March 25, 2022

Understanding NFTs

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Key Takeaways

  • By now you may have heard about NFTs: the new cryptographic asset that is having a major impact in many industries and is likely to continue to do so for many years.

By now you may have heard about NFTs: the new cryptographic asset that is having a major impact in many industries and is likely to continue to do so for many years. Christies sold an NFT of digital artwork for $69 million. An NFT of Jack Dorsey's first tweet sold for over $2.9 million. NBA's Top Shot program has resulted in over $700 million in sales of NFT, and Internet memes are selling for hundreds of thousands of dollars. NFTs are selling for astronomical prices and opening new markets and opportunities for monetizing creative works in ways that previously did not exist. As this new technology gains foothold in mainstream media, novel and critically important legal issues have emerged. This client alert discusses the current NFT craze in the digital world, and the three basic things you need to understand if you are considering entering the NFT world.

1. What is an NFT?

NFT, or non-fungible token, is a unique digital file that resides on the blockchain so that ownership of that digital file can be tracked. It is a cryptographic "hash," or a unique string of letters and numbers that is related to a specific asset or object. The key characteristic of a NFT is that it is not fungible, meaning that, unlike cryptocurrency such as Bitcoin, each NFT is unique—each NFT is coded to verify that it is the only digital asset with its specific attributes, much like an original painting is a physical asset that is unique.

2. What is blockchain?

The underpinning technology that supports NFTs is the blockchain. Blockchain is a digital ledger that records information (such as ownership transfers) in a what is believed to be a secure manner. The hallmark of blockchain technology is decentralization: instead of having one central body (such as a bank, County Clerk's office, or US Copyright Office) maintaining the data, a network of computers maintains the data in an immutable and permanent shared record of transactions—the digital ledger. When an NFT is purchased, the transaction is recorded on the blockchain (most commonly, on the Ethereum blockchain) as a new block of data entry. Each block contains a list of historical transactions and the latest NFT transaction will be added to that list. The block will include information about the payment history, chain of title, and other information about where you can find information regarding the underlying asset. The information on the blockchain will link to the asset's location, which, in most cases, resides off-chain and elsewhere on the Internet.

3. What exactly do you own when you own an NFT?

When you buy an NFT, you are buying the token, and not necessarily the underlying digital asset. Each NFT has a contract (i.e., rules) associated with it which determines precisely what you own. And generally, even if the contract does grant you ownership of the digital asset, it does not transfer ownership of the asset's intellectual property, which will remain with the creator of the asset unless agreed otherwise.

As an example, if you are a huge NBA fan and are committed to collecting exciting plays that last only a few seconds on the court, you can now purchase NFTs on NBA Top Shot, which is an online marketplace that allows users to trade NFTs that present game clips or photos from actual games (i.e., the "Moment", as the NBA Top Shot calls them on its website).

When you purchase a "Moment", such as a clip showing Vince Carter dunks over Shaq, what you would obtain is the ownership of the NFT underlying that Moment but not the ownership of the dunking clip, or the intellectual property embodied in that clip. The purchase of the NFT entitles you to a license to use the Moment in a personal and non-commercial way, such as showing the dunking clip to your friends or trading it for other Moments. But you are NOT entitled to modify or use the dunking clip for other commercial purposes because NBA Top Shot (or the NBA or the player) retains ownership of and intellectual property rights in that clip.

As such, if you wish to modify the clip to make it look like Vince Carter had dunked over Larry Bird and sell it for profit, you will need NBA Top Shot's consent for doing so.

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