NFT Marketplaces and the DMCA Safe Harbors

Sarah Law | February 9, 2022

Introduction:

With the creation of bitcoin and the expansion of digital art on the internet, non-fungible tokens (NFTs) have quickly risen to the center of attention for many people. However, due to their novel nature, many legal questions have arisen around this new art form. A large concern is the protection of intellectual property, both for the NFT itself and the content such as artwork associated with the NFT. In an electronic world where buyers and sellers may never meet, what is the marketplace’s responsibility for copyright infringement? Does the marketplace where the NFT is bought bear a higher level of responsibility than traditional, physical marketplaces? The Digital Millennium Copyright Act offers safe harbors against copyright liability to internet service providers given certain requirements are met. These safe harbors could potentially protect NFT marketplaces from copyright liability, but only if all the conditions are met, and it does not appear as if that is the case.

What Is an NFT?

NFT stands for “non-fungible token,” a computer program called a “smart contract” that is unique and irreplicable, typically associated with some content such as digital art.[1] This is compared to something like bitcoin, where one bitcoin is tradeable with another.[2] Another way to conceptualize what an NFT is would be to compare it to traditional artwork: there is only one of Van Gogh’s Starry Night. NFTs are then bought and sold through online marketplaces. There is some consideration that NFTs may be legally identified as securities, which would require registration and regulation (unless falling within an exception), but mostly, NFTs are analogous to artwork and therefore not securities.[3]

To establish the uniqueness of the NFT, each token must be “minted,” a process by which the data is turned into a crypto collectable on a blockchain.[4] From this point onward, the NFT cannot be edited, modified, or deleted, although further transactions involving the NFT will be recorded.[5] It is also from this point onward that the creator of the NFT can establish a payment system through which they receive a resale royalty from every subsequent sale of the NFT.[6] The minting process is not without its own issues. Last April, a white-hat hacker showed how it was possible for people to mint NFTs for and by artists and then transfer ownership of the NFT back to themselves, all without the original artist’s permission but with the appearance to the unsophisticated buyer that the NFT is proper.[7]

When someone buys an NFT, they are not buying the actual artwork or any of the intellectual property. They are buying the digital token, plus typically a content license that details what they are allowed to do with the associated content or artwork.[8] Often, there is a license to publicly display the work.[9] These different rights licensed simply depend on what is outlined in the contract, but most importantly, the NFT buyer is not buying the actual intellectual property from the seller.

The Digital Millennium Copyright Act Applied:

Secondary liability as copyright doctrine is the primary way through which traditional marketplaces can be liable under copyright law for the selling and buying of infringing works. The two forms of secondary liability are contributory liability and vicarious liability. However, because there is such an incredible difference between physical spaces and online spaces, the Digital Millennium Copyright Act of 1998 (DMCA) created safe harbors that internet service providers can use to shield themselves from monetary liability in cases of copyright infringement. Currently, some NFT marketplaces appear to disclaim that they fall under the protection of those safe harbors, but other NFT marketplaces are not making such claims.[10]

Which Safe Harbor?

OpenSea, one of the largest and most public NFT marketplaces, writes in their Terms of Service that, “If you believe that your content has been copied in a way that constitutes copyright infringement, please report this by contacting our designated copyright agent . . .”[11] This appears to conform with the DMCA §512 safe harbor provisions where a notice-and-takedown option can safeguard sites from copyright liability.[12] An example of how this safe harbor is used would be if a video on YouTube contained infringing copyrighted work, YouTube could be notified of the infringement and would be required to investigate and take the video down.[13] For OpenSea to have such language in their Terms of Service, that highly suggests that it believes its actions fall within a §512 safe harbor provision. If a marketplace does not have such language in their terms of service or use a similar method of removing infringing material, it cannot invoke the DMCA safe harbor and may potentially be held liable under either contributory or vicarious liability.

