The recent report that Sotheby’s has had over $100 million in Non-Fungible Token (NFT) sales year to date is raising questions among Creators and Collectors about what are NFTs, what role NFTs play, and will play, in the Art Market, and whether Creators and Collectors should jump onboard the NFT bandwagon. Those who create and collect art can try to ignore the impact of NFTs but they can’t ignore how NFTs fit into the current Intellectual Property (IP) rights.
Others are interested in NFTs not just for investment but as a means of promoting their brand in markets far away from the Art Market. A recent example of this is Zachary Tinkle , a young NASCAR ARCA driver who weathered a grave family illness and COVID in 2021,and is now exploring using NFTs to fund and promote his 2022 season.
There are both great risks and opportunities in the NFT market today. In order to take advantage of the market, it is necessary to understand what NFTs are --and are not-- the role IP plays, as well as understanding the role of IPs to market brands.
What is an NFT?
A Non-Fungible Token, or NFT is a digital collectible that is a unique, non-reproducible, digital code representing a digital file. It is analogous to a paid invoice for a painting – it is not the painting: it does not guarantee the authenticity of the painting, it does not convey the ownership of the painting, but it does describe a transaction and points the way towards finding out about the ownership of the real asset it refers to.
NFTs are created when a digital file is uploaded to a third party NFT platform or distribution network. Since the digital file is too large to easily be handled on such platforms, an NFT, or Hash, is created as a marker to stand in for the digital file. The Hash points the way to the URL where the digital file is located. This Hash – a digital ID in essence, is what is unique about each NFT. When an NFT is transacted, the Hash is what people buy and sell. It’s also where the transaction is recorded. This process of identification of the URL of data is called the “Smart Contract.” The process of creating this digital ID, or NFT, is called Minting. In essence, the original owner of the digital file mints a new NFT when uploading a digital file onto an NFT platform.
Once minted, neither the NFT nor the digital file that it points to can be altered, hence the name “non-fungible.” If there is a change, the digital ID will reflect that change. When sold, the buyer of an NFT acquires the ability to execute the Smart Contract that points to the URL of the digital file. The buyer does not, however, acquire any ownership rights to the underlying asset (digital or otherwise) and may not even get the right to display, reproduce or use the digital file unless that is explicitly stated in the Smart Contract. Additionally, the buyer may, if the NFT is sold at a later date, owe a percentage of the transaction price to the Creator. The NFT is no guarantee of the authenticity of the digital file or the underlying asset: it only can tell you the provenance of that specific digital file to which it points.
NFTs and Intellectual Property Rights
Intellectual Property (IP) are those rights that the Creator has over the “creations of their mind.” IP rights are created when the work is created, there is no need to register or trademark the work. These rights include the exclusive right to own, display, use and reproduce the work. Those rights can be transferred from the Creator to others by legal contracts, either before or after the creation of the work. So, someone creating a design for their employer is a Creator; but, if the terms of employment require, the Creator may have ceded their IP rights to the employer.
IP rights, and especially copyrights, are hard to enforce for digital assets. Digital assets are simple to reproduce, easy to display and difficult to identify which is the original work. The result is that the Creator often rapidly loses control over the rights to the digital file once it enters the digital marketplace.
The benefit of an NFT is that the Smart Contract can be structured so that the Creator retains control over the use, display, resale and reproduction of this specific version of the digital file. Additionally, the Creator can add resale rights, so that a percentage of each “downstream” transaction accrues to the Creator. For the Creator, the NFT goes some way towards mitigating some of the risks of digital assets in today’s marketplace.
For buyers, there remains the need for due diligence when purchasing NFTs. Just because there is an NFT, there is no guarantee that the “Creator” has any rights to either the digital file or the underlying asset. For example, an NFT of a forgery is a valid NFT of fraudulent work. The third party hosting platforms have procedures to remove fraudulent NFTs; and, in the Terms of Service, these procedures and rights of Creators are spelled out. This means that it is important to actually read the Terms of Service before buying an NFT.
The Terms of Service will also describe how the purchase of an NFT actually effects the IP rights of the Creators, as just buying an NFT does not convey any rights to display, use or reproduce the digital file unless it is specifically described as doing so. Before purchasing an NFT, make sure you understand:
- What are your rights to use, display and reproduce the digital file?
- What is the Seller’s representation of ownership of rights over the digital file?
- How volatile is the NFT, and what happens if the underlying asset is no longer available?
- What are the dispute resolution procedures?
- What are the terms of any indemnification?
- What does the buyer and the third party platform disclaim?
Using NFTs for Marketing a Brand
NFTs have made money not only for Creators and Collectors by the sale and resale rights in these digital markers and digital files, but they have also made money for businesses that use NFTs to market their brands. For some companies, like Campbell’s, Taco Bell and others, NFTs are used to promote the roll out of new products. Others have used NFTs that are linked to not only a digital file but also linked to assets in the real world. For instance, offering an exclusive array of products, early access to services, and even the right to vote on some matters such as naming or color schemes of products.
This use of NFTs has little to do with digital assets and everything to do with marketing - creating an emotional link between the product or service and the customer that owns the NFT. Not only can the NFT be scarce enough to have intrinsic value to the Collector and the Creator, but it gives the Creator the opportunity to retell their story over and over again.
For Zachary Tinkle, who has thousands of fans already, his NFTs will be less about making money as it is promoting his brand for this upcoming season and to finance the required $250,000 needed before the season starts. Selling naming rights for decals on his car may be one way to achieve this. Selling NFTs that give fans the right to enter a lottery for the prime location is even better. It is a way to allow fans to invest in his brand directly, something that Go Fund Me cannot.
It is possible, indeed likely, that NFTs will fade and become worth little or nothing as a digital asset. It is possible that Zachary’s marketing of his Brand for the 2022 racing season will miss his mark. It is, however, certain that the NFT’s that he, and other Creators and even Collectors mint, will endure and will be a necessary part of client’s estate planning. Someday, we can look forward to the time when someone strikes it rich by finding the Key to a Wallet with Zachary’s NFTs in among the papers of a deceased relative.
Matthew Erskine is Managing Partner at Erskine & Erskine.