The word “NFT” suddenly burst on to the stage of digital art and media in the last one year and has been doing a tap dance around questions of commercial models and legality. Celebrities, studios, media companies and even the humble artists are rushing to jump onto the bandwagon and lawyers are busy interpreting, drafting and negotiating clauses to protect rights and future exploitation opportunities in the NFT world. One part of the world is confused how the NFTs are commanding so much value and the other half is confused whether this is another Cryptocurrency. Then there are discussions and even disputes regarding copyright of the work vs. Asset ownership. In the midst of all regulators are groping in the dark to figure out what to do with NFTs. Altogether NFT has just become the hottest topic for creators, businesses, lawyers and regulators.
I have had some interesting conversations with various people regarding NFTs and the discussions have always included topics like how do we monetise NFT? How do you determine the value of the NFT? Is it cryptocurrency and would it be banned by the Indian government? How can you sell or buy NFT if cryptocurrency is banned? Would we transfer copyright also when we sell the NFT? and the million-dollar question, should I invest in NFT, is it safe? In this article, my attempt is to demystify and answer these questions in a manner which is not too tough for a layman to understand while also touching upon certain aspects of law and to assess the way this story will unfold.
To understand NFT, first one needs to understand what is blockchain. To those of you who are not clear as to what blockchain is, in simple words it is a database with entries which is stored and shared across a network of computers. So, it is a shared database where data is collected and stored in groups known as a “block” instead of tables which you would see in a traditional database. Once one block is filled, it is then linked to the previously filled block thus forming a “chain” of data. This kind of structure makes the database on blockchain irreversible due to its decentralized nature. So once a data is made part of blockchain it is cast in stone with a time stamp. So blockchain allows digital information to be recorded and distributed but does not give an option for it to be edited, altered or deleted. Blockchain is also known by the name Distributed Ledger Technology (“DLT”).
Blockchain a.k.a DLT is the technology powering many products like Cryptocurrency, non-fungible tokens (NFT) and also Smart Contracts.
Non-Fungible Tokens (“NFT”) in simple terms is nothing but an authentication mechanism which is based on blockchain technology. It is a token authenticating the source and ownership and is an entry on a distributed ledger using blockchain making it an unalterable record.
While NFT is built on the same platform (i.e., Blockchain) as cryptocurrencies, they are not the same. The main difference is in the name itself. Non-Fungible Token. The word Fungible in economics stands for the property of a good or a commodity where one unit of such good is substantially equivalent to another unit of the same good of same quality (eg: Gold is fungible as 1 gram of gold is equivalent to another 1 gram of gold provided it is of the same quality, whether it is in the form of coins or ingots or any other state. Similarly, one Rs. 100 note is interchangeable with two Rs. 50 notes or in other combinations). Other fungible commodities include crude oil, shares of a company and currencies. So, while a cryptocurrency is fungible, NFT is not as no two NFTs or parts of them are of the same value and so are not interchangeable.
Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 which was rechristened as The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 and introduced in Lok Sabha to ban all kinds of Cryptocurrencies in India other than the proposed Official Digital Currency, defines Cryptocurrency as below:
“Cryptocurrency, by whatever name called, means any information or code or number or token not being part of any Official Digital Currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes;”
While this definition casts a wide net and can draw in almost anything with value and is generated through digital cryptographic means, if you look closely, the intent of the legislature seems to be to ban such things which can replace the official Currency of the country. Even the current definition includes certain qualifiers like (1) having a digital representation of value which is exchanged, (2) including a promise or representation of having inherent value or (3) functions as a store of value or (4) a unit of account. If you look at NFT, it has no inherent value like that you see in Cryptocurrency where one Bitcoin is equal to the value of several thousand US dollars. Also, NFT does not represent any value which is exchanged and it does not function as a store of value or a unit of account. NFT in its pure sense only act as an authentication mechanism which confirms that the work that it authenticates has been produced by X and is owned by X or Y and records the transactions. Value if any of an NFT is not of the NFT itself but of the work of Copyright or a digital commodity (e.g. a digital ticket to an event) that the NFT authenticates. Saying that an NFT holds a value is like saying a title deed has an inherent value. So just like title deed’s value solely depending upon the value of the property it represents, the value of the NFT is also dependent on the asset it authenticates.
