Would you pay a hefty sum to own a video, photograph or digital artwork that everyone can view online and even download for free and legally?

Would you pay to see a tweet that you can download (and retweet) for free??

Think about a book signed by the author, which has additional value compared to an identical unsigned copy, and you might think about it more than once.

What are NFTs and why have they attracted market interest?

Los Tokens No Fungibles (NFT) son certificados de propiedad almacenados en una cadena de bloques respaldados por la tecnología blockchain (principalmente Ethereum y Bitcoin) que suelen estar asociados a un activo digital, como las artes visuales, los vídeos, la música o los objetos de colección. Cada NFT es único o «no fungibles» y no puede borrarse ni falsificarse (a pesar de que podría crearse otro NFT copiando y volviendo a pintar la misma obra de arte subyacente).  Esto los diferencia de otros activos virtuales, como las criptomonedas, e incluso de cualquier moneda fiduciaria como el dólar estadounidense.

La particularidad de los NFT se debe a su carácter limitado o escaso. Aunque las obras digitales, por su propia naturaleza, pueden ser copiadas, recreadas y replicadas infinitamente, aunque los NFT no cambian eso, son capaces de generar un registro digital único que autentifica la propiedad de una versión concreta de una obra digital (normalmente una que el propio creador sostiene como la verdadera versión). Cualquiera puede ver «Everydays: The First 5,000 Days» de Beeple y existen varias copias de la obra, pero sólo una persona puede reclamar la propiedad de la versión autentificada por el propio artista.

NFTs disrupt the traditional art marketplace

NFTs create new revenue possibilities for artists, who have been experiencing increasing constraints, from illegal reproduction, counterfeiting or piracy, high fees, a saturated chain of intermediaries or the need for physical interaction, etc.

• The ERC-721 token standard ensures that digital creative work cannot be counterfeited or pirated.

• NFT creators can set both the selling price and the maximum number of replicas of the digital creative work that can be sold.

• NFTs can be sold on any NFT marketplace or peer-to-peer, without the need for an intermediary.

This phenomenon has obviously created a number of novel legal issues and implications

Legal issues surrounding NFTs

The creation, distribution, ownership and trade of CLTs are new phenomena that raise a plethora of legal issues, many of which are ambiguous or unresolved.

i.) Copyright and intellectual property:

Cuando se compra un NFT no se está comprando la obra digital en sí. Se adquiere simplemente una colección de código o metadatos, que enlaza con la versión «verdadera» de esa obra. Estos metadatos se escriben en la cadena de bloques y contienen información sobre dónde se encuentra la obra original y a quién pertenece esa versión concreta de la obra. Esto no impide que cualquier otra persona pueda descargar y ver la obra de arte digital.

Therefore, the copyright of the digital artwork is not acquired. The rights of NFT holders are generally simply to own, sell, lend or transfer the NFT itself depending on the particular terms of the digital marketplace in which the sale and purchase takes place.

Copyright

In this area the most complex issues arise when someone creates and sells an NFT of an existing work over which he or she has no ownership rights, either in the work itself or in the copyright in the work.

Under copyright law, once copyright has expired and a work has entered the public domain (e.g., in the UK, 70 years after the artist's death) there is nothing to prevent anyone from making a copy of the work and then marketing that copy (through NFT or otherwise).

But where a work that is not in the public domain, copying it, even by NFT, could give rise to copyright infringement, especially if the process of creating and selling the NFT involves making a digital copy of the underlying work.

Then there are the moral rights of an artist, both the right to have his or her work attributed and the right to object to its denigrating and offensive treatment. Even in the conventional art market, there is very little case law in these areas, so how these cases might play out in the digital world is currently a matter of mere speculation.

IP

These rights are typically country-dependent, whereas NFTs can change hands without jurisdictional limit through digital marketplaces. Add in the anonymity behind blockchain technology, and it is typically more complex for those involved in an NFT transaction, and especially the buyer, to enforce any form of intellectual property or contractual rights in the event of an eventual infringement.

In this regard, it is imperative to conduct rigorous due diligence. Specifically:

- Verify whether the seller is actually the creator of the work, holds title to it and has obtained permission from any third party whose IP is present in the digital work

- Check the terms and conditions of any platform to ensure the characteristics of the digital asset for sale.