Many NFT marketplaces appear to be relying on protection from the DMCA. The DMCA safe harbor relevant to NFT marketplaces appears to be § 512(c) for passive storage.[14] When a person mints an NFT, the marketplaces set out guidelines for how large the file size can be.[15] This suggests that the NFT “resides on [the] system or network.”[16] Not every marketplace may be able to claim protection under this section however as some marketplaces curate the tokens that are sold on their platform.[17] A general requirement of §512(c) is that the storage of the material be “at the direction of a user.”[18] If the user is not able to direct the sale and storage of their token, or if the service providers are selecting specific tokens and directing their promotion within the platform, then the service provider may not be able to find protection under §512(c) at all.

Should a user instead provide a direct link to an NFT themselves, or store the NFT somewhere else, the next applicable DMCA safe harbor for the marketplaces would be §512(d) for linking users to another online location.[19] Regardless of which safe harbor applies, both section (c) and section (d) contain the same caveat about the service provider’s financial benefit that may prove troublesome for the marketplaces.

DMCA Disqualification

512(c)(1)(B) and §512(d)(2) contain the same provision that service providers shall not be liable only if the service provider “does not receive a financial benefit directly attributable to the infringing activity, in a case in which the service provider has the right and ability to control such activity.”[20] If a service provider has the right and ability to control the activity that infringes on another’s copyright, and the service provider is receiving a financial benefit from that activity, the DMCA safe harbor will not apply.

The Right and Ability to Control

Even though the marketplaces express the capability to remove material that has been flagged as infringing, that capability alone does not automatically prove a “right and ability to control” as required for the disqualifying provision.[21] As the Second Circuit explained in Viacom, “. . . the ‘right and ability to control’ infringing activity under § 512(c)(1)(B) ‘requires something more than the ability to remove or block access to materials posted on a service provider’s website.’”[22] The example used by the Second Circuit was a service provider who exercised high levels of control over its users (this included the appearance, layout, and content) was found to have the right and ability to control.[23] After Viacom, the Ninth Circuit broadened the meaning to include any “substantial influence” over users.[24] “‘Substantial influence’ may include, as the Second Circuit suggested, high levels of control over activities of users, as in Cybernet. Or it may include purposeful conduct, as in Grokster.”[25]

For a website like OpenSea then, whose interactions with the tokens only seem to be the notice and takedown process, the service provider should not have to worry about this disqualification section at all. For other marketplaces who curate or selectively feature tokens on their platforms, those actions could constitute evidence of the right and ability to control, satisfying the “something more” from Viacom and the “substantial influence” described by the Ninth Circuit. Curated or featuring tokens are not analogous to YouTube in Viacom. Upon remand, the district court found that YouTube did not have the right and ability to control the infringing content because its upload filters were basic (for violent, sexual, or hateful material), it gave access to all material regardless as to whether it was infringing, and it monitored for infringement only.[26] Curated or featured tokens however have been purposely selected by those marketplaces for sale or the promotion of the sale. The user has no direction in that process; the marketplaces is exerting a substantial influence over the sale of those NFTs, something more than the ability to remove or block material.

A Financial Benefit

For marketplaces who have the right and ability to control the infringing material, the second prong of the disqualifying provision is the financial benefit received, directly attributable to the infringing activity. The standard for assessing direct financial benefit is consistent with that of traditional vicarious copyright liability where “. . . the relevant inquiry is ‘whether the infringing activity constitutes a draw for customers, not just an added benefit.’”[27] In practice however, the courts require a somewhat higher level of proof for the DMCA safe harbors.[28] For example, a one-time set-up fee or periodic maintenance payments from someone who is infringing on another’s copyright does not constitute a direct financial benefit.[29] A direct financial interest seems to be a business model whose profits are closer to the actual sale of a product. For example, a court found there to be a direct financial benefit in a case where an online shopping marketplace received a direct profit from the buyer, from which the third-party seller received a commission.[30] Another court found direct financial benefit where a different marketplace received a commission from the sales on its platform.[31] When a marketplace ties their own profits to the profits of an infringing activity, it makes sense that the marketplace has received a direct financial benefit and is disqualified from the DMCA safe harbor as a matter of policy.

