If you’ve spent any time on the internet over the past few months, chances are you’ll have seen a headline about the latest blockbuster sale of an NFT.

Jack Dorsey (founder of Twitter) sells NFT of his first tweet for $2.9 million USD 

Grimes (Canadian musician) releases NFT collection that sells out in 20 minutes for $6 million USD

Beeple (American digital artist) sells NFT of one of his works for $69 million USD

But what are NFTs?  And what role does intellectual property (IP) play in their creation and sale?  We’re glad you asked.

What are NFTs?

NFT stands for non-fungible token.  Non-fungible basically means unique.  By way of comparison, a $10 note is an example of a fungible asset, because it can be replaced with another $10 note, or two $5 notes.  A non-fungible token is a one-of-a-kind digital token that may be linked to another item or asset, often a digital work, such as a drawing, video or piece of music.

NFTs exist on blockchains, which are decentralised, distributed, digital ledgers that record transactions in “blocks”.  This means that each time an NFT changes hands, the transaction is verified, adding a new record to the chain of ownership.  Interested parties can view this chain to see an accurate history of the NFT.

NFTs have a variety of uses which extend far beyond digital artwork.  However, in the digital art world, most NFTs are created or “minted” through a fairly straightforward process by a third party platform.  You create a crypto asset wallet and link your wallet to one of the many marketplaces that exist for buying and selling NFTs.  You then upload a copy of the digital work that you want to represent in NFT-form to the NFT marketplace, pay a transaction fee and click ‘create’.  The newly minted NFT is created by the marketplace and stored in your wallet. The NFT can be offered for sale on the NFT marketplace.

The authors of this article were particularly interested to learn about a New York Times journalist who created an NFT linked to an image of a column he wrote titled “Buy this Column on the Blockchain!”.  The NFT went on to sell for more than $560,000 USD, with the proceeds donated to charitable causes.

What are the benefits of NFTs?

Until now, the sale of digital art has been a difficult proposition.  It’s hard to identify and verify the true owner of content when an identical copy of that content can be created with a few clicks of a mouse.  The ownership of an NFT can be easily authenticated, meaning buyers can have confidence that they are buying the real deal.  For digital content creators and the owners of IP in digital content, NFTs represent a potential new revenue stream.

For example, a person might choose to sell a one-of-one NFT, being the only NFT that will ever be created for that digital work.  Alternatively, they might sell a limited number of NFTs for a digital work (like selling 50 numbered prints of a painting) or offer an NFT of a digital work for sale for a limited time and only mint the number of NFTs purchased in that time.

In addition to revenue generated by their initial sale, NFTs can also be configured so that the creator receives a royalty payment each time the NFT is sold.  The amount can differ but is set somewhere between 10-20% of the purchase price.  This source of income is not available to artists who sell traditional art.  For example, Jean-Michel Basquiat’s estate would not have received any revenue from the recent $41.7 million USD sale of his “Warrior” painting, which became the most expensive Western artwork sold in Asia.

The revenue generated by NFTs can be significant.  Since October 2020, NBA Top Shot (an NFT marketplace created by the NBA that allows fans to buy and sell NFTs of highlight videos featuring their favourite players) has generated more than $200 million USD in sales.

Does buying an NFT mean you own the IP rights in the underlying digital work?

Buying an NFT should not be confused with buying an assignment of any underlying IP rights.

Digital works which are the subject of NFTs will often incorporate copyright material.  Copyright is a bundle of exclusive rights that protects original expression if that expression is in a material or tangible form.  Under the Copyright Act 1968 (Cth), copyright of a literary, dramatic, musical or artistic work includes the exclusive right to reproduce the work in a material form, publish the work and communicate the work to the public.

Multiple pieces of copyright material may exist in a single digital work.  In the case of an animated music video, the film, music and graphics may all be protected separately by copyright and a single individual may not own the copyright in all of these elements.  Anyone looking to create an NFT will need to ensure that in doing so they are not infringing any copyright in the underlying digital work.

