You have probably heard the latest buzzword in the blockchain-space – "NFTs" – but are baffled as to what they are and how they work. Even more so, you are probably wondering why people are spending millions of dollars on items and drawings of cartoon apes which do not physically exist and which anyone can view online for free.
Sales of "non-fungible tokens", known as NFTs, reached some $25 billion in 2021 and have continued to explode in popularity.
The art world and gaming industries have been quick to cash in. NFT marketplaces and auction houses have been selling digital NFTs or NFTs representing well-known artworks (such as Banksy's "Love is In the Air") for astronomical prices, with no physical objects changing hands. One sale that drew particular attention was the sale of Beeple's NFT (effectively a JPEG image) for a record-breaking USD $69 million. Another recent craze is the Bored Ape Yacht Club, which has resulted in several famous footballers and celebrities including Jimmy Fallon and Paris Hilton purchasing digital cartoon NFTs of apes for up to AUD $3 million. On top of this, people have been buying NFT "land" in the metaverse for up to USD $4.3 million.
NFTs also raise interesting legal questions, particularly regarding intellectual property and ownership. We explore those issues below. But first, let's get down to basics.
What are NFTs?
The Merriam-Webster defines an NFT as "a unique digital identifier that cannot be copied, substituted or subdivided, that is recorded in a blockchain, and that is used to certify authenticity and ownership (as of a specific digital asset and specific rights relating to it". Put another way, NFTs are essentially digital tokens used to verify the ownership and authenticity of an underlying asset. They are created by the process of "minting" on blockchain platforms using a smart contract protocol. The blockchain system acts as a digital ledger to track ownership and the authenticity of the NFT.
This is obviously all very complex. For clarity, it might assist to break down the key characteristics of NFTs as follows:
- non-fungible – unlike fungible objects such as currency which are completely interchangeable (ie. you can trade a $1 coin for another $1 coin), NFTs are not interchangeable and hold unique and distinct value. Similarly to trading Yu-Gi-Oh! and Pokemon cards, the assets underlying different NFTs can have rare and distinct features which impact their value.
- a token – NFTs are a "token", in that they indicate control of the relevant asset, rather than ownership of it.
There are several types of NFTs, with varying functions and purposes. They include the following:
These NFTs are not linked to any real-world assets, and include collectables, in-game assets (such as weapons and character "skins") and digital artwork. They include digital artwork and collectables such as Cryptokitties, Cryptopunks and the Bored Ape Yacht Club NFTs. Digitally-native NFTs are typically purchased using cryptocurrencies (usually Ethereum) on NFT marketplaces such as OpenSea.
These NFTs act like a certificate of title and reflect ownership of and the authenticity of a physical and real-world asset. This generally occurs by linking a physical asset with the NFT using a QR code or digital link. Theoretically, an NFT can be linked to any form of tangible asset. Already, we have seen such NFTs being linked to sound recordings, real estate and physical artwork. For example, Ellen DeGeneres satirically sold a video clip of her explaining NFTs on The Ellen Show, several selfies of her holding a sketch of a stick cat and a physical copy of the stick cat drawn on A4 white paper for a total of USD $33,495, which was subsequently donated to charity.
So what is the appeal?
While many believe that NFTs are society's latest manifestation of misguided materialism, the underlying technology and features of NFTs can be advantageous and applied to many different forms of transaction.
One benefit is that NFTs create a timestamped record of transactions so that when an NFT is transferred, the date and time of transfer, the price at the time of transfer and the relevant wallet address is recorded on the blockchain in a manner which cannot be altered. Any individual can look up the digital asset and view its transaction history.
Another benefit is that you can verify the uniqueness and authenticity of an NFT and confirm the number of NFTs relating to an asset that are in existence, providing proof of its rarity. Further, NFTs facilitate a system that allows for creators of an NFT to automatically receive royalty payments each time their NFT is sold, which may be between 10-20% of the purchase price.