- Check that both the artist and the site hosting the digital asset are reputable.

- Check whether the digital artwork itself, which is attached to the NFTs, may be hosted on the servers of a third-party website, and is not secured on the blockchain. This because if the website were to go down for any reason, the NFT would end up attached to nothing and, as a result, would likely lose its value and become redundant

ii.) Smart Contracts:

Smart contracts govern NFT sales. These are digital contracts where the terms of the agreement are written in code and embedded within the purchase tokens. SMART contracts are typically programmed to operate automatically when a set of predefined conditions are met. For example, the SMART contract code might automatically make royalty payments to the creator upon resale of the NFT. The code itself is permanently minted into a token on the blockchain, so it cannot be replaced, deleted or modified. The programmed nature of SMART contracts reduces the level of distrust required between contracting parties, as the contractual terms will be automatically executed upon a triggering event, such as the making of a payment.

The operation of smart contracts should ensure that there are no legal disputes over the terms and execution of the contract. However, there is virtually no case law, legislation or regulation addressing SMART contracts. This raises doubts as to whether SMART contracts are actually legally binding. Additionally, SMART contracts will generally work in conjunction with the text-based terms and conditions of the particular digital marketplace, so these will need to be considered as well.

iii.) Money laundering regulations:

Given the exorbitant sums being spent in the NFT market, and the widespread use of cryptocurrency, concerns have arisen as to whether these transactions are being used to circumvent the increasingly stringent anti-money laundering regulations being implemented around the world. It is of note, coincidence or not, that the popularity of NFTs has coincided with the application to the conventional art market of anti-money laundering regulations for the first time (at least in Europe).

The EU's Fifth Anti-Money Laundering Directive (5AMLD) de la UE somete a todos los «participantes en el mercado del arte» (es decir, a cualquiera que actúe en la venta o compra de obras de arte por valor superior a 10.000 euros) a una plétora de nuevas obligaciones. La más destacada es la obligación de llevar a cabo la Diligencia Debida del Cliente (DDC) para verificar la identidad de un comprador y su fuente de fondos antes de cualquier transacción.

Curiosamente, no está nada claro si los NFT entran en el ámbito de aplicación de la normativa. Si bien la UE amplió su marco regulatorio de ALD para incluir a los «intercambios de monedas virtuales» y a los «proveedores de carteras de custodia» a través de su implementación de la AMLD5 en 2018, no definió regulaciones específicas para los NFT, muy probablemente porque los NFT, aunque son bien conocidos por los entusiastas de las criptomonedas, no estaban siendo utilizadas ampliamente.

However, on September 24, 2020, the European Commission adopted a digital finance package that includes a legislative proposal for the regulation of cryptoassets, the Cryptoasset Markets Regulation (the "MiCA Proposal").La Propuesta MiCA incluye regulaciones que se aplicarían a los NFT en ciertos casos y define por primera vez en la UE un criptoactivo como una «representación digital de valor o derechos que pueden ser transferidos y almacenados electrónicamente, utilizando tecnología de libro mayor distribuido o tecnología similar».

The MiCA proposal aims to comprehensively regulate cryptoassets that were not yet covered by EU financial legislation[1]. La propuesta de la MiCa hace referencia, en general, a tres categorías principales de tokens (tokens referenciados a activos, tokens de dinero electrónico y otros criptoactivos), con diferentes requisitos para cada una de ellas en lo que respecta a la concesión de licencias y a las operaciones de los emisores. Bajo el Título II de la Propuesta MiCa, los NFTs probablemente entrarían en la categoría «general» de “Otros criptoactivos”.

Under the MiCa Proposal, issuers of other cryptoassets - i.e., cryptoassets that are not asset referenced tokens or e-money tokens - have no specific licensing obligations, but are required to be a legal entity (which may be established outside the EU) and to meet certain governance and business conduct requirements[2].

