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Non-Fungible Tokens: the Global Legal Impact

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Non-Fungible Tokens: the Global Legal Impact NON-FUNGIBLE TOKENS: THE GLOBAL LEGAL IMPACT JUNE 2021 NON-FUNGIBLE TOKENS: THE GLOBAL LEGAL IMPACT The market for non-fungible tokens (NFTs), or cryptoassets representing proof of title to a unique digital version of an underlying asset, has soared. In the sports and digital arts sectors, recent NFT issuances have sold out in seconds, netting their creators millions. Subject to limitations in any relevant jurisdiction, NFTs have the potential to facilitate new revenue streams by establishing new forms of digital property, act as new channels for businesses and digital creators to reach customers, fans, and audiences and/or enable the monetisation of physical assets. While NFT issuance is growing rapidly globally, the legal and regulatory treatment of NFTs continues to evolve. We have been advising clients on NFTs in various jurisdictions. In this briefing, we share our experience to demystify NFTs and consider some of the key risks, and how the tokens are regulated across some key financial centres. NBA Top Shot The National Basketball Association's What are NFTs? NFTs have gained traction to date in the (NBA) Top Shot, is a blockchain-based digital space but also have the potential An NFT is a digital asset whose online platform hosted by Dapper Labs to digitise unique physical assets, such as uniqueness and ownership can be for basketball fans to purchase and physical artwork, in theory allowing these demonstrated and verified using trade highlights of NBA sporting assets to be bought, sold and traded distributed ledger technology (DLT). NFTs history (or "Moments") through NFTs more efficiently. In principle, all physical can be used to create a tokenised proof intended to act as virtual trading cards. assets could be tokenised either as of title to a unique digital version of an Moments are minted (i.e. created) on fungible or non-fungible tokens. Many underlying digital asset (such as images, the underlying blockchain platform, businesses have successfully tokenised a videos or other digital content) or physical but are graphically displayed as digital range of assets including iconic images, asset (such as paintings, sculptures or cubes containing the video highlight athletic highlights, entertainment and other tangible assets). in the online marketplace. sports memorabilia, event tickets, music albums, artwork, famous Tweets, internet When someone “mints” an NFT, they memes, gaming and e-sports digital create a unique digital version of the work content, unique sportswear and other as a data file using blockchain, or another collectibles using NFTs. type of DLT. Once minted, NFTs cannot be edited or deleted, and can be viewed publicly and freely traded with verifiable How do NFTs generate security of exclusive ownership and revenue? transaction traceability. An NFT issuance NFTs can enable the efficient may consist of a single NFT, or may commercialisation of unique assets that involve thousands or millions of tokens. are otherwise difficult to sell or prove ownership of, as well as the creation of Each NFT is unique. In contrast, most entirely new digital product lines and other cryptoassets, are fungible, i.e. each revenue streams. token is interchangeable with and indistinguishable from another As with many other digital assets, some NFTs offer the ability to "fractionalise" Some NFTs incorporate smart contracts ownership of the underlying asset, i.e. to which specify and automate certain rights split ownership so that each purchaser of and obligations of the buyer and seller, for an NFT benefits from the underlying asset example, to provide that the NFT creator in proportion to the fraction they own, receives a percentage of the transaction which can enable new ownership proceeds every time the NFT is sold on. structures that proponents assert have 2 CLIFFORD CHANCE NON-FUNGIBLE TOKENS: THE GLOBAL LEGAL IMPACT the potential to democratise ownership of The sale of those NFTs creates a whole Buying Myself Back: assets that have traditionally been viewed new revenue stream. The provenance of A Model for Redistribution as inaccessible. However, other NFTs the underlying digital asset is assured by are indivisible. the NFT. Model Emily Ratajkowski recently sold an NFT called "Buying Myself Back: Transaction structures for minting and An artist could also sell an NFT linked to A Model for Redistribution" for selling NFTs vary. Many NFT creators are a digital version of a physical asset (e.g. US$140,000. Her NFT is linked to a "crypto natives" with DLT expertise who an image or video of a painting or photograph of herself standing in front issue the NFT themselves and also create sculpture) to one buyer, while selling the of a painting by artist Richard Prince of or own the underlying artwork or other physical work itself to another buyer as a photo of herself – for which she was asset to which the NFT is linked. Where an additional opportunity to