NFTs and the Law: How the NFT Craze Benefits Lawyers

Understanding the Nuances of Non-Fungible Tokens (NFTs)

The surge in popularity surrounding non-fungible tokens (NFTs) has led to over $224 million being spent by Ethereum enthusiasts on digital collectibles in 2021 alone, primarily through platforms like OpenSea and Rarible. However, a significant number of purchasers may lack a complete understanding of precisely what they are acquiring.

The Nature of NFT Ownership

According to attorney Nelson Rosario, a founding member of Smolinski Rosario Law, an NFT fundamentally represents control over data recorded within a digital ledger, much like any other cryptocurrency transaction. It’s a matter of controlling information, not necessarily possessing the underlying asset.

It's crucial to recognize that NFT buyers do not gain ownership of the actual media files – be they JPEGs, GIFs, or MP3s – linked to their blockchain records. Instead, they obtain a token representing a claim or right related to that file.

A Historical Perspective on Crypto Collectibles

Determining the long-term viability of the current NFT trend requires examining the history of similar digital assets. Interestingly, the creation of crypto collectibles dates back almost seven years.

Early Challenges with Bitcoin-Based Collectibles

Christian Moss, co-founder of Zebedee, who has been involved with blockchain gaming since 2014, recounts ceasing development of Bitcoin-based collectibles due to escalating transaction costs. Furthermore, a problematic shift occurred where some individuals began treating these tokens as investments rather than recreational items.

“These were tokens built on the Bitcoin blockchain,” Moss explained. “Many developers attempted to inflate the value of their tokens. Players began to perceive themselves as investors, which altered the game’s dynamic.” He expressed a desire to avoid his games becoming investment vehicles, fearing potential legal challenges from players who might lose value in their tokens.

A Shift Towards Clear Valuation

Currently, Moss focuses on enabling users to earn small amounts of Bitcoin through participation in popular video games like Counter-Strike. This approach establishes a clear distinction: cryptocurrency functions as currency, while in-game assets remain as entertainment items.

NFTs as Receipts, Not Items

“NFTs aren’t actually game items; they function as receipts,” Moss clarified. “Possessing the receipt may grant access to an item within a game, but incorporating an NFT representing, for instance, a Zelda sword into Counter-Strike could lead to copyright infringement, presenting significant legal hurdles.”

Legal Considerations Surrounding NFTs

The legal ramifications are central to the NFT phenomenon. The extent to which a court would uphold the receipt-holder’s ownership rights over a specific file is contingent upon numerous factors.

“If an artist intends to transfer copyright ownership to an NFT purchaser, the question becomes whether that transfer can be legally validated and recognized by a court or copyright office. This introduces complexities related to legal jurisdiction,” Rosario stated. “Brands and platforms must ensure they have appropriate agreements in place to govern these relationships.”

The Legality of NFT Sales Based on Existing Content

Regarding sellers who create NFTs from screenshots of others’ content, Rosario indicated that determining legal violations is complex. “The initial step would likely involve reviewing the terms of service of platforms like Twitter, and the outcome would depend on the specific circumstances,” he noted, adding that impersonation or unauthorized access to accounts are separate legal concerns.

Remaining Unresolved Issues

Beyond copyright and fraud, further legal questions remain open, including those related to sanctions compliance and regulations concerning adult content.

• NFTs represent control of data, not ownership of the underlying media.
• Early crypto collectibles faced challenges with transaction fees and investment speculation.
• Legal implications surrounding copyright and content ownership are crucial considerations.

The Search for Platforms Supporting Adult Content

An increasing number of adult content creators are utilizing platforms such as Rarible to sell erotic Non-Fungible Tokens (NFTs), frequently generating substantial revenue – often hundreds of dollars – per image. PolyAnnie, a creator in this space, reports that her earnings from Rarible alone have surpassed her typical yearly income from platforms including OnlyFans, Patreon, and ManyVids.

Specifically, she stated, “I achieved a revenue of 10.11 ETH through the sale of 90 NFTs within a five-month period.” Furthermore, PolyAnnie also invested in the work of other creators, acquiring 18 NFTs.

Regulatory and Platform Challenges

Certain legal areas mandate age verification for platforms hosting adult material. Conversely, other jurisdictions hold platforms accountable for the presence of child pornography or revenge porn if insufficient content moderation is implemented. Consequently, platform operators generally adopt cautious approaches to their terms of service.

“Many of these NFT marketplaces are hesitant to engage with the potential risks associated with sexually explicit content,” PolyAnnie explained.

