When chains change, do NFTs stay the same? How Hard Forks Can Affect NFT Value and Licenses | Proskauer – Blockchain and the Law

At 02:43 EST on September 15, 2022, the first Ethereum block was validated using Proof of Stake, signaling the success of the Ethereum Merge, one of the most anticipated events in the history of blockchain and computer science. The merger moved the Ethereum blockchain (native token ETH, or ether) from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism, which has reduced the network’s energy usage by approximately 99.5% . Ethereum now enables a 7-day average of over one million transactions per day, with a volume of over $600 million per day, making Merge an engineering feat similar to changing a car’s engine while driving on the Autobahn.

The merger, explained:

Technically, the merger involved merging the Ethereum Mainnet protocol (the blockchain that supports transactions and smart contracts) using PoW with the Beacon Chain PoS network, which was a testnet launched in 2020 that ensured the PoS consensus mechanism was working before being activated on Ethereum Mainnet. . In other words, the Beacon Chain operated in parallel with the Ethereum Mainnet until the Mainnet’s protocol and the Beacon Chain’s PoS consensus layer were merged. Merging these two chains involved swapping the Mainnet’s PoW consensus mechanism with the Beacon Chain’s PoS consensus mechanism; The Beacon Chain started accepting transactions from the Mainnet, packaged the transactions into blocks, and then added those blocks to a blockchain using the PoS consensus mechanism, all while the PoW miners shut down their business and let the PoS mechanism take over. As a result, transactions are executed on a single, new proof-of-stake network. Node operators who stake 32 ETH tokens can become validators, gaining the ability to create new blocks, secure the network and validate transactions. Validators on the network receive rewards based on the amount of their stake ETH as an incentive to approve transactions and secure the Ethereum network.

Although enthusiasts and curious around the world watched with bated breath for the first PoS-validated block, the event, which involved waiting until the first PoS block was created, was seemingly anticlimactic given the technical difficulty inherent in switching the network’s consensus layer without interruption or loss of data; But as discussed in my previous post, the implications are far-reaching. Not only did the Ethereum network reduce energy use by approximately 99.5%, but the merger resulted in a 0.2% reduction in Total global energy use – one of the largest decarbonisation events in history.

An externality of the merger’s initiative to reduce energy use is that Ethereum PoW miners, who invested heavily in mining equipment with no use other than mining ETH, are stuck with their – sometimes mortgaged – equipment without any ability to generate cash flows on the new Ethereum PoS network. As a result, many Ethereum miners have ceased operations or switched to mining alternative PoW coins on the Ethereum Classic (ETC) network,[1] the separatist EthereumPoW (ETHW), and some other lesser-known chains that can be mined with their rigs. EthereumPoW was created from the Ethereum Network when miners decided to “harden” the network to EthereumPoW (ETHW) which would continue to use PoW, hence the name.

WT(H)F (What (Hard) Fork) does this mean for my NFTs?:

A hard fork creates a permanent departure from the previous version of a blockchain and duplicates the history of the blockchain, so every transaction before the fork exists on each new chain: in this case, Ethereum 2.0 and EthereumPoW (for simplicity let’s call the networks ETHPOS and THPOW, respectively). As a result, there are two records for each transaction up to the fork. Not only are there DeFi-related transactions, among other types of transactions, but the majority of NFT buys and sells are recorded on the Ethereum blockchain, resulting in duplicate homes on ETHPOS and ETHPOW for NFTs minted prior to the merger (note: the is expected that the vast majority of new mints will occur on ETHPOS). For NFTs minted post-merge on the ETHPOS chain, it is therefore business as usual (assuming the prevailing industry practice is to mint only on ETHPOS), but pre-Merge minted NFTs now reside on two chains[2] – the new ETHPOS and an ETHPOW chain – which raises certain questions.

As a result of the dominant NFT chain’s duplication, a question therefore arises: does an NFT buyer get a license corresponding to every chain on which NFT can reside? For example, some traders may sell their ETHPOW-based NFT and hold their ETHPOS-based NFT, perhaps to hold onto something of potential value or to attempt to game the system. In that scenario, what happens to the buyer’s rights granted to it under the license, which might include a commercial right to exploit and sublicense? Does the buyer of the ETHPOS-based NFT have one set of rights and the holder of the token on the ETHPOW chain have some rights that might conflict with the new buyer? Do the terms of the new buyer cancel any remaining rights to the NFT on the ETHPOW chain? Generally speaking, would the value of NFT be affected if two identical copies exist on two different blockchains? Does the NFT owner or marketplace have a say in which blockchain to recognize?

These rights are not insignificant, as the holder, depending on the license grant, is usually permitted to display or otherwise use the NFT in a non-commercial way, and in some cases may even be able to exploit commercially, or provide a person(s) right to commercial exploitation, NFT. Understanding which package of rights, and whether others share that package, is useful for valuing the NFT and its underlying IP, as well as branding.

