Resource Identifier (URI) is used to link each NFT to a specific location, such as a HTTP URL on the web or a more secure InterPlanetary File System (IPFS) hash (which is a protocol and peer-to-peer network for storing and sharing data in an alternative distributed file system).
NFT Smart Contracts
Whether any rights, beyond any 'right' to a digital record of data, are conveyed when minting or transferring an NFT, will depend on the terms of the smart contract that are applicable to the NFT in question. Importantly, the assignment of any intellectual property rights (as a matter of English law) will require a written contract to be effective, but in the absence of any agreement there is uncertainty as to what rights, if any, are purported to be granted or conveyed.
'Off-chain' approaches, in which the parties enter into an agreement which governs the applicable NFT transaction, have been the most prevalent methods for parties purporting to make NFT transactions subject to legal terms. This could take the form of a written agreement between two parties, but is more usually in the form of terms and conditions which are purported to apply to a person 'minting' an NFT or acquiring an NFT on a secondary marketplace.
Another approach has been to attempt to incorporate a legal agreement into the metadata of a smart contract. For instance, digital artists Jennifer and Kevin McCoy incorporated reference to a Rights Agreement in the metadata relating to their Quantum Leap NFT drop.
Under English law, for a contract to be validly formed, an unequivocal offer, capable of acceptance, needs to be made, and acceptance of that offer needs to be communicated to the offeror, together with consideration and an intention to be contractually bound. Therefore, when devising a legal framework applicable to the minting and subsequent sale and resale of NFTs, care needs to be taken to ensure that terms are legally binding.
Ownership of Intellectual Property Rights
NFTs can be used to create tokenised proof of title to a variety of digital assets (such as images, videos, music, or 'in-game' assets, such as plots of land or avatars) or physical assets (such as paintings, sculptures, physical collectibles, or other tangible assets).
Copyright
However, an NFT does not (unless stated otherwise) transfer or assign copyright or other IP rights in the underlying asset. Copyright to the underlying work would only be transferred where specifically agreed (and validly assigned) pursuant to a legally binding agreement. If copyright to the underlying work is not transferred with an NFT, then the original creator retains the exclusive right to do certain acts in relation to the work which are restricted by copyright, namely the right to make additional copies, distribute, display or sell copies of, or transfer copyright in, the work to someone else. What rights the purchaser of the NFT acquires in such a scenario is open to debate.
In many cases, purchasing an NFT is comparable to purchasing physical art, which rarely involves an assignment of copyright in the artwork. An NFT in this context may be intended to operate to purport that the underlying asset is authentic or unique. However, it should be noted that, as an original creator may retain the right to make additional copies of a work, an NFT may not guarantee uniqueness of the underlying work itself, but merely the uniqueness of the token ID. Whether an NFT conveys rights to an authentic or unique underlying asset will depend on the terms applicable to the NFT.
In the absence of express provisions governing ownership of intellectual property rights or usage rights, under English law a purchaser of an NFT would typically be limited to a right of personal use of the underlying copyright work, and the right to resell the associated NFT. There are, however, many examples of NFTs being sold on a variety of different terms, and granting different rights to the underlying asset. Some terms are clearer than others, however.
For example, the Rights Agreement relating to the Quantum Leap NFT drop provides that "Jennifer and Kevin McCoy retain all legal right, title, and interest in all intellectual property rights underlying the artwork, including, but not limited to, copyrights and trademarks". The acquirer of the artwork is granted "a non-exclusive, world-wide, assignable, perpetual, and royalty-free license to display the artwork solely for non-commercial purposes, provided that such display right may only be assigned to a subsequent owner of the artwork simultaneously with the transfer of ownership of the artwork and this agreement". The Rights Agreement therefore makes clear that copyright is retained by the authors of the underlying work, and a limited non-commercial right is granted to the NFT purchaser.
In contrast, the smart contract governing the BAYC NFT collection does not expressly incorporate contractual terms as to the ownership of intellectual property rights. However, the website relating to the collection includes Terms & Conditions applicable to the ownership of BAYC NFTs, which provide that "when you purchase an NFT, you own the underlying Bored Ape, the Art, completely". Although these terms purport to covey ownership of the art relating to the NFT, the terms suggest that the copyright in the artwork is, in fact, retained by the original author. However, the NFT owner is granted a worldwide, royalty-free license to use, copy, and display the underlying artwork for personal and commercial use, including the right to create derivative works.
Re-sale and Moral Rights
Even if the legal framework applicable to an NFT is considered to assign intellectual property rights to a related digital or physical asset, purchasers should also be aware of creators/artists retaining certain resale rights in relation to their creations (such as payments from future sales) and moral rights (such as the right of attribution, and the right to object to derogatory treatment of a work). If such rights are retained, the original creator/artist may be able to, for example, claim payments from future resales, or object to the acquirer of a related NFT making derivative use of a profile picture, if such use is shown to be prejudicial to the honour or reputation of the creator/artist. The legal terms applicable to NFTs should ideally confirm, where possible, that a waiver of resale and moral rights has been obtained.
Commercialising Intellectual property rights through NFTs
NFTs have presented brands with a number of new potential revenue streams, in which they can also target new or evolving target audiences. Many well-known brands, including the likes of Nike, Coca-Cola, McDonald's, Gucci and Clinique have sought to capitalise on NFTs.