This reluctance has resulted in content censorship for some sex workers on platforms like Rarible. OpenSea, a leading NFT marketplace that recently secured Series A funding from a16z, employs moderation practices and restricts the visibility of adult content in search results. Access to these NFTs is therefore limited to direct visits to the creator’s profile, as stated by CEO Devin Finzer.

“We are still refining our approach, but a dedicated section on our site for this type of content is one possibility we are considering,” Finzer noted.

Emerging Adult-Focused NFT Platforms

As a result, PolyAnnie is involved with a group developing NFT platforms specifically designed for adult content, such as Leafless and Non-Fungible Porn.

“The adult entertainment industry places a significant emphasis on ensuring the involvement of only consenting adults, prioritizing safety and preventing platform shutdowns,” PolyAnnie emphasized. “Even in the event of identity theft, the NFT would not originate from my digital wallet.”

NFTs present a distinctive opportunity for lesser-known performers, she believes. Prior to her entry into the NFT space last year, PolyAnnie lacked a substantial, technologically proficient fanbase. Having already established herself through performances ranging from fire dancing to nude yoga, she quickly adapted to the crypto environment and cultivated a new audience, offering them exclusive products.

Benefits and Considerations of NFT Ownership

Some of her NFTs include “unlockable” links providing access to exclusive photo sets or complimentary trial periods for platforms like OnlyFans. While a buyer could potentially share these exclusive photos instead of trading the NFT, doing so would diminish the asset’s resale value.

Conversely, when a buyer resells PolyAnnie’s NFT on OpenSea, she receives 20% of the resale proceeds. This fosters a mutually advantageous relationship between creators and collectors. Moreover, the blockchain record allows fans to verify whether the NFT was originally issued by the performer’s verified crypto wallet or profile.

“This allows for stronger connections with my supporters than previously possible. I now have fans who actively promote my brand and resell my NFTs,” PolyAnnie stated. “Even if content is stolen or pirated, its origin remains traceable to me, allowing for verification of my authorship.”

However, while these immutable blockchain records are particularly beneficial for adult content creators, they may pose challenges for NFT artists in countries like Cuba and Iran, as some platforms are implementing measures to identify and restrict users from sanctioned regions.

Navigating Legal Considerations Regarding Digital Identities

The relationship between financial sanctions and Non-Fungible Token (NFT) transactions remains somewhat ambiguous. However, Rosario indicated that future compliance efforts will likely concentrate on the platforms facilitating these trades, rather than individual NFT users.

When questioned about the potential implementation of geo-blocking measures for sanctioned regions on OpenSea, Finzer stated: “Further measures to account for sanctions are being developed and will be implemented.”

Several cryptocurrency firms, including BitGo and BitPay, have already faced penalties for enabling transactions with users located in sanctioned jurisdictions, such as Iran and Cuba, where U.S. financial regulations are prohibited. Rosario advised that NFT startups should exercise caution and remain aware of these existing regulations.

“A prudent approach would involve ensuring that transactions are not processed with blockchain addresses listed on the Office of Foreign Assets Control [OFAC]’s Specially Designated Nationals And Blocked Persons [SDN] list,” Rosario explained. “This is an area currently under consideration by officials within the U.S. Treasury.”

Legal Challenges for Artists

These emerging legal complexities suggest that artists may require legal counsel. Without it, their work could be utilized in ways that negatively affect their reputation. The experience of cartoonist Matt Furie, whose Pepe the Frog character was appropriated by white supremacist groups, serves as a notable example.

Giorgio Angelini, director of the documentary “Feels Good Man,” expressed feeling exploited when a Pepe-inspired NFT was sold for a higher price than the funds raised for his film, which premiered at the Sundance Film Festival. Essentially, a greater sum was spent on a blockchain record of a simple meme than on the creation of a two-year documentary about Pepe’s originator.

“While I understand the motivations of those creating NFTs, it’s challenging to differentiate between legitimate projects and those with less honorable intentions, such as pump-and-dump schemes disguised as fan art,” Angelini said. “Effectively defending copyright is typically a capability reserved for large corporations like Disney. … Significant legal issues had to arise before a major law firm offered assistance to Matt on a pro bono basis, as a public service.”

Angelini clarified that he holds no ill will towards the specific seller of the Pepe NFT and is also exploring opportunities to leverage the NFT trend. Beyond the legal expenses, Angelini believes NFTs have the potential to “democratize” traditionally established media industries like fine art and filmmaking.

“NFTs could empower artists to participate in the resale market, a sphere currently dominated by galleries,” Angelini stated. “The film industry is largely controlled by three major streaming companies, all of whom were initially skeptical of Pepe and its associated culture. … We are actively investigating ways to engage with NFT markets, and any film NFT we create will be unique and thoughtfully designed, rather than a superficial offering.”