profit. NFTs paid US$150 at the time. Her NFT the content creator/owner is not native to have opened the door to artists and served two purposes – (1) to take the crypto space (e.g. a celebrity, content producers further commercialising back control of her own image, musician, athlete or sports club or other their work in a digital environment, by which she believes Prince had business), a third party may issue the NFT providing an infrastructure in which value exploited; and (2) to generate on behalf of the content creator/owner. can be ascribed to a digital 'copy' of a revenue. The purchasers of her The third party may also provide the work due to the uniqueness of that copy. NFT will not receive a physical copy underlying technology platform for minting of the photograph. and selling the NFTs, or another platform Commercialisation of provider may be involved. Revenue physical assets sharing models between the various While NFTs have been mostly linked to participants differ considerably and digital assets to date, fine art, luxury should be carefully considered. goods and other physical assets have the potential to be linked to NFTs. This Commercialisation of digital assets ensures the provenance of the underlying A digital asset, such as a significant asset but can also assist with increasing tweet, a video file or digital photograph, liquidity. Considering the collectible wine can be linked to a finite number of NFTs. investment market for example, NFTs may Glossary • Blockchain is one type of DLT in • Non-fungible token (NFT) which the data is set out and built up An NFT is a unique cryptoasset that in successive blocks, where each new represents rights to an underlying block of data verifies the content of ‘tokenised’, often digital asset, which the previous block. It is known for is created and transferred using DLT. being the technology underlying This contrasts with many existing Bitcoin, but has been integrated into cryptoassets, including cryptocurrencies many other transaction and asset like Bitcoin, which are fungible types. Most NFTs are minted on the or interchangeable. Ethereum blockchain. • Smart contract • Cryptoasset A smart contract is commonly defined A digital asset created using as an agreement written in computer cryptography. Cryptocurrencies are code with automated performance. a subset of cryptoassets with Smart contracts are automatable and money-like functionality. The term enforceable either by legal enforcement token is often used synonymously of rights and obligations (though they with cryptoasset. may not always amount to legal contracts) or via tamper-proof • Distributed ledger technology (DLT) execution of computer code. DLT is a decentralised peer-to-peer data storage system where • Token participating computers (known as A token is a digital entry on a DLT nodes) hold and maintain identical register or other digital infrastructure copies of the ledger. Data integrity is where a person is recorded as owning achieved through public-private key a unit or other entitlement. Tokens cryptography, so that an individual may represent a permission to control node cannot tamper with the a resource native to the DLT platform, information recorded in the ledger by rights granted to the holder, or a “real rewriting the transaction. world” asset. The latter is commonly referred to as the "tokenisation" of underlying assets. CLIFFORD CHANCE 3 NON-FUNGIBLE TOKENS: THE GLOBAL LEGAL IMPACT reduce the risk of counterfeiting and for NFTs develops and regulation substitution by linking individual bottles of evolves, regulated firms may seek to wine to a unique NFT (e.g. by way of a offer specialist intermediary services to QR code) that proves provenance, history help the market develop. of ownership and provides a record of how and where the wine has been Asking the right questions stored. A secure physical storage facility Understanding the legal and regulatory is likely to be a key component of any issues is critical before deciding whether structure. As such, collectible wines can to issue, purchase or deal in NFTs. Here be virtually traded more easily while are some questions to consider: showing proof-of-ownership and proof-of- value. However, in the short term, liquidity Are there any licensing may be more limited as investors will requirements? need to be comfortable with the Most jurisdictions do not yet have technology and the operator of the legislation or regulations specifically platform, as well as the issues around applicable to NFTs, but a host of existing secure and effective storage that typically regulations may still apply. This will accompany collectible wine. depend on: Royalty collection as a • the token's characteristics and payment model features; Some NFTs are coded to incorporate • the activities performed in respect of smart contracts that can be programmed such token; and to include the automatic allocation of a portion of the amount paid by an NFT • the territorial scope of the particular purchaser to the original owner/issuer of regulatory framework.
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