NFT sales are hot! But what is actually for sale?

September 13, 2022 – NFTs, or non-fungible tokens, represent ownership interests in digital assets. Each NFT is unique, distinct from fiat assets such as US currency, Bitcoin or Ethereum, and created on a blockchain (by “mining”).

By way of background, an NFT typically consists of two components: the on-chain token and the off-chain digital work or real asset that the NFT links to or identifies. The link between these two components is reflected in the metadata of the NFT, which often includes a pointer to the digital work’s location. While the NFT buyer owns the token on-chain, the digital work is usually only licensed.

NFTs allow any digital thing to be “tokenized”. A .jpeg or. gif of a meme or tweet, a video or audio file, a piece of digital art or any other digital file can be tokenized. With NFTs, you can invest in something of value without having to physically own or store the respective item. NFTs are sometimes referred to in conjunction with “Web3”.

Web3 is a term that describes a new, decentralized version of the internet. Web 3 uses blockchains, cryptocurrencies and NFTs to give ownership to users, and has been said to put “power in the hands of individuals instead of corporations.” See https://ethereum.org/en/web3/.

Once an NFT is created, it can be bought, sold and resold on secondary market platforms, such as OpenSea or Rarible. Buying an NFT usually gives you some basic usage rights, like being able to post the photo online or set it as your profile picture – plus, of course, bragging rights – with a blockchain record to back it up. And the value could increase, meaning you could potentially sell it for a profit in the future.

But what else do you get? Do you own intellectual property rights (IP) related to your NFT?

Each NFT comes with “rules” or software code (called smart contracts), registered on the blockchain to govern actions such as ownership verification, permitted use and transferability, as well as royalty payments for secondary sales and beyond. Smart contracts can also be used to connect NFTs to any number of other assets, including art, music, other digital files, or even assets.

It is therefore important to distinguish between ownership of an NFT – the unique token on the blockchain – and ownership of an asset that may be linked or associated with that NFT.

The purchase of an NFT linked to an asset does not necessarily equate to the purchase of IP rights in the underlying asset. These rights are transferred to the NFT buyer only if the owner of that asset expressly transfers them in a license agreement with the NFT purchase.

The IP of the underlying asset is still governed by traditional IP laws. IP rights are usually granted from an NFT creator to an NFT buyer through a license agreement in a smart contract. IP license agreements are necessary to protect IP creators and their financial interests in and to their intellectual property, even after it is sold.

Because NFTs are intellectual property, the same applies to NFT license agreements. Specifically, NFT creators can dictate exactly what rights original owners and purchasers have in purchased NFTs, while preserving their ability to continue to profit from their creations by requiring a certain percentage of the subsequent sales of their NFTs are to be paid to them.

When NFTs hit the mainstream in early 2021, the scope of licenses for digital works was extremely limited. This is due to the standard rule that IP rights, especially copyrights, at the heart of most NFTs, remain with the rights owner unless explicitly granted to another, even where someone purchases a physical work containing those rights. (For example, under copyright law, the copyright owner has the exclusive right to, for example, reproduce or distribute the copyrighted work. The purchase of a copyrighted work (such as the book, “Dune”) does not automatically grant the purchaser any underlying copyright rights.)

The question of whether terms and conditions bind the owner of an NFT is particularly complicated with respect to downstream buyers, often referred to as secondary buyers, because there is currently no effective and generally accepted mechanism for legal terms for traveling with an NFT.

When a secondary buyer seeks to acquire an NFT through a marketplace or directly from an NFT owner, they are likely not presented with the terms of use that accompanied the initial sale. Instead, they can see an image and certain identifying information about the NFT and the price. While secondary marketplaces usually have their own terms and conditions, these relate to the use of the marketplace, not the NFTs being sold.

NFT marketplaces typically have standard NFT license agreements available to creators through their platform. These may or may not provide the full protection a creator is looking for.

Some marketplaces allow a creator to draft their own custom license agreement. For example, if a creator wants to set parameters for what buyers can do with the NFT, how subsequent buyers gain ownership of the NFT, or even whether to attach a physical experience to an NFT, they may be able to do so via a custom permission.

An examination of the terms and conditions and licenses granted by well-known brands that have released NFT collections reveals a range of approaches to licensing rights in underlying IP. Although not exhaustive, the following three categories are illustrative:

(1) a “traditional” approach, where the purchase of an NFT gives the owner no rights to the underlying IP;

(2) an intermediate approach, where some rights are granted in the underlying IP; and

(3) a “crypto-native” approach, where the purchase of an NFT gives full rights to the underlying IP.

Much of the potential and promise of Web3 and NFTs centers on the technology’s ability to support creators and communities, and, through tokens, ownership by those creators and community members of the value they help create. Traditional approaches tailored to the metaverse and NFTs present risks familiar to those who have long worked to protect their IP IRL; However, crypto-native approaches that seek to engage the creators and community that represent the promise of Web3 will present new risks.

When an NFT owner grants a buyer a license to IP rights in the NFT – to commercialize or create derivative works – it is crucial to clearly state in the terms and conditions the scope of permitted use as well as restrictions on use. An example of this is the “NFT license” developed by Dapper Labs (creators of CryptoKitties and NBA Top Shot).

In addition to addressing personal use, the NFT license grants owners limited commercial use rights. The license also sets out a number of clear usage restrictions, prohibiting owners from using their NFT IP to promote hatred, intolerance, violence or cruelty; promote other third party products or services; or produce films, videos or other media. If NFT owners violate these provisions, the original creator of the NFT may terminate the agreement.

In practice, it may be difficult for a brand to reclaim an actual NFT as a consequence of a purchase that violates an underlying license. However, since a brand’s license agreements govern the NFT owner’s rights with respect to the underlying assets of the NFT, it becomes important to draft clear licenses that are presented to buyers and readily available to protect a brand’s IP.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed under the fiduciary principles to integrity, independence and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.