A question was raised in the Rajya Sabha on 19th July 2022 to the Finance Minister regarding status of Crypto and NFTs wherein clarification was sought whether Government considers “Crypto and “Non-Fungible Tokens (“NFTs”) as assets. The Minister of State while answering this question confirmed that NFT falls under definition of Crypto but also clarified that Vide notification no.75/2022 dated 30th June 2022, Central Government specified that a token which qualifies to be a virtual digital asset as non-fungible token within the meaning of sub-clause (a) of clause 47A of section 2 of the Finance Act 2022 but shall not include a nonfungible token whose transfer results in transfer of ownership of underlying tangible asset and the transfer of ownership of such underlying tangible asset is legally enforceable.
While this clarification is purely from a taxation perspective and not from perspective of determining legality of Crypto assets, it still shows that the fate of digital artwork NFTs is still a matter that needs to be determined as they fall under virtual digital asset and not a tangible asset.
Firstly, for creation of an NFT, a digital work should be selected. This can be an image file like JPEG, GIF etc., music file, video file or any other digital property which can be seen or heard by the buyers. The crux of creating value of an NFT is to make the work the NFT authenticates a unique work. It is like a designer wear where each piece has to be rare to create value for the buyer. While the copies of the same digital work maybe available, none of the copies of such work which is authenticated through NFT may be available thereby making that rare. If copies of the same digital work is made available in the form of NFT, then that will dilute the value of the NFT work. There are some NFT works which are released in groups also which means there would be a limited number of such NFT works and that brings in the rarity. So basically, the value of the NFT work is based on pure economics of demand vs. supply. If there is no demand for the work, then value is zero and if there is demand for the work but supply is larger than the demand, the value of the work becomes lesser. If there is high demand for the work but supply is low and best of all ‘nil’ other than that single work, then the NFT work will demand premium value. To explain this further, we can also look at the example of how paintings by professional artists attract value. If the artist is well known (that is the source of work) and he creates one painting (that is the work), the painting keeps appreciating in value provided the same artist does not create more copies of the same work. Most of the costliest paintings we can see are works done by artists who are no more like Leonardo da Vinci, which basically means that supply of any kind of paintings from such artist is not a possibility anymore thereby making it rarest of rarest.
Another example of value creation to understand this better would be to equate an NFT Artwork like owning a cricket ball which is authenticated by a credible agency like ICC as being the ball which was used in a world cup match. The value of that ball will substantially be higher than all other cricket balls only because it is authenticated as the cricket ball used in the world cup by a credible source. Otherwise, it’s just another ball. Similarly, a digital artwork becomes more valuable when an authentication is done by minting it into an NFT which verifies the origin of the content and that turns such digital artwork into a collectible.
Finally, the value of the NFT work also depends on perception about the work in mind of public. If you think about it, perception is also a key driver in stocks rising and falling (for eg: when Competition Commission of India imposed penalty on tyre manufacturers for cartelisation, stocks of public tyre companies took a dip).
The business of NFT intersects at many points with the Copyright Laws. Works like photographs, artistic works, musical works, audio visual works etc. are defined as “works” and is protected under copyright laws. So only the owners or such person who has been licensed by the owner of such works can create an NFT using such works. If a person creates an NFT using any work which such person does not possess the rights, then it would be considered as an infringement. So, creation and sale of NFT is also similar to any other exploitation of such works.
Another important point for discussion is whether creating a work of Copyright as an NFT and selling the same will also transfer the copyright to the buyer. As we discussed earlier, NFT is nothing but a token authenticating the work it is attached to. So, the best inference we can draw in this scenario is to equate NFT with the brand label of the manufacturer on a branded item of merchandise that you buy. In this case the label is the NFT. Buying a t-shirt which is from a manufacturer will only transfer the ownership of that particular t-shirt to you and not the ownership of the design and images on the t-shirt which is the intellectual property of manufacturer. In this case manufacturer will continue to own the rights to its intellectual property. Likewise, the buyer of an NFT is in fact only getting the ownership of that particular copy of the digital work which is authenticated through NFT and not the ownership of the Copyright in the work itself. However, when the terms and conditions of sale of NFT works are not clearly communicated to the buyers, this leads to confusion as to how such NFT works can be utilised by the buyers and this further leads to disputes.
