Non-fungible tokens and digital assets – what's the deal?

11 minute read  06.10.2021 Peter Carstairs, Lucy Sanderson

The art world is abuzz as a bizarre and potentially lucrative new market has emerged for digital artists known as non-fungible tokens (or NFTs). People operating in the digital marketplace need to understand the rights attached to NFTs so that they can trade with confidence.

Key takeouts

  • A non-fungible token (NFT) is a unique digital certificate that functions as proof of ownership, or authenticity, of a digital artwork or asset. It is not the artwork itself.
  • When you own an NFT, you typically do not own the copyright in the digital artwork to which it relates. Like a physical artwork, unless specifically assigned to the purchaser, the copyright will remain with the artist.
  • NFT creators and purchasers should carefully review the scope of the licences and terms of service within NFT smart contracts and NFT marketplace platforms before proceeding with a purchase/sale.

What are non-fungible tokens?

Until October 2020, the highest price that Mike Winkelmann, a digital artist known as Beeple, had ever received for one of his prints was $100. In October 2020, Beeple 'sold' an artwork via an NFT for US$69,000. In March 2021, it was resold by Christies for a record-breaking US$69.3 million. Twitter CEO, Jack Dorsey, recently tokenized his first ever tweet: 'just setting up my twttr'. The final bid at auction was $US2.9 million.

So what is an NFT and why are people willing to pay so much for them?

A non-fungible token is a unique digital certificate that functions as proof of ownership, or authenticity, of a digital asset – but it is not the asset itself.

In the context of digital artwork, a unique code or token (the NFT) is created which corresponds with the artwork, usually a limited edition of the work. In this way, NFTs are analogous to the title deed in relation to a house, or a certificate of authenticity for a limited edition physical artwork or record.

That is, they verify that the owner of the NFT owns an 'original' or 'limited edition' of something. Unlike a house or a physical artwork, however, in the digital realm there may be an infinite number of virtually identical digital copies of the artwork that are indistinguishable from the original.

'Non-fungible' simply means the token cannot be interchanged with another, unlike the way in which bank notes or Bitcoin can be interchanged. Because NFTs are non-fungible, and because they are stored in a blockchain (more on this below), this has enabled an entirely new market in digital artworks to be created whereby digital works can be readily bought and sold.

In addition to serving as proof of authenticity, 'tokenizing' digital assets can simplify transactions by removing intermediaries and connecting artists directly with audiences or 'the market'. While tokenization of physical items is not yet as developed, it is possible that one day it may be possible to purchase a car or home and receive proof of ownership via an NFT.

NFTs use blockchain networks

NFTs are recorded, stored and traded on blockchain networks (such as Ethereum). This is the same technology that supports cryptocurrencies such as Bitcoin. Blockchain is essentially a digital public ledger which records transactions. Blockchain stores data in encrypted blocks that are then chained together chronologically. As new data comes in, it is entered into a new 'block' in the 'chain'. Because each block in the blockchain is linked to the previous one, attempts to change information stored is easily detected. This tamper-resistance is why NFTs cannot be duplicated or copied. While an NFT exists solely on blockchain, the corresponding digital artwork exists somewhere else on the internet.

Smart contracts

Smart contracts are a key feature of blockchain technology and are usually entered into when buying or selling a digital work via an NFT. Like regular contracts, the terms and conditions of the agreement are encapsulated in the smart contract but, unlike regular contracts, they are written as code and will automatically execute when pre-defined conditions are met, such as the exchange of cryptocurrencies. This allows automation of the contract and, in many cases, can eliminate the need for an intermediary (such as a trading house).

What are an NFT owner's rights?

Copyright issues

Copyright and the rights conferred by NFTs can easily be conflated. When an NFT is purchased, what’s really being bought are certain rights in relation to a digital asset, not the asset itself. Whilst the purchase of an NFT confers ownership of a digital token, the NFT is nothing more than proof of ownership or authenticity of the digital asset.

An NFT owner's right in relation to the work connected to the NFT will include a right to claim 'ownership' of a limited version of the work (including the right to prevent others from doing so). Beyond that, a purchaser's rights in relation to the actual work will be governed by the terms of the transaction as set out in the terms of service of the NFT marketplace platform and in the smart contract. The terms of the agreement will determine, for example, what uses the NFT owner will have in relation to the work, including how they might display or present it. Consumers who purchase an NFT commonly obtain a licence to do certain acts comprised in the copyright attached to the artwork, such as a limited licence to use, copy and display the artwork associated with the NFT for personal, non-commercial use.

Unless stated otherwise, copyright in the artwork itself will remain with the creator (or 'author') of the artwork. This is reflective of the position when you buy a physical piece of art or a limited edition. As such, despite owning an NFT and having this proprietorship reflected on the blockchain, NFT owners do not have the right to prevent others from downloading, copying, sharing or printing copies of the artwork from the internet for themselves. These rights remain with the copyright holder, usually the creator.

Whilst most NFTs are in relation to 'limited editions' there is no reason why an artist couldn't provide a purchaser with a 'single edition' by granting an exclusive licence in relation to an artwork. While the artist would still retain copyright in the work, an exclusive licence bestows on the licensee the right to exercise the copyright to the exclusion of all others (as well as additional rights, such as the right to bring an action for copyright infringement against any other person allegedly infringing copyright in the artwork). So, whilst the artist is still the owner of copyright, the exclusive licensee enjoys rights which are very similar to those of an owner.

Paradoxically, a misunderstanding of what rights an NFT owner actually has could result in an NFT owner unknowingly infringing the creator's copyright. For example, if an NFT owner posted the digital artwork onto Instagram or made the artwork their Facebook profile picture, this may, depending on the terms of the transaction between NFT owner and artist, amount to an infringement of the artist's copyright.