Many people question the value of NFTs where the purchaser generally receives a licence to display the asset, but does not obtain ownership of any tangible property or intellectual property rights. However, given the amounts that people are willing to pay for NFTs, it must be accepted that they have a "value" which is impacted by factors common to many assets, including utility, uniqueness/scarcity, fame of the NFT creator, ownership history, liquidity and aesthetics. Time will tell if NFTs are only a short-term craze, or whether they will continue to hold their value over time.
Intellectual property challenges
NFTs are not specifically regulated and there is no Australian case law involving NFTs as yet. In some instances, depending on its specific use, an NFT may fall under securities, virtual assets and consumer laws.
Ownership of an NFT is distinct from ownership of the underlying asset, as an NFT owner will have no proprietary or intellectual property rights per se in the asset, unless otherwise specified in the smart contract.
Where an NFT for digital artwork is concerned, for example, a purchaser of the NFT will generally only acquire a limited licence to use the artwork in specified ways (generally to display the work, make a personal copy of it or generate revenue up to a certain value). The creator of the artwork will generally retain all copyright in their work, which includes the right to make a copy of it or make it available to others on the internet. This is similar, in a sense, to the rights acquired by a person who purchases a physical painting. They can hang that artwork in their home, but do not (unless authorised by the copyright owner) have the right to make copies of it.
Of course, this will depend on the contractual terms agreed in the relevant smart contract. Generally, the terms of the smart contract are determined by the NFT marketplace, but in some instances, terms can be negotiated with the seller. Sometimes, an assignment of intellectual property rights (such as copyright) may be incorporated in the sale. However, in order to be effective, buyers should ensure that any assignment meets the formal requirements for intellectual property assignments within the relevant jurisdiction. Buyers of NFTs should also confirm whether the relevant terms enable them to subsequently assign their rights or prevent the creator from minting additional NFTs of the same work, as this will impact its resale value.
Another risk is that ownership and access to NFTs is reliant on the maintenance of the blockchain node. Therefore, if the blockchain node ceases to exist in future, the NFT would be irretrievable.
The risk of trade mark and copyright infringement
NFTs can be created illegally, by creators copying existing works or using a trade mark without consent. Given the recent boom in NFTs, it is unsurprising that unlawful conduct concerning NFTs is rife.
An NFT marketplace called Cent has recently halted all transactions because of "rampant" fakes and plagiarism. This has included people selling unauthorised copies of other NFTs, making NFTs concerning content to which they do not possess the relevant rights, and selling sets of NFTs which resemble a security.
The owners of at least some major brands have clearly had enough. For example, in January 2022, Hermès commenced court proceedings in the US against Mason Rothschild, an artist who had created an NFT series called "MetaBirkins". Hermès is the brand behind The Birkin bag, being one of the world's most coveted handbags. "MetaBirkins" is a collection of digital Birkin bags reimagined with different colours, fabrics and patterns that sell for up to USD $65,000 each. Hermès sued Rothschild for (among other things) trade mark infringement, alleging that Rothschild's work "simply rips off Hermes' famous BIRKIN trademark by adding the generic prefix 'meta' to the famous trademark BIRKIN" and that Rothschild is openly trying to "create the same kind of illusion that [the Birkin] has in real life as a digital commodity" but in the virtual world. Hermès is seeking a permanent injunction to restrict the creation or trade of the "MetaBirkins" NFTs, an order that Rothschild surrender the MetaBirkings.com domain names to Hermès, and pay damages arising from Rothchild's sale of the NFTs. While the OpenSea NFT marketplace has removed the "MetaBirkins" NFTs from the market, Rothschild is heavily pushing back, arguing that "MetaBirkins" is within the confines of free speech (a concept which enjoys significantly broader protection under the US constitution than in Australia): "the First Amendment gives me the right to make and sell art that depicts Birkin bags, just as it gave Andy Warhol the right to make and sell art depicting Campbell's soup cans".