Esta última categoría estaría sujeta a la normativa relativa a la admisión a cotización en una plataforma de negociación y a la autorización de los proveedores de servicios relacionados, así como a las normas de abuso de mercado para las empresas relacionadas. Sin embargo, la Propuesta MiCA exime a los emisores de «criptoactivos [que] son únicos y no fungibles con otros criptoactivos» del requisito de publicar un libro blanco para las ofertas públicas. Esta exención se extendería probablemente a los NFT. En particular, esta exención es el único lugar de la propuesta de la MiCA donde se mencionan específicamente las criptoactivos que son «únicos y no fungibles».

iv.) Hosting and data storage:

An NFT and the digital asset it represents are typically stored separately. The NFT is stored on the blockchain and contains information about the location of the digital asset. The NFT is connected to the digital asset through a link. However, if the digital asset is deleted or the server hosting the digital asset fails or goes offline, the link will be broken and the remaining NFT will be worthless because it will no longer be associated with the digital asset and there will be no way to back up the NFT. Since the NFT is unique and cannot be replaced, the purchaser of the NFT could be left without these resources. Depending on the use of the specific NFT, this can result in business interruptions, regulatory record violations and data loss.

Today there is a remedy using decentralized storage. The Interplanetary File System (IPFS) is a peer-to-peer protocol and technique and a trusted data store for sharing large files and eliminating the possibility of censorship or unilateral deletion. The combination of distributed computing and content-based addressing makes IPFS high performance and reliable persistence. The smart play is to use IPFS and place the immutable IPFS hashes in a blockchain transaction to time stamp and secure the NFT content without having to put the data on the chain itself.

v.) Data protection regulations:

In general, data protection laws give individuals various rights over their personal data, including those of deletion or rectification, but the immutable nature of the blockchain may pose an obstacle to the enforcement of these rights. Therefore, NFTs containing personal information could violate data protection laws.

vi.) Fractionalization of NFTs:

Since some NFTs sell for significant amounts of money, fractionalizing the asset (f-NFT) would allow smaller investors to buy shares of an NFT. New entities have emerged to facilitate the sale of f-NFTs. The f-NFT trading platform, Niftex, allows owners to split f-NFTs into fragments, a piece or fragment of an f-NFT, for purchase at a fixed price, and the fractions can subsequently be traded in the market. The site also allows fragment owners governance rights on the platform. With fintech platforms, decentralized finance (DeFi) and decentralized applications on the rise, the continued fractionalization of NFTs is inevitable. The development of f-NTFs raises concerns that they may be securities. These efforts to create the market and value surrounding f-NTFs will raise flags with financial regulators. Efforts to create fractal interests will raise questions about whether f-NTFs resemble an investment product that regulators might classify as a security under the Howey test.As SEC Commissioner Hester Peirce stated during the recent 2021 Security Token Summit, si alguien quiere colocar numerosas NFT en una cesta y vender F-NFT o tomar un NFT y vender fragmentos, entonces «será mejor que tenga cuidado de no estar creando algo que sea un producto de inversión, que sea un valor.»

vii.) Royalties:

Most NFTs reside on the Ethereum blockchain (other platforms include Wax and Flow). When creating an NFT on a particular platform, the creator designates the amount of royalty to receive with each secondary sale. A creator can configure the smart contract that manages NFTs, but the existing ERC-721 token standard has some limitations.

First, it does not provide for platform interoperability for a royalty payment. In most existing implementations, that royalty payment will only occur when the work is sold on that same platform. That, since royalty payment implementations are typically not compatible with the other platforms across the NFT ecosystem. As NFT development matures, it will need to address this cross-platform interoperability.

Second, some legislation, such as the US, does not recognize resale rights relating to creative works, so the law does not provide any remedy for unpaid resale royalties in the US, which is the case in approximately 70 other jurisdictions, including the UK and the EU.  

viii.) Estate and succession planning:

Death and judicial incapacitation.

One issue affecting investors that younger investors, such as Generation Z may not be considering, is how the applicable legal framework treats digital collectibles upon the death of the owner. This is an increasingly important issue given the number of estates that now have a digital footprint. This has highlighted the need for comprehensive estate planning when dealing with assets such as NFTs.

One of the key issues is access to NFTs after death, as (like cryptoassets) they can only be accessed by a unique personal key and password. Given the real risk that these potentially money-making assets could be lost forever (and there are an alarming number of known examples of private keys and passwords to digital assets being forgotten or misplaced), investors should, at the very least, take some simple steps to mitigate these risks.