Due to the global nature of NFTs, it will also be important for NFT-creators to have an understanding of the global copyright landscape.  In Australia, the rights protected by copyright arise automatically upon the creation of a work and there is no need or ability to obtain a registration for copyright.  By contrast, in the United States, registration of copyright is a prerequisite to filing a lawsuit for copyright infringement.

Trade marks are another form of IP that may be relevant to NFTs.  Trade marks are typically associated with a brand and may include brand names, slogans and logos.  A trade mark owner may wish to apply their trade mark to a digital work which is the subject of an NFT to demonstrate authenticity and associate it with the trade mark owner.  This may increase both the value of the NFT and the goodwill in the trade mark.  Conversely, if the digital work includes a trade mark, care will need to be taken to ensure that the digital work doesn’t use that mark as a trade mark without the consent of the trade mark owner.

What rights does an NFT-owner acquire?

When you buy an NFT for a digital work, in most cases what you are buying is the NFT only and a limited licence to use the underlying digital work in certain ways or for certain purposes.  The terms of this licence often differ based on the terms of service of the marketplace on which the particular NFT is created and sold.

Under these terms of service, the person or entity that created or was responsible for the creation of the underlying digital work (henceforth called the creator) typically retains all IP rights in the work.  This is similar to the position for traditional art.  Buyers do not acquire the IP rights associated with a piece of art unless they have expressly agreed this with the creator or in specific defined circumstances.

Accordingly, unless expressly stated, the IP rights that subsist in a digital work are not transferred with the sale of an NFT associated with that work.  Instead, the person who buys the NFT is usually granted a licence to display the underlying digital work.  This means that the creator can create and sell multiple NFTs for a single digital work, which could impact on resale value.  The rights granted may also prohibit the purchaser from making any commercial use of the work or modifying or using the work in a way that prejudices the creator.  Anyone interested in selling or buying an NFT should ensure they understand what rights they are granting or obtaining, respectively, by reviewing the terms of service for the marketplace that they intend to use.

What else should NFT buyers be aware of?

There are a number of other issues that NFT buyers should consider before making a purchase.

Marketplaces typically require parties to verify their identify before minting an NFT.  This system is not foolproof.  Buyers should undertake thorough due diligence to ensure that the person who minted an NFT is in fact the creator of the underlying digital work, that the person owns the IP rights contained in the digital work and is entitled to grant the rights associated with the NFT.

NFT buyers looking to purchase a purported “one-of-one” or “limited edition” NFT should consider whether the terms of service for the relevant marketplace restrict the creator from minting additional NFTs for the same underlying work.  If the uniqueness or scarcity of an NFT is not guaranteed, this is likely to affect the NFT’s value.

It’s also important to remember that the way NFTs are created means that an NFT does not contain the underlying digital work.  Instead, the digital work is hosted “off-chain” (often on the servers of the company that operates the marketplace on which the NFT was minted) and the NFT is linked to that location.  If the hosting servers are compromised or the company operating the servers encounters financial difficulties, the link between the NFT and the underlying digital work may break.  NFT buyers should carefully review the marketplace’s terms of service to verify the security of the underlying digital works.

Should IP owners be thinking about NFTs?

If you are an artist who has created a digital work or a company that owns digital works, there are a number of NFT-related issues that you should be considering.

IP owners who have already granted or plan to grant licences for IP that may be suited to use in NFTs should consider whether the scope of these licences includes use of the IP in NFTs.  IP owners may want to expressly prohibit licensees creating NFTs based on their IP.

Alternatively, IP owners may want to license their IP specifically for use in NFTs to generate additional revenue and goodwill in the IP.  In these circumstances, the IP owner may want to impose restrictions on modifications that can be made to the IP and limit the number of NFTs that the licensee can create to maintain scarcity and value.  IP owners may also want to impose conditions on where NFTs created using their IP can be sold and require licensees to only sell NFTs of the IP owner’s IP to third parties under licence terms that have been approved by the IP owner.  In addition, IP owners should consider whether such licence terms will apply to owners of the NFT beyond the initial buyer.

