The Ethereum Merger: What Does the Hard Fork Mean for My NFT Licenses? | Insight

Touted to be “the most significant upgrade in the history of Ethereum,” the long-awaited Ethereum merger is finally slated to happen in mid-September. The existing execution layer of Ethereum will transition from a proof-of-work (POW) protocol to a proof-of-stake (POS) protocol, which is intended to improve the blockchain’s energy efficiency and increase transaction throughput.

The consensus protocol is the core element of all blockchains: since it determines the “correct” block in the blockchain, it confirms which data and transactions should be added to the blockchain record.

However, despite the expected benefits of POS, many miners who have kept the Ethereum blockchain going in the years since its inception have invested significant resources in the POW model – resources that would be devalued in a POS model.

If a significant number of Ethereum users continue to use the POW model, the blockchain may split into two separate blockchains – ETHPOS and ETHPOW (The Ethereum merger will not affect directly existing Ethereum Classic blockchain, which uses POW).

Post-Merge hard fork

If a hard fork occurs on Ethereum, it will raise unique questions for many token ecosystems built on top of Ethereum, such as governance tokens; non-fungible tokens (NFTs) and tokens linked to real products. Here we will focus on the effect on NFTs because Ethereum is the dominant chain for most NFT issuances.

Blockchains have experienced forks in the past, but Ethereum Merge is unique in many ways because of the many applications built on top of it. For example, the original, and largest, blockchain, Bitcoin, has gone countless times since its launch in 2008. However, the Bitcoin blockchain does not have NFTs based on it. And while Ethereum underwent a major fork in 2016 due to a hack that drained the DAO of 3.6 million ether, creating Ethereum and Ethereum Classic, NFTs had yet to become a major application on the Ethereum blockchain.

When a hard fork occurs, the blockchain is duplicated, and every transaction before the fork is the same on both blockchains up to the fork. Then, like a branching tree, future transactions on the separate blockchains diverge and are determined by each blockchain’s separate protocol.

While many people buy NFTs to own an avatar, artwork or event ticket, in reality buyers usually receive a tokenID (stored on a blockchain) and metadata that refers to some form of storage where the artwork resides (such as AWS or IPFS) . In a fork, the token IDs the buyer received before the fork duplicates and continues to exist on every blockchain. So, in the event of a fork occurring after the Ethereum merger, new NFTs will either be minted on the ETHPOW blockchain or the ETHPOS blockchain, but any NFTs that existed on the Ethereum blockchain before the merger will duplicate and exist on both ETHPOS and ETHPOW.

Questions about NFT licenses in a hard fork

Although US copyright law does not automatically grant purchasers of artwork the right to reproduce, adapt, or even publicly display the artwork, often NFT creators will license such rights to purchasers when they purchase an NFT. But some interesting questions arise in the event of a hard fork and the subsequent duplication of the then existing Ethereum NFTs and their continued coexistence on the divergent Ethereum blockchains, which NFT has the license to the artwork that was given to the buyer when they purchased the NFT from the creator ? Is the license on the ETHPOW blockchain or the ETHPOS blockchain? And who decides? The NFT creator? The NFT holder? If the NFT holder sells the NFT to a buyer on the ETHPOW blockchain, but continues to hold the NFT on the ETHPOS blockchain, does the license stay with the holder or is it transferred to the new buyer?

Since licenses are not applied consistently across projects, the answers to these questions depend on the license agreement entered into between the NFT creator and the original purchaser. However, in the absence of clear guidelines from the license agreement, the ownership of the license may be ambiguous and disputes may arise between the parties. The recent CryptoPunks license agreement from Yuga Labs is an interesting example: the agreement expressly allows Yuga Labs to “designate” which NFT on which chain holds the license agreement. This approach was also followed by the Can’t Be Evil malicences published by a16z (DLA Piper participated in the drafting of these licences).

In fact, legal precedent exists that allows blockchain service providers to limit their liability in the event of a fork. IN Archer v. Coinbase, a California appellate court affirmed summary judgment in favor of a cryptocurrency exchange against a user who had claimed that the exchange was obligated to give him access to all counterfeit versions of the Bitcoin he held in his exchange account. The court reasoned that the exchange’s user agreement did not contain any terms obliging the exchange to support all forks. Following Archerplatforms for trading blockchain assets (including NFT trading platforms) often expressly provide in their terms of use that they retain the right to decide which of the blockchain forks they can support.

As a matter of best practice, NFT issuers should provide clear guidelines on how they will handle forks in the license agreement to avoid disputes later.

Learn more about the implications of the Ethereum merger and potential hard forks by contacting one of the authors.