If the infringing activity is the NFT itself, which is then sold via the marketplace, the marketplace is receiving financial benefit from the infringing activity. The NFT sale is not just an added benefit of participating in the marketplace, it is the point of the marketplace. Marketplaces operate by charging fees for the posting of the NFT on the platform, charging for a percentage of the sale of the NFT, buyer surcharges, and other various forms of profiting off the actual sale of the NFTs.[32] The profit structures are slightly different for each NFT marketplace. OpenSea charges a 2.5% fee of each sale, paid by the seller; Rarible charges a 2.5% fee from both the buyer and seller, earning 5% total on each sale; and SuperRare charges a 3% fee from each sale, paid by the buyer, as well as a 15% “artist gallery” commission fee for initial sales, paid by the sellers.[33] These models seem closer to the cases where other service providers received profits from the sales on their platform, but overall, it is unclear where courts will come out on this matter.

Simply because the NFT marketplaces may not fall under one of the DMCA safe harbors does not necessarily mean can be held liable for secondary copyright infringement. Falling outside the safe harbor does not prove secondary liability. The potential plaintiffs must still prove either contributory liability, vicarious liability, or both.

Conclusion:

NFT marketplaces appear to be anticipating the need for a DMCA safe harbor. Given the novelty of the market however, and the variety of how each marketplace operates, there is currently no universal, or even common, application of the DMCA safe harbors to such places. The marketplaces should carefully consider their level of involvement with the NFTs, both in the selection and promotion of the tokens, and reevaluate their fee structures should they exhibit a “right and ability” to control. Without the protection of the DMCA safe harbors, NFT marketplaces could potentially be held liable for contributory or vicarious liability in cases where NFTs contain infringing artwork or material.

[1] NFTs: Legal Risks from “Minting” Art and Collectibles on Blockchain, Quinn Emanuel Trial Lawyers, https://www.quinnemanuel.com/the-firm/publications/nfts-legal-risks-from-minting-art-and-collectibles-on-blockchain/ (last visited Nov. 20, 2021).

[2] Media, Entertainment and Technology Litigation Update – Non-Fungible Tokens (NFTs) – April 2021, Gibson Dunn, https://www.gibsondunn.com/media-entertainment-and-technology-litigation-update-april-2021/ (last visited Nov. 20, 2021).

[3] See generally, Friel v. Dapper Labs, Inc., No. 653134/2021 (N.Y. Sup. Ct. filed May 12, 2021); see also David Z. Morris, Are NFTs Securities?, CoinDesk (Aug. 24, 2021, 11:48 a.m.), https://www.coindesk.com/markets/2021/08/24/are-nfts-securities/.

[4] Harrison Jordan, No, NFTs Aren’t Copyrights, TechCrunch (June 16, 2021, 10:15 a.m.) https://techcrunch.com/2021/06/16/no-nfts-arent-copyrights/?guccounter=1; Catherine Zhu and Louis Lehot, Legal Guide to Launching an NFT Marketplace (Mar. 19, 2021) https://today.westlaw.com/Document/I01d725ee886a11ebbea4f0dc9fb69570/View/FullText.html?transitionType=Default&contextData=(sc.Default)&firstPage=true; NFTs: Legal Risks, supra note 1.

[5] Emily Taylor, How NFT minting works – an initial guide to NFTs, AZ Big Media (Oct. 29, 2021) https://azbigmedia.com/business/how-nft-minting-works-an-initial-guide-to-nfts/.

[6] Id.

[7] Tim Schneider, The Gray Market: How a Brazen Hack of That $69 Million Beeple Revealed the True Vulnerability of the NFT Market (and Other Insights), Artnet News (Apr. 21, 2021) https://news.artnet.com/opinion/sleepminting-nftheft-monsieur-personne-1960744 [https://perma.cc/2MSM-YW9S].

