NFTs: disruption or speculation? At the latest since NFTs worth more than USD 2.5 billion were traded in the first half of 2021 and numerous participants — including start-ups, large corporations, artists and sports teams and leagues — entered the extremely dynamic market, questions have arisen regarding the legal classification of NFTs. Therefore, the following overview aims to introduce the topic and its the legal aspects with a particular focus on copyright issues.
Tokenisation of assets on a blockchain
In concrete terms, NFTs are strings of characters stored on a blockchain. A blockchain is a continuously expandable list of cryptographically interconnected data sets which acts as a decentralised registry for example like a decentralised land registry, that can be viewed by everyone. An added value of NFTs lies in the transparent and forgery-proof identification of a particular digital object (the reference object) as a specific individual item and the assignment of this reference object to an owner.
Firstly, this is based on the property of many blockchains to store data records in a decentralised and virtually tamper-proof manner. Secondly, certain blockchains, such as Ethereum and Cardano, enable the programming of so-called smart contracts (code executed on the blockchain) which can be used to generate NFTs (known as minting). For this purpose, a particular software is used (usually on a trading platform such as OpenSea, which is connected to a user’s wallet) and a fee is paid for the creation of an NFT. Once the NFT has been minted and the reference object and the NFT have been linked, the specific character string on a blockchain – the NFT – clearly represents a specific asset, such as a digital piece of art. This process is also referred to as tokenisation (of the asset).
Benefits and commercial applications
The NFT enables certification of ownership or other rights to a reference object. Digital goods that can otherwise be copied virtually free of charge are therefore artificially rendered scarce. A commercial and particularly copyright-relevant use case can be found in the markets for digital art, collectibles and other digital goods, which have grown strongly in particular since the beginning of 2021. Examples include the trade of digital artworks such as the CryptoPunks, as well as musical samples and the sale of so-called collectibles in the context of computer games (e.g. virtual Formula 1 racing cars). In addition, the football club FC Bayern Munich, for example, has issued digital trading cards showing its players and the NBA has sold short video clips (known as moments). Major companies such as TikTok, Twitter and Visa have recently entered this market, while others — such as Facebook — are considering it.
However, NFTs and asset tokenisation offer many more commercial applications. In addition to digital objects, physical objects can also be referenced using NFTs. For example, Noerr has already advised 360X AG (whose main shareholders are Deutsche Börse and Commerzbank), which develops new blockchain-based marketplaces and ecosystems for physical but less liquid assets such as physical artworks and real estate (Noerr advises 360X Art AG on partnership with Weng Fine Art AG, Rüdiger K. Weng and Johann König). In addition, by way of fractionalisation, only shares of such assets can be traded, which increases their liquidity and makes the respective markets accessible to the general public.
In the context of NFTs, many new legal questions arise that call for innovative answers. Under civil law, NFTs could at least enjoy protection in torts as “other rights” under section 823 para. 1 of the German Civil Code, but, at least according to the very predominant view, they do not constitute absolute rights and, due to their lack of corporeality, they are not “objects” within the meaning of sections 90 and 903 of the German Civil Code. The specific legal significance of individual NFTs is therefore primarily left to the contractual arrangements made by the parties involved.
The legal relationships between the buyer and seller of an NFT, as well as the rights associated to the NFT and related to the reference object, therefore depend primarily on (i) what absolute rights exist in the reference object under the respective legal jurisdiction and (ii) what the parties agree regarding the transfer of rights. In the context of the currently particularly active (digital) art market, the absolute rights are primarily copyrights and the transferred rights are rights of use under copyright law (licenses). However, this requires further clarification on a case-by-case basis.
Copyright law issues
While the legal relationships of the parties concerned can thus be described from the perspective of (copyright) law, NFTs also raise new issues of copyright law of practical relevance. The most important of these will be presented below.
Copyright relevance of minting
First of all, it is still unclear whether the minting itself is relevant under copyright law and can, for example, interfere with a right of use of a rights holder. It is important to consider that the minting of an NFT does not represent the digital asset itself, but instead creates a token on the blockchain that is linked to metadata of the work. This includes information needed to identify the token, the artwork and the token owner, including a link to the work. In practice, questions arise primarily at two main points: Firstly, the minting right as an unknown type of use could already be the subject of existing licensing agreements (see section 31a of the German Copyright Act). In particular, if rights of use were to be granted extensively, the right to mint would then no longer belong to the author, but rather on the buyer. Consequently, only the buyer would be entitled to mint an NFT and offer it for sale. Secondly, the unlawful minting of an NFT would enable the right holder to claim injunctive relief and, if necessary, damages (section 97 para. 2 of the German Copyright Act). The issue is therefore particularly relevant in practice and requires speedy clarification by the courts.
Formulation of licensing terms
The buyer and seller can agree that certain rights of use of the reference object are transferred in the transaction of an NFT (e.g. to a copyrighted artwork such as a painting). Special attention should be paid to the wording of the licence terms. After all, licences in copyright contract law can be drafted in a highly individual manner (section 31 of the German Copyright Act). In particular, the right of use may be limited in terms of territory or time or to certain types of use. Of particular importance in this context is the distinctions between non-exclusive or the far-reaching exclusive rights of use which give their buyer exclusivity (section 31 para. 2 and 3 of the German Copyright Act). Remuneration also requires specific contractual regulation (see section 32 of the German Copyright Act).
Monitoring and misuse
While blockchain technology offers the possibility of seamless tracking (e.g. through on-chain analytics), right holders must also face risks of abuse. After all, third parties can also create NFTs for a reference object (e.g. an artwork) even though they are not authorised to do so. Additionally, an artist, for example, may create several NFTs for a reference object. This should be contractually counteracted by buyers of an NFT. To prevent misuse by third parties, transparent processes are required in practice from which it is clear which NFT can be allocated to a reference object.
To this end, practical difficulties arise regarding enforcement. While blockchains allow tracing of NFT trades, their owners cannot usually be identified via their wallet addresses. Therefore, some NFT trading platforms require (KYC) identification processes for the creation of wallets. The international dimension of NFT trading will also create enforcement problems.
Automated royalty payments
Certain blockchains also allow artists as creators to participate in their commercialisation beyond the sale of an NFT by means of smart contracts. In practical terms, it could, for example, be agreed in the code of a tamper-proof smart contract that an author will receive a proportion of the proceeds if the buyer resells for a certain price. There is also the option of defining that a share is held in every further transaction. In these cases, no further human act of transposition is required. By means of special technical interfaces, certain automated decisions can also be made on the basis of external sources (e.g. on the basis of reliable databases). All of this requires prudent and forward-thinking contract drafting.
Outlook: On-chain NFTs and the metaverse
The reference objects are (still) almost exclusively digital or physical objects that are not stored on a blockchain themselves. However, this may change in the future as a result of new technological developments, such as on-chain NFTs, which enable data to be stored on blockchains independently of trading platforms. In addition to their usefulness in making traditional digital and physical assets tradable, NFTs could also provide a basis for the metaverse – the emerging collective virtual space, which may develop into a multi-billion market (see e.g. recent media reports). In the metaverse, users interact, exchange services and transfer assets such as virtual land and other objects. NFTs are becoming a central infrastructure for this, making it all the more important to resolve the legal issues.
- Dr. Torsten Kraul, Associated Partner | email@example.com
- Dr Max von Schönfeld, Associate | Max.vonSchoenfeld@noerr.com
- Dr Marvin Bartels, Associate | Marvin.Bartels@noerr.com
Compliments of Noerr – a member of the EACCNY.