There is also the issue of incorporating third party copyright in a work then selling it via an NFT. In fact, numerous artists have already reported that other 'digital artists' have sold NFTs of digital artworks that incorporate their copyright protected work without permission. DC Comics, for example, recently sent a warning letter to its freelancers after one of its artists made $1.85 million by selling NFTs linked to artworks featuring DC's comic characters (the copyright in such characters belonged to DC, not the freelancer). Whether there has actually been an infringement, however, will depend on whether the rogue NFT seller has also reproduced or communicated the digital work to the public. He or she may have just provided a link to the artwork, rather than uploaded it, in which case there may not be any actual infringement (although, depending on the circumstances, the NFT seller may be liable for authorising copyright infringement.

Moral Rights

Moral rights are created automatically in Australia under the Copyright Act, are personal to the author (artist) and cannot be transferred. In the same way as they apply in relation to a physical artwork, moral rights place an obligation on anyone dealing with the artwork to ensure that (a) the artist is credited (b) the artist is not falsely credited, and (c) the artwork is not treated in a derogatory way. In an NFT context, the obligation not to treat the artwork in a derogatory way might involve, for example, not using the artwork in association with unsavoury advertising. Like any agreement in relation to an artwork, an artist's moral rights can either be retained (which prevents the user treating the artwork in a way that will infringe the artist's moral rights), or the artist can consent to infringement of its moral rights. A purchaser of a digital artwork via NFT should be aware of how the artist's moral rights have been dealt with under the terms of the transaction and ensure that the artwork is used in a way that does not infringe the artist's moral rights.

Other legal issues

Like any other consumer contracts, assuming the transaction occurs in Australia, contract law and consumer law are also likely to apply. In Australia, if the buyer of a digital artwork via an NFT considers that the scope of what they were acquiring has been misrepresented or if it appears, for example, that the creator has sold additional copies of the work despite the contract requiring the work to be a limited edition NFT, the usual rights and remedies under contract and consumer law are likely to apply. Similarly, as is the case with any other consumer contract, NFT purchasers should be given reasonable notice of the terms and conditions prior to purchase, in order for those terms to be later relied upon by the NFT creator.

NFT trading marketplace platforms

Most NFT platforms require buyers to have a digital wallet and use cryptocurrencies to pay for their purchases.

NFT marketplaces such as OpenSea contain very broad licence terms in their terms of service. Whilst artists retain copyright to any content they submit to the platform, they grant the platform 'a world-wide, non-exclusive, royalty-free licence (with the right to sublicence) to use, copy, reproduce, process, adapt, modify, publish, transmit, display and distribute' the content via any media distribution method.

Similarly, other platforms such as NBA Top Shot, a platform on which NFTs linked to videos of NBA highlights are traded, grant the purchaser a limited licence to use, copy and display the work for the buyer's own personal, non-commercial use.

NFT creators and purchasers should carefully review the scope of the licences within the terms of service of the NFT marketplace platform and smart contract before proceeding with a purchase or sale.

So why are people buying NFTs?

Amongst other things, consumers are interested in NFTs because, when you buy an NFT artwork, you are essentially buying the implicit knowledge that you are closer to the artist, the work and his or her peers. NFTs also acquire value by virtue of the fact that the chain of ownership is stored in the token.

For example, you may be able to purchase a GIF which, for a certain period, was in Lady Gaga's digital collection.

Whilst to some it may seem inherently artificial, NFTs create a sense of scarcity in relation to digital artworks in the same way that scarcity may exist in relation to physical artworks. In the physical world, for example, there is only one true original of the Mona Lisa painted with oil on canvas, yet there are countless physical and digital copies available which possess little or no value. The original and a copy, whilst they exist in different formats, are fundamentally the same image. However, society has imposed qualities on the original creation by the artist that give it value. Arguably, the same applies to NFTs. The only difference is that the original artwork is usually created digitally (rather than with oil on canvas). Hence, the original digital work and any digital copies are identical in every way, including format.

For some, this may be a difficult concept to reconcile, perhaps because we are simply not accustomed to the idea of attributing 'value' to something which has been created digitally. Digital works are inherently ephemeral and until now have seldom been monetized effectively. While NFTs do not actually create a new form of intellectual property, arguably they are creating a new market for intellectual property which has always existed but was not yet 'realised'.

Moving forward, there may be more tangible benefits associated with ownership of digital assets via NFTs. The rock band, Kings of Leon, for example, have announced that their new album will be released via two different types of NFT. The first will allow owners of the NFT access to a digital download of the music, a limited edition vinyl record and exclusive audio-visual artwork. The second, of which just six will be sold at auction, effectively amounts to a lifetime ticket to the band's shows. This use of NFTs would mark a return to the concept of value in owning music. Much like rare vinyl albums, music via an NFT essentially amounts to a collectible limited edition item. There is even a digital race horse platform called that allows the digital breeding and racing of digital horses via NFT.

Evolution of NFTs going forward

By default, the owner of an NFT will not own the copyright in the work. Like a physical artwork, unless specifically assigned to the purchaser, the copyright will remain with the artist. The owner of the NFT simply obtains exclusive ‘bragging’ rights in relation to a limited edition of the work and a licence to use the artwork in certain settings and in certain ways. Much like rare physical artworks, however, owning an original or limited edition digital artwork via an NFT is as valuable as the market makes it.

As the use of NFTs evolves and is utilized for more diverse, and as yet unforeseeable, purposes, novel legal issues will continue to arise and, with them, continue to test the applicability of existing laws.