What are … niff-tees? articles
20 Apr 2022
NFTs, or non-fungible tokens, are unique digital assets. By contrast, a cryptocurrency like Bitcoin is ‘fungible’ (i.e. each unit is equivalent to the next). NFTs can take numerous forms. To an uninformed observer, NFTs could be seen as nothing more than overpriced jpegs, but that is to oversimplify them and understate their potential value.
NFTs have a range of use cases, from artwork, collectibles, sports, gaming, entertainment, identity verification, to real estate and finance. NFTs offer a unique entertainment experience for promoters, musicians, brands, sports teams and their fans. They can be not only tickets or digital merchandise, but also a unique opportunity to own and trade memories and reward fan engagement. For example, California music and arts festival, Coachella, recently announced that it was releasing a collection of NFTs which offered onsite perks and VIP access.
According to Binance Academy:
“NFTs have the potential to be one of the key components of a new blockchain-powered digital economy. They could be used in many different fields, such as video games, digital identity, licensing, certificates, or fine art – and even allow fractional ownership of items. Storing ownership and identification data on the blockchain would increase data integrity and privacy, while easy, trustless transfers and management of these assets could reduce friction in trade and the global economy.”
Recent eyewatering sale prices of crypto art have confirmed crypto as a new medium and class of assets in this traditional asset space. For example, digital artist Beeple’s ‘Everydays: The First 5000 Days’ sold for $69m USD via famous art auction house Christies, and digital images of celebrated New Zealand artist Charles Goldie sold for $127k at New Zealand’s first NFT auction via Webbs. High profile artists like Damien Hirst have also begun experimenting with NFTs (in his case selling 10,000 unique hand-painted dot-covered works on paper, each one corresponding to an NFT).
Such sales open a veritable ‘Pandora’s box’ for the estates and beneficiaries of artists, musicians, sportspeople, and other creatives who hold caches of intellectual property that can be digitised. It is no surprise that crypto businesses, like Glorious Digital, an NFT creative studio and marketplace, owned by former All Black Daniel Carter and former Solicitor-General Michael Heron QC, are popping up to meet local and international demand. As this article reports, the International Art Centre in Parnell, in conjunction with Glorious Digital and Rita Angus’ estate, is selling a limited edition NFT version of New Zealand painter Rita Angus’ celebrated ‘Cass’ painting.
This article from The Spin Off provides a useful breakdown of what they are, how they work, and where to buy them (e.g. marketplaces such as Opensea and MagicEden). New Zealand NFT projects such as Flufs and Pixelmon have featured recently in news media, the latter for being comically bad despite raising over $100m.
However, it is important for all NFT enthusiasts to be aware that, unlike fungible crypto like bitcoin which is very ‘liquid’ (i.e. able to be transferred easily), because NFTs are unique they are potentially very ‘illiquid’ (i.e. cannot be transferred easily). This brings risk if, for example, there was to be a market correction and funds were to flow out of crypto into other asset classes (e.g. cash or treasury bonds). In such a case there may be no market for the NFT at all.
Types of NFTs
NFTs can be a digital image, like the artworks of New Zealand-born Samoan artist Iokapeta Magele-Suamasi:
Or NFTs can be part of a collection, more like baseball collector cards or comic books. The creator can ‘mint’ a range of different forms of digital media (e.g. picture, video, photo, audio) and can build in a continuing royalty. In art terms, an NFT offers provenance via the publicly searchable blockchain.
Far from being limited to just personal profile pics or ‘PFPs’, NFTs are also becoming a gateway to the metaverse. For example, Portals, which is an NFT built on Solana, allows a holder to own digital real estate within the Solana metaverse, where they can build out unique spaces to conduct meetings (a bit like Zoom) and display their other NFTs.
Some NFTs cross-over between between use cases. For example, CyberKongz crosses over between artwork, collectibles, gaming and finance. The holder can ‘stake’ their Kongz on the CyberKongz platform and receive ‘BANANA’ tokens in return. If you have two genesis Kongz, once you have a certain amount of BANANA tokens, you can receive a ‘BabyKong’.
NFTs and play-to-earn games highlight the growing market demand for and interrelationship between crypto and gaming. Games such as Axie Infinity allow digital artworks and collectibles to be ‘minted’ (i.e. included in a block) by the content creators, used in the game, and traded (similar to stocks) in crypto markets. According to this video children as young as 12 are making a living playing Axie Infinity. During the pandemic, countries like the Philippines saw large scale adoption as people used the game to supplement their income.
‘GameFi’ shows the potential for people of all ages to own and trade crypto and for there to be such assets within relationship property pools and estates that might not have previously been considered.