[8] Harrison Jordan, supra note 4; Nonfungible Tokens and Copyright: Diligence Issues to Consider, Morgan Lewis (Apr. 12, 2021) https://www.morganlewis.com/pubs/2021/04/nonfungible-tokens-and-copyright-diligence-issues-to-consider.

[9] Nonfungible Tokens and Copyright, supra note 8; Media, Entertainment and Technology, supra note 2.

[10] See Terms of Service, OpenSea, https://opensea.io/tos (last visited Nov. 20, 2021).

[11] Terms of Service, OpenSea, https://opensea.io/tos (last visited Nov. 20, 2021).

[12] See 17 U.S.C. §512(c), (d).

[13] See Viacom Int’l, Inc. v. YouTube, Inc., 676 F.3d 19, 37 (2d Cir. 2012).

[14] Non Fungible Token (NFT) platforms must secure Metadata in their ERC-721/ERC-1155 implementations, Medium (Dec. 7, 2019) https://medium.com/@showcaseteam/non-fungible-token-nft-platforms-must-secure-metadata-in-their-erc-721-erc-1155-implementations-88f55e987fc7 (last visited Nov. 20, 2021); Kyle Tut, Who Is Responsible for NFT Data?, Medium (Apr. 6, 2020) https://medium.com/pinata/who-is-responsible-for-nft-data-99fb4e8147e4 (last visited Nov. 20, 2021).

[15] AlexWGomezz, Minting Your NFT: File Size Upload Limitations and Restrictions, Cyber Scrilla, https://cyberscrilla.com/minting-your-nft-file-size-upload-limitations-and-restrictions/ (last visited Nov. 23, 2021).

[16] See 17 U.S.C. §512(c)(1).

[17] See SuperRare Terms of Service, SuperRare, https://www.notion.so/SuperRare-Terms-of-Service-075a82773af34aab99dde323f5aa044e (last updated Nov. 22, 2021); Nicholas Rossolillo, 10 Top NFT Marketplaces, The Motley Fool (Nov. 2, 2021, 1:13 p.m.), https://www.fool.com/investing/stock-market/market-sectors/financials/non-fungible-tokens/nft-marketplaces/ [https://perma.cc/69U6-94XM].

[18] 17 U.S.C. §512(c)(1).

[19] See id. at §512(d)(1).

[20] Id. at §512(c)(1)(B), (d)(2).

[21] Viacom Int’l, Inc. v. YouTube, Inc., 676 F.3d 19, 38 (2d Cir. 2012) (quoting Capital Records, Inc. v. MP3tunes, LLC, 821 F.Supp.2d at 645 (S.D.N.Y. 2011).

[22] Id.

[23] Id.

[24] Viacom Int’l, Inc. v. YouTube, Inc., 940 F. Supp. 2d 110, 118 (S.D.N.Y. 2013).

[25] Id. (quoting UMG Recordings, Inc. v. Shelter Capital Partners LLC, 718 F.3d 1006, 1030 (9th Cir. 2013)).

[26] Id. at 121-22.

[27] Edward Lee, Decoding the DMCA Safe Harbors, 32 Colum. J.L. & Arts 233, 239 (2009) (quoting Perfect 10, Inc. v. CCBill LLC, 488 F.3d 1102, 1117-18 (9th Cir. 2007)).

[28] Id.

[29] Id.

[30] Feingold v. RageOn, Inc., 472 F. Supp. 3d 94, 102 (S.D.N.Y. 2020).

[31] Venus Fashions, Inc. v. ContextLogic, Inc., No. 3:16-cv-907-J-39MCR, 2017 U.S. Dist. LEXIS 155748, at *74 (M.D. Fla. Jan. 17, 2017)

[32] Liam Kemp, How Do NFT Marketplaces Make Money?, Coinformant (Sept. 14, 2021) https://coinformant.com.au/how-do-nft-marketplaces-make-money/ (last visited Nov. 20, 2021).

[33] Id.