An NFT is a special, one-of-a-kind digital asset that raises a number of novel legal questions.
Earlier this month, a blockchain firm bought a US$95,000 print by the British street artist Banksy, only to burn it in a livestreamed video and re-sell it for US$380,000 as a virtual asset called a non-fungible token (NFT) — sparking a flurry of news around what may prove to be this year’s hottest crypto craze.
How did the Banksy sale work? The group explained that by removing the physical piece from existence and releasing the NFT as digital art, the value of the physical piece will be moved onto the NFT. This trend isn’t just setting the art world ablaze; in fact, musicians and even footwear companies are finding ways to break into the space.
At the same time, NFTs are raising novel legal questions — including those concerning digital ownership and intellectual property, royalty collection and payments models to benefit artists, financialization of non-fungible asset classes, and unique contracting and financial regulatory issues in the digital realm.
This post is an introduction to NFTs, and a jumping off point for the more specialized posts in Latham’s blog series on NFTs. This installment will explain what an NFT is and why people may start hearing a lot more about them. It will also preview some of the key legal issues that Latham lawyers will explore as a part of this series.
What is an NFT?
At its core, an NFT is a special, one-of-a-kind crypto asset. It is not mutually interchangeable, and this is really what sets it apart.
For comparison, consider a cryptocurrency like bitcoin. One bitcoin could be replaced with any other bitcoin, and still essentially be the same asset — it’s like trading one dollar bill for another dollar bill, at the end of the day you still have $1. NFTs, on the other hand, are more like Fabergé eggs; they all follow the same basic concept (a jeweled egg), but each one is an original creation with a different shape, size, or pattern. As such, the eggs are not like-for-like interchangeable. This feature is the essence of an NFT.
Importantly, the Fabergé egg analogy only works to a point: each egg came from the same source (Peter Carl Fabergé), and they are limited in number. By contrast, anyone can create an NFT, and there is no limit on the overall number of NFTs in circulation. The key point is that each NFT is unique, which is why NFTs derive value as a crypto asset class and, because they are unique, there is also a relatively easy way to trace ownership of the asset.
How do they work?
To understand how creative works get tied to NFTs, one has to understand exactly how an NFT functions. NFTs are unique crypto tokens that are managed on a blockchain. The blockchain acts as the decentralized ledger that tracks the ownership and transaction history of each NFT, which is coded to have a unique ID and other metadata that no other token can replicate. This process gives NFTs the attributes of originality and scarcity that makes them so attractive when coupled with digital media.
NFTs are coded with software code (called smart contracts) that governs aspects like verifying the ownership and managing the transferability of the NFTs. Like any software application, NFTs can be further programmed beyond the basics of ownership and transferability to also include a variety of other applications and functionality, including those linking the NFT to some other digital asset. For example, a smart contract could be written to automatically allocate a portion of the amounts paid for any subsequent sale of the NFT back to the original owner, thus giving the owner an ability to realize the benefits of the secondary marketplace. (For more information, see the proposed EIP-2981 standard for handling royalty payments for ERC-721 tokens.)
Thus, when someone makes (or “mints”) an NFT, they are writing the underlying smart contract code that governs the NFT’s qualities, which…