Brand owners have sought to utilise NFTs in a variety of different ways. For example:
- In December 2021, Nike announced its acquisition of RTFKT, a digital design studio which creates NFTs linked to digital trainers and other collectibles that can be worn across different metaverse and online environments. Nike stated that the acquisition was another step to accelerate its digital transformation and would allow Nike to serve athletes and creators at the intersection of sport, creativity, gaming and culture.
- McDonald's launched an NFT to promote the return of its 'McRib' burger (the NFT's metadata included a digital image of the burger), which were awarded to 10 people who followed McDonald’s account on Twitter and retweeted a post during a promotional period.
- Clinique's NFT drop is also linked to a digital image and is to be given away to a limited number of consumers who are signed up to its loyalty program, together with the right to receive free products.
- In March 2022, Gucci announced that it had teamed up with 10KTF, an NFT project which encompasses a virtual shop in a metaverse known as New Tokyo, to launch Gucci Grail, which enables owners of certain profile picture NFTs (such as BAYC) to kit their avatar out in the latest Gucci gear.
Gaming
The gaming industry is another sector which has seen significant utilisation of NFTs in the past year. Virtual metaverse games such as The Sandbox and Decentraland enable users to acquire NFTs linked to virtual land in their respective metaverses, as well as a variety of in-game avatars and assets (in the form of NFTs). Play-to-earn gaming models are also becoming increasingly popular in the blockchain gaming space. In August 2021, Louis Vuitton launched a mobile video game app named 'Louis the Game', in which players are rewarded with NFTs.
Music
Music related NFTs are also becoming increasingly popular, in which certain artists have sought to sell their music in connection with an NFT. For instance, in February 2022, the rapper Snoop Dogg acquired the Death Row Records label and subsequently pulled various tracks owned by the record label from various streaming services. In March 2022, Snoop Dogg started listing various tracks owned by Death Row Records on OpenSea. Music NFTs appear to provide a mechanism for artists to obtain greater control over the sale of their content.
The upshot of these activities is for brands to develop and enhance their presence in online platforms and web3.0.
Enforcement
There has been a wave of different types of enforcement actions in various jurisdictions following the launch of NFTs. Some relate to IP rights and allegations of infringement, and others relate to the enforceability of terms purported to govern rights in NFTs.
With respect to IP infringements, takedown notices have been increasingly relevant, and many marketplaces incorporate takedown provisions in their terms of service to address complaints.
CryptoPunks
One of the most highly publicised takedown notices concerned CryptoPunks NFTs. In 2017, the creator of CryptoPunks offered the original collection of 10,000 NFTs for free. An error in the smart contract resulted in purchasers of the NFTs receiving the funds relating to the applicable purchase, rather than the seller. The creator of CryptoPunks then created a version 2.0 collection which remedied the defect in the smart contract and airdropped the version 2.0 collection to the holders of the version 1.0 collection. The version 2.0 collection used identical images to those used in the original NFT collection. A number of the holders of the original version 1.0 CryptoPunks subsequently re-listed the original collection under a new smart contract. In early 2022, the CryptoPunks' creator sent a DMCA (Digital Millennium Copyright Act) takedown notice to OpenSea (pursuant to US law), which demanded OpenSea to cease hosting the alleged copyright infringing materials. As a consequence, OpenSea subsequently delisted the original version 1.0 collection of CryptoPunks that had been re-listed.
The Art Wars
The Art Wars NFT collection was also delisted by OpenSea in early 2022. The collection was linked to images of sculptures of 'stormtrooper helmets', in often colourful patterns/designs. The collection was delisted following a takedown notice sent by the artists of the original sculptures.
A wave of litigation has also ensued in the US, in which well-known brands such as Nike and Hermès have filed proceedings on the basis of infringement of their trade mark rights. Enforcement action concerning intellectual property rights used in connection with NFTs is expected to grow as brand owners grapple with infringements in new digital environments.
Nifty Gateway Case
Other litigations have been concerned with enforcement of legal terms concerning NFTs. The first English court judgment concerning NFTs (Amir Soleymani v Nifty Gateway LLC) concerned a claim brought by Amir Soleymani, a well-known collector of NFTs, against Nifty Gateway LLC, a New York based marketplace operator. Nifty Gateway had commenced arbitration proceedings in New York claiming that Mr Soleymani had refused to pay for an NFT on its marketplace after submitting a winning bid. In parallel to the arbitration proceedings, Mr Soleymani brought a claim before the English High Court, seeking a declaration that the arbitration clause in Nifty Gateway's Terms of Use was unenforceable because it was unfair under the UK Consumer Rights Act 2015, as well as challenging the jurisdiction clause in Nifty Gateway's Terms of Use. Nifty Gateway responded by contesting the English High Court's jurisdiction. The High Court upheld Nifty Gateway's challenge, finding that it did not have jurisdiction in relation to Mr Soleymani's request for a declaration that the arbitration clause in Nifty Gateway's Terms of Use was unenforceable.
Comment
Before diving into the world of NFTs and the 'metaverse', corporates and brands need to carefully consider the legal framework applicable to the minting and secondary sales of NFTs and should also consider whether their existing trade mark registrations provide sufficient protection in connection with virtual goods and services connected to NFTs.
In this article, we have sought to provide a brief introduction into NFTs and highlight some key intellectual property considerations. If this article has been of interest, please look out for further publications in the comings weeks and months where we will explore specific intellectual property opportunities and issues relating to NFTs in greater detail.
Also, in a previous article, Non-Fungible Tokens - The Global Legal Impact we examined the legal and regulatory treatment of NFTs and considered some of the key risks, and how the tokens are regulated across some key financial centres.
References