As with everything in the ever-evolving cryptosphere, there is variation in how license agreements handle forks. For example, the terms of one NFT marketplace, Rarible’s Standard Collectibles Sale and License Agreement, indicate that it recognizes NFTs on both chains:

“Collector” of a Collection Object means at all times, the person who legally has exclusive right to and ownership of NFT included in such Collection Object, for as long as such person continues to have such right to and ownership of such NFT. All references to “Collector” include the Collector’s lawfully permitted successors and assigns. In the event that an Ethereum Persistent Fork creates copies of the Collectibles at the same addresses as they were then held on Ethereum, the scope of the term “Collector” and all licenses granted to and other rights of a Collector under these Terms shall be deemed extended to include each person who legally has exclusive right to and ownership of the copies of such NFTs included on the Ethereum Persistent Fork. The parties acknowledge and agree that, as a result of the foregoing sentence, in an Ethereum Persistent Fork, the aggregate number of Collectibles may be increased, which may have a negative effect on the value of each Collectible or the aggregate value of the total. Collectibles.

While Rarible’s license agreement may lead to a doubling of the amount of “Collectibles” in the event of a fork, Yuga Labs, a Web3 developer of NFTs, reserves the right to specify which fork is valid for their remarkable Cryptopunks.

The license applies only to CryptoPunk NFT on the blockchain that Yuga, in its sole discretion, may designate, which designation shall apply retroactively. Thus, for example, if a fork or other event purports to result in duplicate CryptoPunk NFTs, only the non-fungible token registered on the blockchain designated by Yuga Labs will be eligible to receive the benefit of the license. Any license purportedly granted hereunder to the owner of a non-fungible token registered on a blockchain not designated by YugaLabs is void ab initio.

Yuga Labs’ approach is similar to that of venture capital firm a16z, which granted five template NFT licenses, each providing the industry-recognized chain.

Transfer and Sublicensing. The licenses granted in these Terms are non-transferable, except that if you lawfully transfer ownership of your Project NFT, the license to NFT Media in Section 1.1 to you shall terminate on the effective date of such transfer, and such licenses will be assigned. to the new owner of Project NFT linked to such NFT Media. As a condition to any sale, transfer or similar transaction of the Project NFTs, the transferee agrees upon the acquisition of the Project NFTs that (a) the transferee is not a restricted party and (b) the transferee agrees to these Terms. Further, if you choose to sublicense any of your Licensed Rights set forth in Section 1.1 above, you are permitted to do so only if any such sublicensees agree (i) that they are not Restricted Parties, (ii) to the same agreement that not to assert as set forth in the penultimate sentence of Section 1.2, and (iii) that if your Licensed Rights in Section 1.1 are transferred (for example, because you sell Project NFT), then any sublicenses you have granted in such Licensed Rights will automatically is terminated. Because virtually all public blockchains are licensed under open source licenses, it is possible that the blockchain could split, merge, or duplicate the original blockchain that originally recorded ownership of your Project NFT. In such event, rights granted under these Terms to owners of a Project NFT will only be granted to the legal owners of such Project NFT whose ownership is registered on the main network version of the blockchain that is generally recognized and predominantly supported in the blockchain industry as the legitimate successor to the original blockchain (as determined in its sole discretion).

Alternatively, a creator may reserve the right to upgrade NFT’s smart contract in the event of a fork, reserve the right to declare future restrictions on NFT’s use, or remain silent altogether. In the absence of a license agreement or specific guidelines, Archer v. Coinbase, Inc., 53 Cal. App. 5th 266 (2020), provides some clarity on how forks can be handled. IN Archer, a user claimed that a cryptocurrency exchange was needed to give him access to all forked versions of Bitcoin in his exchange account. The court disagreed and reasoned that the exchange’s user agreement did not oblige the exchange to support all forks. The court also found that Coinbase’s refusal to support a new form of forked cryptocurrency was not action constituting conversion, as Coinbase did not host the forked cryptocurrency in the first instance, and thus could not have deprived the plaintiff of an ownership right or exercised dominion over the forked cryptocurrency the cryptocurrency. Accordingly, platforms for trading digital assets (token, NFT or otherwise) tend to expressly reserve the ability to decide which forks they support or otherwise reserve the broad right to impose future restrictions on transactions.

It remains to be seen if ETHPOW will become a profitable chain for miners. Regardless, other chains may undergo hard forks, so NFT issuers and marketplaces should consider the effect a fork may have on their business models and provide clear guidance and update relevant terms as necessary to explain how they will handle any future hard forks

_______________

[1] Ethereum Classic is the original Ethereum network. The Ethereum blockchain was hardforked from Ethereum Classic after The DAO was infamously hacked. The effect was that the new Ethereum network erased the history of The DAO theft, while Ethereum Classic, which remained philosophically pure to some supporters, maintained the unchanged history.

[2] As mentioned, mining can go back to mining on Ethereum Classic, but since there are no NFTs in the shared histories, the duplication issue is unclear.

[View source.]