IP owners should also clearly address revenue sharing issues in the licensing agreement.  The agreement should contemplate revenue generated from both the initial sale of NFTs and any royalties generated upon resale.

Owners of IP that can be easily exploited for use in NFTs (such as trade marks and copyright) should be wary of the potential for infringement.  For instance, DC Comics recently warned its artists against selling NFTs containing the company’s IP.  Once an NFT containing unauthorised IP has been transferred from the creator to the crypto asset wallet of a buyer, it can be difficult to establish the identity of the wallet’s owner.  Accordingly, if an IP owner identifies an NFT that infringes their IP, they should respond quickly (ideally when the relevant NFT has been listed on the marketplace but not yet been sold).  The IP owner may wish to send cease and desist correspondence to both the NFT’s creator and the marketplace on which the NFT is listed.

Owners of registered trade marks that are thinking about entering the NFT space should consider whether their existing registrations capture use in relation to NFTs.  If not, they may want to apply for new trade marks to ensure their interests are adequately protected.

Any other issues to be aware of when it comes to NFTs?

Regulation

In previous guidance issued on initial coin offerings, which are a form of fungible crypto asset, ASIC emphasised that Australian consumer protection laws apply regardless of whether a crypto asset (of which an NFT is one example) is issued by an Australian or foreign entity.  Both ASIC and the ACCC are empowered to take enforcement action in this regard.

NFT marketplaces, NFT creators and IP owners operating in the NFT space should avoid engaging in any conduct which is misleading or deceptive.  For instance, it will be important to ensure that buyers understand what rights they will and will not obtain in the digital work that is the subject of an NFT they purchase.  Other Australian laws, including those relating to directors’ duties, will also apply to the process of creating, marketing and selling NFTs.

Cybersecurity

There have been no reports of NFTs themselves being successfully targeted by hackers.  However, there have been reports of crypto asset wallets containing NFTs being compromised.  Particularly where a wallet is hosted or managed by a third party, the wallet and thus the NFT’s security are subject to the cybersecurity measures implemented by that third party, meaning there may be cybersecurity vulnerabilities which can be exploited.

Climate concerns

The energy consumption involved in mining crypto assets is significant.  In the crypto asset context, “mining” refers to the process of verifying and settling transactions on a blockchain, which in ‘proof of work’ systems (such as bitcoin) requires high-powered computers to solve complex computational maths problems.  This process is incredibly energy intensive.  A recent International Electricity Association report estimated that bitcoin mining is responsible for between 0.2 per cent and 0.5 per cent of all of the electricity consumed worldwide each year.

The extent to which NFTs contribute to this consumption is unclear.  However, many of the players in the NFT space are conscious of this issue and various solutions have been proposed.  Some artists have invested in renewable energy projects to offset the emissions generated by their NFTs.  Many crypto asset miners are using renewable energy to power their mining.  Methods of verifying and settling transactions on a blockchain other than proof of work have also been proposed that may consume less energy.

Future applications

Currently, NFTs are largely associated with digital works, but are already used in many provenance-related blockchain solutions to track and authenticate ownership of physical assets.  Nike recently lodged a patent for a product called CryptoKicks.  When a customer buys a physical pair of CryptoKicks shoes, they will also receive an NFT linked to a unique identifier for those shoes.  If the customer later wants to sell the shoes, they can transfer ownership of both the physical shoes and the associated NFT.  This gives potential buyers comfort that the product they are receiving is genuine and not a counterfeit.

Innovations such as these show that there is an exciting future ahead for NFTs.

The editors wish to acknowledge our in-house blockchain expert, Hannah Glass, for her assistance with this article