What Are NFTs and How Will They Affect the Legal Field? - Martindale-Avvo

What Are NFTs and How Will They Affect the Legal Field?

What Are NFTs?

NFTs, or non-fungible tokens, are a form of cryptocurrency that has become increasingly popular in the past five years. NFTs are licensed to use specific digital assets, usually digital art but also things like music and video. NFTs are different from other forms of cryptocurrency because NFTs are for unique digital assets.

Thanks to a newer technology called blockchain, property rights for digital assets are now more easily discernible. Blockchain is a digital record that tracks every transaction when a digital asset is transferred from one person to another. Each transaction creates a record, called a block, and the blocks eventually make the blockchain, which then has the complete record of the digital asset’s history.

The blockchain for NFTs contains information about the smart contract, which specifies what sort of property rights were transferred. Most NFTs are merely licensed to use the digital asset, not ownership of it. The license may also limit the uses for the digital asset. For example, you may be able to use it for personal purposes but not for commercial purposes.

NFTs became more popular in 2017 as a way to own and transfer rights to digital art and other digital assets, investment tools, and currency. They have also been in the news more recently as the United States government has begun considering how to regulate NFTs and cryptocurrency. As legislators and regulators continue to work to address NFTs, the legal issues involving NFTs will only increase as courts begin interpreting and applying existing and any new laws to this rapidly emerging field.

What Legal Issues Do NFTs Involve?

NFTs potentially implicate several legal issues, from personal property rights and licensing to intellectual property. Until Congress and other agencies hash out more definitive rules and guidance on NFTs, whether NFTs can be classified as securities or commodities is still unclear so the SEC rules may apply to NFTs. Taxation is also an issue that is not well-settled regarding NFTs. And as with other forms of cryptocurrency, potentially illegal uses of NFTs abound. Read on for more specific information about these areas of law and how they may impact NFTs.

Personal Property Law and NFTs

Most NFTs do not involve ownership rights to the digital asset. Instead, most NFTs involve limited licenses to use digital assets. The license is often limited to personal use, not commercial use, without the right to reproduction. An attorney familiar with licensing and personal property law as it relates to technology may have the appropriate expertise to help sort out what personal property rights the NFT involves.

The type of license granted may also implicate issues with gambling, as the license may prohibit the use of digital assets in gambling. Many games involving NFTs have removed pure chance as a mechanism to win an NFT, and instead, some form of skill is required.

Intellectual Property Law and NFTs

Because most NFTs only involves a license to use the digital asset and not ownership rights, intellectual property rights are a big issue for NFTs. The property owner, in most cases, still holds the copyright to the digital asset, whether art, music, or a mem. Any royalties that result from its later use belong to the copyright holder, not the licensee. An attorney specializing in copyright law and understanding the licensing issues with NFTs would be best prepared to address copyrights and NFTs.

In addition to copyright law, issues with trademarks involving NFTs have come up recently. A company called StockX LLC sold NFTs connected to images of Nike sneakers. Nike filed suit against StockX LLC, claiming the sale of images containing Nike’s trademark swoosh violated trademark laws. The case is more complex because the NFTs at issue were connected to a physical product instead of merely a digital one—StockX LLC primarily deals in the resale of physical products, and the NFTs at issue were images created of StockX LLC’s physical inventory of Nike shoes. 

And as the meta verse continues to expand, companies like Panera and McDonald’s are filing trademarks for NFTs to use as virtual restaurants in the metaverse. Trademark law will have to rapidly develop to keep pace with the ever-expanding use of NFTs. Trademark attorneys who can stay up to date with the technology will be important in navigating this area.

Securities Law and NFTs

The Securities Exchange Commission (SEC) has begun to weigh in on whether federal securities laws apply to cryptocurrency and digital assets. There are some reports that the SEC has already started addressing, specifically whether some NFTs can be considered securities. Under the Howey Test, a financial transaction can qualify as involving security regulated by the SEC if it involves an investment in a common enterprise with a reasonable expectation of a financial return due to the efforts of others.

The proposed Lummis-Gillibrand Responsible Financial Innovation Act, introduced on June 7, 2022, by Senator Kristin Gillibrand (D-AZ), classify NFTs as a commodity, like wheat or oil, mainly removing NFTs from the purview of the SEC.

Taxes and NFTs

The proposed Lummis-Gillibrand Responsible Financial Innovation Act would require the Internal Revenue Service (IRS) to adopt guidance to clarify taxation issues concerning NFTs. How NFTs are taxed can be very complicated depending on the type of asset tied to the NFT and the mechanism by which it is transferred, and the IRS has not yet issued any specific guidance to NFTs. Centralized databases are rare for NFTs, so the IRS’s ability to monitor transfers is limited. Taxpayers are mainly responsible for reporting their activity and calculating their tax burden. A well-versed tax attorney in cryptocurrency is essential to ensure a taxpayer does not overpay and prevent future unfavorable audits.

Money Laundering and NFTs

In some circumstances, criminal laws relating to money laundering may be implicated when it comes to NFTs. As a form of cryptocurrency subject to minimal government regulation, the potential to launder money using NFTs is significant. The United States Department of Treasury has looked closely at money laundering and NFTs, publishing a study in February 2022. As the marketplaces and demand for NFTs continue to expand, the Treasury will continue scrutinizing their use. Attorneys specializing in white-collar financial crimes like money laundering can help clients navigate the Treasury’s response to the expansion of money laundering to the digital realm.

Insider Trading and NFTs

The United States Justice Department recently announced the first insider trading charge involving NFTs. Individuals who work with large sellers of NFTs or NFT marketplaces can potentially be involved in insider trading. Accordingly, companies who sell NFTs must have and enforce insider trading policies. Attorneys who have drafted such policies for other industries will be well-equipped to handle insider trading policies involving NFTs.

International Sanctions and NFTs

The Office of Foreign Assets Control (OFAC) is also involved with NFTs, issuing sanctions and designating a slew of digital currency marketplaces as specially designated nationals because of their involvement in financing ransomware actors. Because of the designation, U.S. persons cannot deal with those marketplaces or NFTs associated with those marketplaces. Accordingly, the source of an NFT is critical. An attorney with expertise in both NFT technology who can help verify the source of an NFT and understands OFAC sanctions may be helpful for this issue.

What Lawyers Represent NFT Cases?

Lawyers who understand the technology behind NFTs and their intersection with the more traditional areas of law implicated by NFTs are in the best position to represent NFT cases. These lawyers can draft policies and procedures, such as an insider trading policy, for businesses that regularly deal in NFTs and help navigate the personal property rights and other issues involved.

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