Reliability, Not Just Regulation, is Key

Ultimately, the value of a blockchain-based receipt, such as a Non-Fungible Token (NFT), is fundamentally dependent on the dependability of the blockchain it resides on.

One observer recalled the early adoption of Ethereum in 2015 by many gamers, drawn by its initially low transaction fees. However, this was viewed as a temporary solution, merely postponing potential issues.

As highlighted, elevated transaction costs previously hindered the widespread adoption of crypto collectibles and rendered them inaccessible for numerous game types. Companies utilizing NFTs often mitigate this by managing transactions on their own platforms, giving users the choice of blockchain involvement. Established legal precedents exist for accountability when assets are compromised on centralized platforms; the legal ramifications of blockchain network manipulation remain uncertain.

“Issuing an asset on a blockchain with a value exceeding that of the underlying base asset creates an incentive for miners to potentially alter or reverse blocks, thereby endangering all transactions within that block,” Moss explained, pointing out that high-value NFTs can surpass the value of the Ethereum tokens intended to secure them, given ether’s current trading price below $2,000.

Legal considerations surrounding the open-source blockchain network extend beyond NFT companies, and clarity will likely emerge through future legal challenges seeking compensation for losses attributed to the blockchain system itself, rather than individual theft. The prevailing assumption regarding NFTs relies on Ethereum’s robustness and decentralization, ensuring blockchain immutability, a condition that isn’t consistently met.

Regarding alternative blockchain ecosystems, Jesse Powell, CEO of Kraken, suggested that Bitcoin’s Lightning Network could provide viable NFT solutions.

“NFTs existed prior to Ethereum, with colored coin projects on Bitcoin,” Powell stated. “If we define it simply as a digital representation, a proof of ownership, then perhaps the blockchain’s privacy becomes paramount. Can users utilize or transfer the NFT without universal visibility? What metadata can the blockchain retain? What information about the token can be accessed without relying on external layers?”

Akash Nigam, CEO of Genies, an avatar company established in 2017 and having secured $52 million in funding, indicated his company will employ the Flow blockchain for authenticating digital goods, rather than solely relying on Ethereum.

“Eventually, interoperability will be achieved,” Nigam predicted. “[The NFT] will accompany the user, enabling login and access to functionalities across different platforms.”

Nigam noted his company collaborates with “thousands” of influencers marketing these digital goods, though the extent to which fans will embrace blockchain networks or crypto wallets remains to be seen. Genies has facilitated NFT sales for celebrities like Shawn Mendes and Mesut Özil, alongside partnerships with brands such as Gucci. Several fashion brands are cautiously exploring the NFT space, seeking a balance between specialized crypto applications and broader consumer appeal.

Powell expressed uncertainty about which blockchain networks will ultimately dominate the NFT landscape, be it Ethereum, Bitcoin, Flow, or another emerging technology. He anticipates potential involvement from platforms like Twitter or Instagram, offering NFT galleries or direct sales, thereby simplifying the user experience and eliminating direct interaction with blockchain receipts. Such initiatives will inevitably encounter the scaling challenges that have long plagued Bitcoin enthusiasts. Technically, NFT tools cannot simultaneously guarantee infinite scalability, liquidity, and self-sovereign immutability; blockchains are inherently slow and complex, which is precisely why they provide dependable records.

“Bitcoin hype also tends to follow cyclical patterns spanning approximately four years,” observed angel investor Paul McKellar. “It’s common for inexperienced investors to purchase during market peaks, driven by enthusiasm. … Currently, we are witnessing altcoins attempting to deliver on promises previously unfulfilled by older altcoins, and even those before them.”

Social media platforms could facilitate NFT payments using various currencies, particularly given Twitter CEO Jack Dorsey’s ownership of Square, a bitcoin-focused company. Currently, Powell acknowledges a significant surge in demand for crypto assets related to NFTs.

“In January and February alone, Kraken processed over $116 billion in trading volume,” Powell reported. “We are closely monitoring NFTs and maintain a strong interest. … However, drawing from my experience with art galleries and digital goods in video games, I anticipate that many NFTs will not retain their current value. The market is currently saturated.”

Powell decided against adding NFT trading options to his exchange, believing it unwise to treat NFTs as speculative investments or savings vehicles. He personally owns two NFTs, acquired as a means of supporting artists.

“Individuals will naturally want to showcase these assets on their social profiles or within identity-based status indicators,” Powell concluded, envisioning the future of NFTs on platforms like Twitter. “If I enjoy it and wish to support the artist, I view it as a cost I am willing to bear.”