What in the World are NFTs? A Primer

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The news and social media have been abuzz lately with talk about NFTs. Artists and creators are rushing to potentially cash into the craze, and even the sketch-comedy show Saturday Night Live has poked fun at them in this somewhat informative and hilarious skit.

Those three letters could spell huge boons or consequences to the world of media and entertainment. To those unfamiliar with cryptocurrencies (like myself), the whole concept is equally intriguing as it is confusing. To cryptocurrency gurus, NFTs are a new method to support artists and participate in collecting unique items.

NFTs Explained

A non-fungible token, or NFT for short, is a unique cryptographic asset linked to an issued object on a blockchain.  The key characteristic of an NFT is its non-fungibility.  The best way to understand this is in terms of fungibility and non-fungibility.  Fungible assets are those that can be exchanged for something with similar value.  In other words, the items are interchangeable.  The clearest example of this is demonstrated with money.  There is no difference between the value of five $1 bills versus a $5 bill.  A store clerk would be satisfied with either form of payment.  Something that is non-fungible, on the other hand, cannot be easily interchanged with something else.  Examples of non-fungible assets include paintings, diamonds, and cars.  If Person A lent Person B their car, it would be unacceptable for Person B to return a different car–even if it was the same make and model.

So what makes an NFT?  Basically, it is an item that does not have an interchangeable replica but in a digital form.  This is where the cryptocurrency element is implicated.  Whereas a non-fungible asset, as most would understand it exists in a physical, tangible form, an NFT exists only digitally and in the blockchain.  Blockchain–for this article–can be understood simply as a database or ledger that records transactions, is easily traceable, and very transparent.  On the blockchain, ownership of an NFT is directly linked.  When an NFT is purchased, the sale, the ownership, and the authenticity are all recorded and can be traced back to the source for legitimacy.

To put it all together, an NFT is a digital asset, such as a unique, indivisible, and non-fungible piece of art stored on a blockchain ledger so that the owner can be proven and irrefutably established–like a digital certificate of authenticity.  Imagine it like a digital baseball card.  NFTs are simply a broad name for a new type of asset that only exists digitally.  Just like there is a market for baseball cards, there are also markets for NFTs.  They can be found online at sites like OpenSea and Rarible.

When someone buys an NFT, they own the right to claim ownership over the NFT.  Upon purchase, the buyer receives a certificate that identifies the buyer as the rightful owner and, in theory, grants them some rights to exclude others.  Other rights depend on the terms of the contract.

In the News

While NFTs have been gaining popularity in the past few years, their jump to prominence has been amplified by several high-profile sales.  In March 2021, digital artist Beeple sold an NFT through Christie’s auction house for $69.3 million.  Also, in March, Twitter CEO Jack Dorsey sold his first tweet as an NFT for $2.9 million.  The market is hot.  The National Basketball Association has capitalized on this trend by opening the NBA Top Shot, a platform that packages and sells a scarce number of officially licensed video highlights of top players such as LeBron James.  NBA Top Shot has already generated over $300 million in sales since its launch in 2019.

With big payouts like these, likely, other sports leagues will soon follow suit.  Tampa Bay Buccaneers quarterback Tom Brady recently announced he would be creating an NFT company to develop unique digital collectibles and bring “ground-breaking experiences to a community of fans and collectors.”  The market is certainly ripe considering Brady’s rookie trading card just sold for $2.25 million.

Artists are also understandably excited–NFTs create new opportunities to connect with loyal fans and cut out the middlemen that are publishing companies and record labels.  In March, rock band Kings of Leon released the first-ever NFT album.  While the album was released on other platforms, the NFT version included special perks such as a limited-edition vinyl.  Additionally, the NFT version was only available for a short period of time–creating the sort of scarcity that usually drums up demand.

As more creators catch on, NFTs are bound to have a massive impact on the entertainment world.

What Good are NFTs?

Part of the allure of NFTs to artists and creators is that NFTs provide the ability to sell artwork in a “verifiable, digital form” directly to consumers without the need of intermediaries that would normally take a share of some profits from a sale.  Also, NFTs impact royalties for artists.  An artist normally would not receive any royalties from future sales of their work. NFTs may be programmed so that the original artist would receive a predetermined royalty after each subsequent sale.  Beeple, the aforementioned digital artist, will receive a 10% royalty each time his $69 million NFT, “Everydays: The First 5000 Days” is sold again.  Additionally, NFT markets allow artists to sell their work that otherwise might not have wide market appeal.

The desire for NFTs from a consumer standpoint is the same as those created by tangible non-fungible assets.  People enjoy collecting items that are in short supply.  Loyal supporters can own exclusive, one-of-a-kind items.  NFTs by design grant ownership of something that cannot be copied.  Anyone can buy a print of The Son of Man, but only one person can own the original painting–that is what NFTs try to capture.  Depending on the programming of the NFT, there are usually basic usage rights that accompany a purchase as well.  Add in the blockchain element, and the owner can authenticate the digital work and identify as the rightful owner.

Finally, there is the speculation that the NFT may accrue in value, and the owner can later sell it for a profit.  In this way, NFTs function similarly to the fine art market.

Some Legal Issues with NFTs

As the prevalence of NFTs continues to soar, several legal issues still have yet to be resolved.  One of the first questions that must be answered is what law applies to NFTs.  Their unique structure could lead to some application of intellectual property law as well as securities law.  For instance, there seems to be a general understanding that when an NFT is purchased, the owner is the same as someone who has just purchased a piece of art.  They own the NFT and now have the ability to sell, lend, or transfer the NFT.  But what about the ability to make copies or create derivative works?  This is where it starts to get messy.  Because NFTs are solely digital, it would be fairly simple to screenshot an NFT and “mint” it as a new NFT.  Of course, specificity in NFT programming may solve these problems in the future.

NFTs could present a lucrative estate asset to be transferred through a will or trust in terms of estate planning.  However, specific provisions that are not yet in widespread use are likely needed.  The risk of loss is high since NFTs require a specific personal key to access the asset–their touted security may be a double-edged sword if passwords and access codes are not properly shared with future inheritors.

In the context of royalties to artists in subsequent sales, U.S. copyright law imposes limitations such as the first-sale doctrine.  The first-sale doctrine, codified in 17 U.S.C § 109, allows an individual who purchases a copy of a copyrighted work to sell or otherwise dispose of that particular copy without the consent or consultation from the original copyright owner.  However, the first-sale doctrine might not apply to digital copies or assets.  The United States Court of Appeals for the Second Circuit held that it was impossible to transfer a digital file without making a copy. That transfer is still subject to the copyright owner’s reproduction right instead of the distribution right granted by the first-sale doctrine.  NFT creators and purchasers should be cautious, relying on doctrines such as first-sale to apply NFTs.

Finally, an NFT–depending on the purpose it was created for and how it is marketed to buyers–could be deemed to be a security.  If courts and regulatory agencies decide to include NFTs as a security-based on tests such as that of SEC v. W.J. Howey Co.–the markets where they are exchanged, and creators could be subject to sanctions by the SEC.  NFTs as art and digitally authentic collectibles are likely safe from securities law.  NFTs being created for and marketed as an investment return are more likely to be considered a security under the Securities Act of 1933 and the Securities and Exchange Act of 1934.

These are simply a few of the potential issues that surround NFTs.

Parting Words

The law is often slow to catch up to technological advancements.  At this point, it is unclear how NFTs will be treated under different areas of law or even if they will have enduring popularity.  For now, it is simply a matter of time.