Another recent case concerned American filmmaker Quentin Tarantino. In November 2021, film studio Mirimax sued Tarantino for breach of contract, copyright infringement and trade mark infringement. Tarantino wrote and directed the film Pulp Fiction, which was released in 1994. More recently, he released a "Pulp Fiction" NFT collection, which comprises of seven "exclusive scenes" from his hand-written Pulp Fiction script. The collection will be offered as "secret NFTs", which are a type of NFT with programmable privacy features that do not contain publicly accessible information relating to verification, ownership and authenticity. They were also promoted as follows:
"Each NFT consists of a single iconic scene, including personalized audio commentary from Quentin Tarantino. The collector who will purchase one of these few and rare NFTs will get a hold of secrets from the screenplay and a glimpse into the mind and the creative process of Quentin Tarantino. The owner will enjoy the freedom of choosing between: 1) Keeping the secrets to himself for all eternity 2) sharing the secrets with a few trusted loved ones and 3) sharing the secrets publicly with the world".
Miramax argues that Tarantino does not have the right to engage in this conduct because, by virtue of a contract signed by the parties in 1993, Tarantino assigned his rights (including copyright and trade mark rights) in Pulp Fiction to Miramax. While obviously not expressly contemplated by the parties at the time, Mirimax argues that this now gives Mirimax (and not Tarantino) the right to mint NFTs relating to Pulp Fiction. In his defence, Tarantino is arguing that under the contract, he retained the right to engage in relevant "print publication (including without limitation screenplay publication, "making of" books, comic books and novelisation, in audio and electronic formats as well, as applicable)". A core question in the dispute is whether Tarantino's right to screenplay publication covers the planned NFT sale.
Miramax has also alleged that Tarantino has breached copyright by using imagery of cartoon illustrations of the Pulp Fiction characters played by John Travolta and Samuel L Jackson on his NFT auction website. Miramax's complaint also includes a claim for trade mark infringement based on its unregistered and registered trade marks in the name "PULP FICTION". It alleges that Tarantino's use of the "PULP FICTION" mark in commerce in connection with the sale of the Pulp Fiction NFTs will cause deception and confusion among consumers as to whether the NFTs originate from or are associated with Miramax. However, the trade mark registration for "PULP FICTION" being relied on by Miramax only covers merchandise, including clothing, action figures, toys and posters. There is therefore a question, which will need to be addressed by the Court, as to whether (and how) such a registration can be used to restrain the sale of NFTs.
The outcome of the Hermès and Miramax cases is yet to be seen. However, they serve as a warning for those wishing to profit from NFTs. Just because they are new and (as yet) not specifically regulated, the same old rules can apply, and intellectual property owners have significant power to restrain unauthorised use of their rights.
Can inventions in the NFT space be patented?
NFT patents are already here, and more are likely to be on the horizon. For example, Nike has obtained several U.S. patents for a method of cryptographically securing digital assets to physical articles of footwear using NFTs. These patents relate to Nike's blockchain compatible sneaker project called "CryptoKicks". "CryptoKicks" will allow buyers to track ownership and verify the authenticity of sneakers using the blockchain system. When buyers purchase a "CryptoKick", they will receive a digital asset attached to a unique identifier of that shoe. Nike has also mimicked Cryptokitties in allowing owners of "CryptoKicks" to intermingle or breed the digital shoe with other digital shoes to create "shoe offspring" and have the offspring made as a new, tangible pair of shoes.
NFTs can also be used as tools to assist in the transfer of patents and other intellectual property rights, and you can also purchase patent NFTs on NFT marketplaces. For example, a patent for a method of separating the storage and process of a computerised ledger for improved function was recently auctioned as an NFT on OpenSea for bids starting around USD $7.5 million.
Takeaways for IP owners
NFTs have taken the world by storm and are presenting many novel challenges and opportunities – including (but not uniquely) for intellectual property law practitioners. While there is much speculation about the longevity of NFTs, trade mark and copyright owners should (as always) monitor whether their rights are being infringed in the online and digital world, including in the NFT space. While we are yet to see a case brought in Australia for trade mark or copyright infringement in the NFT context, the increasing ubiquity of these digital phenomena suggests this is inevitable.