A very interesting case is underway on this space which has put in collision course, the rights of the creator of the NFT vs. the rights of the owner of the NFT work. Larva Labs, the creators of the most traded NFT collection in the world “CryptoPunks” decided to delist the V1 collection of the CryptoPunks NFTs and released V2 collection. While this withdrawal was announced, the V1 collection was still available in the market place OpenSea and Larva Labs sent out a Copyright infringement notice to OpenSea to takedown the V1 collection. However, the owners of the V1 collection have challenged this takedown notice. This is a classic example of ownership of Copyright vs. the ownership of the asset.
Another issue we have been facing in India is the uncertainty regarding fate of Cryptocurrency. Will it be banned or regulated? The question is still pending decision. The most usual way for purchasing an NFT is to use Cryptocurrency. So, it poses our next issue, how can you buy or sell NFT work if cryptocurrency is banned? If the NFT work that you have purchased is traded only using cryptocurrency, then it poses a unique challenge to buyers in India if Cryptocurrency is banned. Especially if the creator of the Cryptocurrency and more importantly, the platform facilitating the sale/transfer of the NFT work is situated in another country which allows Cryptocurrency transactions. In such case, the creator and platforms may not change the way their transactions are done only because regulators in India takes a stand against Cryptocurrency transactions. However, if the creator and platform facilitating the trade is also based out of India, it would only be logical for them to adapt to such changes to keep the business running. There are various creators and platforms who have already opted for a hybrid model by allowing purchase of NFT works using fiat currency through credit card transactions or using Cryptocurrency. A notable one is NBA Top Shots which sell NBA digital collectibles. So, it is evident that we may see more of this hybrid approach going forward to make the NFT works purchasable by people across the world.
Another lingering question about NFT is, whether it is safe to buy NFT works/assets? Obviously, the answer to this question is not that simple and it depends on various factors we discussed above. So, buying an NFT works/assets can be incredibly profitable or may end you up with zero value depending upon the kind of NFT works/assets that you buy, the rarity, uniqueness and perception in the mind of people regarding the NFT. This may be the reason why The Advertising Standards Council of India (ASCI) has framed guidelines for advertisement of Crypto products including NFTs asking the advertisers to prominently display a disclaimer on ads and promotions related to virtual digital assets like cryptos or non-fungible tokens stating that Crypto products and NFTs are unregulated and can be highly risky and that there may be no regulatory recourse for any loss incurred from transactions involving them. As we have discussed above, the value of NFT works/assets depend on many things and the investment is not risk free.
While we talk about the risks and rewards of NFTs, we also need to talk about whether NFT is only for purpose of digital collectibles or does it have a bigger future. As we have discussed above, NFT is used to tokenize and authenticate an asset. This can also be done for any real-world assets which will help in bringing transparency to the ownership of the asset by recording creation and each transaction and ensuring that the records are incorruptible as it is on blockchain. NFTs can also be used to tokenize and authenticate real world things like property deeds and intellectual property ownership. This has potential to even change the entire landscape of governance. Presently if you are to buy a property, you will have to engage a lawyer to check the mutation records for at least 30 years and confirm the devolution of title from original owner to the seller. If the title deed of the property is tokenized using NFT and the government allows transfer of such property only through transfer of the NFT, it will record each transaction and everything will be available to the subsequent buyers at the click of a button. Also, corporates like Facebook and Microsoft are spending billions of dollars in building Metaverse and it is only a matter of time this becomes a reality. Metaverse would definitely act as a catalyst to the NFT explosion. Once metaverse becomes a parallel universe where people interact with each other and conduct business digitally, it would also precipitate digital ownership and NFT will be there to authenticate and tokenise the ownership and record the transfer of various assets in the Metaverse, which we may not be even aware of today. So, it is evident that things are just getting started on the NFT space and there is much more to come. It is highly possible that between the time I am writing this and you are reading, there may be several new developments which has already happened in this space and that is what makes it exciting.
Disclaimer: This article only presents my personal views on the subject and is not to be considered as legal advice or the views, plans or policies of the organisation I am associated with. Readers should be mindful that, this is an evolving sector with constantly shifting regulatory approaches and positions today can dramatically and diametrically change tomorrow.
www.grandmasters.in | 8 Years & Counting
www.rcls.in | 8 Years & Counting
www.itlegalsummit.com | 8 Years & Counting
www.bfls.in | 8 Years & Counting
www.maels.in | 8 Years & Counting
www.plcs.co.in | 8 Years & Counting
Copyright © 2020 Lex Witness - India's 1st Magazine on Legal & Corporate Affairs Rights of Admission Reserved
