Legal And Regulatory Challenges Related To Non-Fungible Assets – Technology

Bizar Male

One of the hottest trends of 2021, non-fungible tokens (NFTs)
have empowered a new generation of digital artists and turned many
speculators and creators into millionaires and overnight
celebrities. NFTs are also gaining traction in the video games
industry thanks to their ability to solve problems such as the
creation, management, and sale of rare commodities. NFTs are
frequently used to grant players – rather than the game developer -
ownership of their in-game assets. Assets created, found, mined,
grown, bought, traded, and even plundered in-game can be
transported across platforms and sold in real-life. Beyond the art
and gaming world, NFTs are also used for verifying identity,
ticketing, tokenizing physical property, and other practical
functions. NFTs are unique, scarce, durable, and extendable. While
there is no shortage of information about the advantages that NFTs
bring to digital transactions and activities, there are several
legal, regulatory, environmental, and operational challenges that
must be overcome for businesses and organizations to take full
advantage of this potentially game-changing technology.

Intellectual Property

As NFT applications expand beyond cryptocurrencies and into new
industries, not everyone involved in the buying and selling of
assets attached to them fully understands what they are dealing
with. Possession of an NFT does not automatically grant ownership
of the underlying artwork or another asset. An NFT merely grants
the buyer the right to use the creative output or object it
represents for their personal use. For example, if someone buys an
NFT tied to a painting, he or she merely has gained the right to
display the digital art in their token wallet. They will not have
the right to reproduce, create derivative works, or sell prints or
copies of the painting. From a copyright perspective, an NFT is
simply a digital receipt indicating ownership of a particular
version of the artwork.

Given the immature market and spotty regulation of NFTs,
criminals have already found ways to use them to steal intellectual
property. Several prominent digital artists have seen their work
sold as NFTs without their permission and have voiced concern that
once their digital art has been hijacked and inscribed in a
blockchain-enabled token, they will lose ownership over their work.
While the tokens can be sold, art can only be tokenized legally
with the artist’s permission. Artists’ concern over losing copyright to
creative output is unfounded, but the inherent difficulty in
proving the place of origin of a piece of digital art places NFTs
in a legal gray area for non-experts.

Jurisdictional Issues

A principal idea behind the blockchain technology that underpins
NFTs is that the ledger is not centrally located or managed. While
this makes it near-impossible to reverse-engineer or fabricate
transactions, it also poses a complex jurisdictional challenge, as
the lack of a specific governing locale makes it subject to
different and often conflicting legal frameworks. The problem posed
by conflicting laws is especially important from the perspective of
copyright and moral rights. For example, moral rights differ
significantly among common law and civil law jurisdictions
(especially those with Germanic and Napoleonic legal traditions).
In France, moral rights are perpetual, inalienable, and
imprescriptible while in the US, moral rights come with statutes of
limitation. As a result, the rights of artists to their underlying
artwork can differ from jurisdiction to jurisdiction, and in some
cases, there may be no way to clearly determine applicable laws and
to select a legitimate forum to consider disputes involving
NFTs.

Smart Contracts

One of their most striking features of blockchain technology and
NFTs is the self-executing “smart contract.” Smart
contracts are sets of promises that are usually specified in a
digital format that form the basis on which the parties perform
their specific contractual duties. Due to their inherent uniqueness
and complexity, it is difficult to say whether smart contracts fit
into the legal framework governing traditional contract law. This
is especially true in the United States, where no federal contract
law exists. Further, at the time of this article (April 2021),
there is no federal law or guidance explicitly defining the
legality of smart contracts in the first place. The only exception
to this is the Electronic Signatures in Global and National
Commerce Act of 2000, which provides limited legal validity to
smart contracts. The legal validity of smart contracts
vis-à-vis NFTs, however, remains unclear, setting the stage
for potentially lengthy litigation in the future.

Privacy Concerns

The security that NFTs provide in assuring anonymity between
contractual parties is often hailed as one of the technology’s
greatest benefits. Nevertheless, this advantage is not guaranteed
to continue. Some believe it is only a matter of time before the
marked improvement in blockchain analytic tools wil be able to
reveal identities and terms. Analysis tools such as Chainalysis,
Reactor, Elliptic, and others can already trace blockchain
transactions. While most are used for purposes such as tracing
fraud and money laundering over the blockchain, they have the
potential to track confidential and sensitive information.

Consumer Protection

NFTs raises significant issues related to consumer rights.
Issues such as assigning permission and responsibility for
recording transactions, the legality of digital receipts,
anti-fraud and anti-money laundering procedures are critical, as
many consumers have little concept of what they are buying and
their rights and responsibilities in relation to NFTs. Since the
legal status of NFTs as consumer goods is still evolving, many
customers may be left in the lurch in the event that complications
with transactions or ownership arise. This is especially pertinent
since, unlike traditional bank and credit card transactions, there
is no financial institution to intervene if the end-user incurs a
loss due to hacks, fraud, or breach of security.

Financial and Business Challenges

Other logistical, legal, and financial challenges will need to
be addressed before NFTs become universally accepted. First, most
NFT transactions involve cryptocurrencies that are not legal tender
in the US and are not backed by any central issuing authority or
inherently valuable asset. Cryptocurrencies are regulated by
individual states and presently there is no protection available to
consumers in the event of fraud. Second, there are tax implications
related to buying NFTs with cryptocurrencies. Many buyers and
sellers are unaware that they may be obligated to pay steep taxes
if they profit in cryptocurrency trades. Third, NFTs could run
afoul of US sanctions law which prevents US residents or citizens
from conducting business with individuals or entities operating in
nations on which the US has placed economic or trade sanctions.
Though there are some exceptions for the use of NFTs for artwork
from sanctioned nations, buyers and sellers should consult a lawyer
if they have any questions or doubts about the legality of an NFT
transaction.

Operational Challenges

Despite the hype surrounding NFTs, operational problems also
plague NFTs:

  • They are based on decentralized networks which are not 100
    percent user-friendly. This means verifying, promoting, purchasing,
    selling, and storing an NFT requires a basic understanding of
    blockchain technology. In fact, only sophisticated blockchain
    technology users can use NFTs effectively.

  • For NFTs to be truly successful, they need to be as ubiquitous
    as smartphones.

  • The speculative nature of NFTs may pose a challenge for the
    gaming industry because players may be inclined to buy and hold
    NFTs with an eye toward selling them in the future for a profit
    instead of using them within the gaming ecosystem.

As with cryptocurrencies, the legal challenges related to NFTs
are likely to become more pronounced over the coming months as the
media focuses more and more attention on the technology. It is
important to consult an attorney before creating, launching, or
buying an NFT as the regulatory framework is still evolving. An
experienced attorney will be able to guide you on anti-money
laundering regulations, tax implications, financial regulations,
intellectual property issues, and the like. They can also prepare
all the preliminary legal documents before you dive into the world
of NFTs.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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