Some considerations for the creators
NFTs undoubtedly present enormous opportunity for New Zealand businesses to disintermediate middlemen who are clipping the ticket on their products. See, for example, New Zealand artist @askewone leveraging Instagram and SuperRare to promote his digital art:
While Glorious Digital claims to be ‘artist centric’, the platform still takes 30 percent of the sale price (compared with ‘most galleries where it is closer to 50 per cent’) and a ‘small tranche of the revenue each time a work is resold’. Contrast Glorious with say, Solsea, where an artist or intellectual property owner can mint and list for a fraction of a SOL (less than 1c NZ), set the percentage of royalty they wish to receive from future sales, and decide the nature of the copyright licence attached to the NFT.
As this article notes, minting NFTs on different protocols and platforms costs varying amounts. The owner will also pay transaction fees (usually in the crypto for the protocol that the NFT was minted e.g. SOL or ETH) for the NFT to be listed. These fees can be volatile which can affect the market for the NFTs. Minting on the Ethereum protocol, for example, could be less risky in terms of security, than e.g. minting on a less well known protocol
Again, not all platforms and protocols are created equal. A creator may view one protocol as more secure, or a marketplace as larger, and therefore be content to pay higher fees. For example, they may prefer an Ethereum based marketplace such as Opensea which relies upon the security of the Ethereum blockchain (a more established, more decentralised and therefore likely more secure protocol) even though the fees might be higher, vs a lower cost option like Solanart, which is powered by the Solana blockchain, which is newer and arguably less decentralised (and therefore potentially at greater risk of vulnerabilities in the code or a 51 percent attack) where the fees are lower.
With all that said, investors and content creators may well prefer a platform like Glorious Digital if, for example, they can have a higher degree of trust that the content originated from the original creator or intellectual property rights owner, than a platform where there is no guarantee what has been minted was legally owned by the minting party. The above highlights how there are markets for different platforms and blockchains and that they can all co-exist.
For the artists, NFT projects like Skeleton Crew Artist Collective are helping indie artists to launch their artwork collections as NFTs. Software, such as Treat Toolbox, also allows them to create generative collections without the need to understand coding.
Some legal considerations
Product or security?
Due to their variability, NFTs present unique challenges for lawyers. In some respects, they can look like simple products, like an artwork or music file. In other cases, they can look more like financial products potentially subject to our Financial Markets Conduct Act 2013 (FMC Act).
For example, the goal of Vesta Equity is to allow homeowners to tap into the equity in their homes through tokenization. According to the company, token holders would then be able to sell off a portion of it as a fractionalized NFT. This form of NFT looks much more like a security.
SEC Commissioner and ‘Crypto Mom’ Hester Pierce has also noted the risks, particularly associated with selling fractions of individual NFTS or NFT baskets, that NFTs are unregistered securities. As this article reports, the US securities regulator, the SEC, is looking into NFT projects to see if they are illegal token offerings / unregistered securities. We can expect our regulator, the FMA, is doing the same in New Zealand.
Regulators are not the only parties to be concerned about. As the case of Friel v Dapper Labs shows, disgruntled private litigants might also claim damages for securities law violations. The Dapper Labs case involves a class action lawsuit in respect of the NFT project ‘NBA Top Shot’.
Intellectual property ownership and royalties?
Do not assume that if you buy an NFT you will automatically acquire the ownership of the underlying intellectual property. The NFT purchaser must acquire either outright ownership of the work or a licence of these underlying rights from the party that created or commissioned the original work. An NFT is, at its core, a ‘hash’ of a digital file. Hashing is how input data is encrypted and incorporated into the blockchain through cryptography.
Creators can, in most cases, determine what licence and royalty attaches to the NFT. For example, on Solsea, creators can grant rights as limited as private use/ non-commercial exploitation through to reproduction / commercial exploitation and can set whatever percentage of royalty they want (up to 50%) on secondary sales.
Creators should check the terms of the platform they are minting on and/or the smart contract encoded with the NFT. It is possible that a separate agreement might be required, if, e.g. it is intended that both the NFT and the underlying asset be sold / acquired (as was the case with the Webb’s Goldie NFT sale) or if it is unclear who has the rights to the underlying digital file. Some platforms might wish to create exclusivity arrangements with artists which could preclude listing on different protocols and marketplaces (and therefore constrain sales and income). If unsure it would pay to speak to a lawyer before entering into any agreements.