Entre otras, destacan el dar conocer estos activos a los representantes personales (y a los asesores profesionales), elaborar un inventario en el que se detallen los activos y la forma de acceder a ellos (protegido y con actualización periódica), y elaborar un testamento que incluya las instrucciones sobre cómo acceder a los NFT. Esto ayudará a crear un plan de «legado digital» más sólido.

El aumento de los NFT y de los criptoactivos ha acelerado inevitablemente el desarrollo de la tecnología en este ámbito, por lo que no sólo es posible realizar copias de seguridad de estos planes de legado digital utilizando proveedores de almacenamiento de datos en la nube, sino que ahora hay productos sofisticados en la industria que se crean específicamente para estos activos. En relación con los criptoactivos, por ejemplo, las «billeteras multisig» permiten a los usuarios asignar a un tercero una «clave de respaldo» en caso de emergencia. Esta tecnología está pensada para que los representantes personales del propietario puedan recuperar los fondos a su muerte en nombre de sus beneficiarios. En este sentido, es imprescindible contar con las protecciones de ciberseguridad adecuadas.

The same is extensible to situations other than death, such as judicial incapacitation.

Trusts:

Trusts are often used as an estate planning mechanism to avoid the need for assets to go through probate. While at first glance this may seem attractive to investors (also for confidentiality reasons), trustees should carefully consider their investment approach and fiduciary duties when it comes to holding digital collectibles such as NFTs. Given the speculative and volatile nature of these assets, trustees should be aware of the limits of their investment powers, including their diversification powers, etc. Where trusts are used to hold these assets, consideration should also be given to including additional provisions relating to NFTs (i.e. relating to liability, management or delegation).

ix.) Taxation:

Another area where legislation has not yet caught up with the increased popularity of NFTs is taxation. There is a dearth of legislation and guidance dealing specifically with NFTs, both in Europe and globally. In the UK, HMRC's recently updated «Manual de criptoactivos» del HMRC, recientemente actualizado, se ocupa principalmente de las criptomonedas. Los NFT pertenecen a una categoría ligeramente diferente de activos digitales y el manual establece que los NFT son identificables por separado y, por tanto, no se «agrupan» a efectos del impuesto sobre las ganancias de capital (CGT). Parece claro que el CGT puede aplicarse a las ganancias o pérdidas en la enajenación de los NFT y que, sin duda, entran en el ámbito de aplicación del Impuesto sobre Sucesiones y otros impuestos del Reino Unido, aunque la situación fiscal precisa no está nada clara.

A particularly difficult issue is determining where NFTs are situated for tax purposes. This is a key issue for foreign domiciled owners whose overseas assets may fall outside the scope of taxation in some EU country. The consensus view is that cryptocurrencies are taxed where the beneficial owner resides and it is possible that they will take the same approach with NFTs, especially where the underlying artwork is in digital form, although the law is unclear on this point.

How Can Gowper Help You?

NFTs have a great deal of potential to make a significant difference in the art market. However, it remains to be seen whether NFTs will establish themselves as a legitimate art form or whether they represent a bubble that may burst. In any case, the commercialization and ownership of digital art and NFTs will continue to raise complex legal issues. Regulators and governments will need to move quickly to keep up.

Our attorneys can assist and educate clients from a legal and technical standpoint to incorporate these emerging technology trends safely and efficiently to help their businesses stay ahead of the competition. Please contact our attorneys or the author of this article if you have any questions.

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This article was published on September 21, 2021 and has not been updated since then. It is a summary of legal considerations as of that date and is not intended to constitute legal advice.

[1] That is, those that do not qualify as financial instruments as defined in Directive 2014/65/EU ("MiFID II").

[2] See Art. 13 of the MiCA Proposal.

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El NFT en la portada se titula «Epic Charms Ethereum #6» y ha sido creado y es propiedad de Chriscu_nft. Según Chriscu_nft, «Epic Charms Ethereum está destinado a la buena suerte. Bucle de 20 segundos que traerá toda la buena suerte a tu cartera digital y a tu vida en particular. Cada uno tiene una característica o valor que lo hace único y especial.» El autor ha autorizado expresamente a Gowper a publicar la obra.

NFT is available for sale here.

More from the author here.