A recent example of high profile NFT projects which differed in their intellectual property rights are CryptoPunks and Bored Ape Yacht Club (BAYC). BAYC’s creators, Yuga Labs, bought the intellectual property rights for CryptoPunks and Meebits from their creators, Lava Labs, and gave the NFT holders ‘full commercial rights’ to their use (where previously they held only limited rights).
If the intellectual property rights are breached the rights holder could have a legal claim against the NFT purchaser. In New Zealand a rights holder could seek an injunction against the breaching purchaser, damages or an account of profits, or orders to hand over the infringing goods (assuming they know who and where they are). Potentially the Court could even impose a fine or prison sentence if the intellectual property infringement constitutes a criminal offence. Market places for the NFTs could also restrict the purchaser’s user account.
An example of a court proceeding over infringement of intellectual property rights and NFTs is French luxury group Hermès, the creator of the iconic ‘Birkin’ bag, is suing the creators of ‘MetaBirkins’ for trade mark infringement.
Websites and social media have become incredibly effective marketing tools. A boom in the number and values of crypto assets, especially the pop culture phenomenon of NFTs, has given influencers and corporate brands alike, a very real financial opportunity to leverage their follower / customer base with crypto. But what many ‘influencers’ or content creators might not appreciate is that they could still be subject to legal claims, from members of the public or regulators, if their posts are false, misleading or harmful.
Potentially the FMC Act, the Fair Trading Act 1986, and Contract and Commercial Law Act 2017 could apply, if statements made about NFTs are misleading or false. Parties minting NFTs, and selling or promoting them via their websites or social media pages, are well advised to seek legal advice, particularly around their terms and conditions of use, because appropriate use of disclaimers could reduce the risk of an adverse claim.
As this article notes, NFTs can be a vehicle for money laundering. What many creators might not appreciate is that, if they are using their websites to facilitate transfers and exchanges of their NFTs, or involved in issuing and selling virtual assets to the public, or distributing royalties to others, they might be caught by our AML / KYC legislation, as a virtual asset service provider or ‘VASP‘. VASPs have AML/CFT responsibilities, including:
- Reporting suspicious activities and certain transactions.
- Verifying the identity of customers in some circumstances.
- Assessing and mitigating money laundering and terrorism financing risks.
Data privacy and security
NFT marketplaces are a veritable honeypot for cyber thieves. A recent case against Opensea (alleges that the marketplace was negligent in allowing hackers to exploit a vulnerability in the platform’s code and get away with a number of BAYC and other NFTs. Opensea has also apparently suffered a phishing attack that exploited a vulnerability in the smart contracts of the protocol that the NFTs were created with, that allowed the hacker access to the private keys that permitted the transfer of the NFTs. The owners of the NFTs unwittingly authorised the transactions, effectively handing the hackers open access to their assets.
As we discuss in our article, New Zealand’s privacy law was updated not so long ago to bring it into line with other jurisdictions. The Privacy Act 2020 includes increased liability for ‘agencies’ for privacy breaches resulting in serious harm to individuals. Parties minting and facilitating the transfer of NFTs, which process involves the collection of private data, are well advised to take data security and legalities regarding the same very seriously.
Taxing crypto is a major focus now for many governments. It has been reported that the Biden government is targeting crypto wealth for $11 billion (USD) in new tax revenue. As we discuss in our crypto tax articles,if you are minting NFTs to sell them, or trading them regularly, this could lead to a tax liability.
While changes to the tax treatment of crypto is proposed, for now GST still applies to NFTs. Whether GST is payable or claimable at 15% turns on whether the consumer is based in New Zealand or overseas. In a world which is largely anonymous, this can be difficult or potentially impossible to determine. In any case, it is sensible for creators to seek professional tax accounting advice.
This articleis not intended as legal advice and it should not be considered or relied on by any reader as such. Like most aspects of law, each crypto legal issue must be considered by reference to its own facts. Stace Hammond do not profess to be experts in any other field discussed in this paper, e.g. economics, financial advice, accounting. The article should not be treated as professional advice of any kind (e.g. legal, accounting, tax, or financial advice). It is for educational purposes only. Please note that the material linked in the article is for illustrative purposes only. Its inclusion is intended to make the paper accessible for all readers, not just lawyers. Except for our own web articles, Stace Hammond does not necessarily agree with or endorse the statements made in the linked material. We reference it for its overall usefulness for this discourse. Stace Hammond does not claim any copyright or other intellectual property rights in those linked works. We also reserve the right to correct any errors in the paper that we discover.
 Please note that this is not an exhaustive list. Each NFT project tends to be different and so each requires consideration whether it could be a financial product. As the FMA has the power to deem any token a financial product, one should not assume that an NFT is not a financial product / security.
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