“I’m selling this song about NFTs as an NFT… Actually, doesn’t feel quite right selling this. Will pass...”

- Elon Musk circa 17 March 2021

Re-Cap | What are NFTs in Hong Kong?

Non-Fungible Tokens (the full name of NFT), are unique digital certificates stored on the Blockchain and are designed as a digital medium to certify a defined set of ownership rights in an asset (which is usually in digital form (e.g. digital art).

NFTs is unique in that it is able to provide a powerful tool to establish and demonstrate ownership rights especially in view of how quickly digital works can be duplicated and redistributed in the age of the internet.

NFTs are “non-fungible’ in the sense that each NFT is unique and hence, of different value which is a contrast to ‘fungible’ assets like the US Dollar or Bitcoin, which are identical and interchangeable with one another.

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Birth of a NFT | The Minting Process

The ‘Minting’ of an Non-Fungible Token refers to the creation of an NFT and its documentation on a blockchain. Minters may be the creator of the work associated with the NFT, such as the artist, or someone with the appropriate rights to mint an NFT of a digital asset.

There are a number of different third-party platforms, not affiliated with Christie’s, that provide services that help creators and rights holders mint NFTs. Some of these platforms also serve as marketplaces for buyers and sellers of NFTs.

Usually, NFTs are generated using a ‘smart contract’ which is essentially a computer code that is stored on the blockchain. A NFT will include a number of different fields including

  1. the NFT’s unique identifier (AKA ‘TokenID’) (“ID”);
  2. the wallet address of the current owner of the NFT (“Ownership”); and
  3. an identifier of where the digital work of art attached to the NFT can be found (“Location”).

Since blockchain transactions are fully transparent, anyone can view an NFT and its underlying information, including the blockchain address of the current owner and the blockchain address of each owner since the creation, or ‘minting’ of the NFT.

When an individual purchase an NFT, they will need to have a digital wallet to (i) receive, (ii) access and (iii) transfer the NFT in question. An NFT can as a result be bought and sold like any other pieces of traditional property (no different than baseball cards). Such sales and purchase are effectuated via NFT transfers through the blockchain from the seller to the purchaser.

Benefits of NFT (A non-exhaustive list)

One of the biggest attraction of NFT is the concept of uniqueness. Since NFTs are non-fungible asset stored on the blockchain, the owner of the artwork (via NFT) knows that they alone hold that specific NFT.

Note: In some cases, an artist or rights holder may decide to have a smart contract generate a limited number of NFTs for the same work, similar to the manner in which an artist might release a limited edition of a physical work, though such an act may be construed as fractionalization, which may have legal/regulatory implications depending on the jurisdiction.

That said, buyers of NFT can see the number of tokens affiliated with a specific artwork and can purchase such tokens as part of a limited collector’s edition.

Once an NFT is minted on the blockchain, the NFT in question will be a unique virtual asset where anyone with access to the internet can view and access to confirm the following properties:

  1. metadata;
  2. history of ownership (note that Chinese paintings increase in value via noteworthy owners);
  3. TokenID (the unique identifier of each NFT);
  4. blockchain address; and
  5. any other underlying information.

On top of that, since all transactions taking place on the blockchain are publicly viewable so long as there exists the internet, buyers can see the address from which the NFT was first minted. The added history of ownership may theoretically add value to such artwork overtime without traditional concern for fraud.

As emphasized above, history adds value. Similar collection of traditional Chinese paintings in which preceding owners will put their unique ownership stamp at the back of the painting, every transfer or purchase of NFT is recorded on the blockchain (which is so much more immutable). Further details such as other blockchain address of every digital wallet which has held the NFT will also be held. As such, the ownership history of the artwork can be tracked. Provenance in turn will become automated, accurate and verifiable, unlike traditional artwork.

What Does ‘Minting’ a NFT Really Mean?

The Minting of an NFT is the term used to describe the creation of an NFT, a process of which includes documentation of the NFT’s birth on the blockchain. The mint of the NFT may be the creator of the artwork associated with the NFT (e.g. the artist) or someone with the appropriate rights that will enable that person to mint an NFT into a digital asset.

There are a number of different third-party platforms that provides services which will help creators create the rights associated with NFT (essentially selling the service of crafting a smart contract (as opposed to lawyers creating a deed of ownership)). Many such platforms will also serve as a market place for NFTs.

Who Provides Certificate of Authenticity for NFTs?

As NFTs are stored and recorded on the blockchain, the NFT itself is the certificate of authenticity with the birth of the NFT documented on the blockchain.

Where are Non-Fungible Tokens Stored At?

As mentioned, each NFT is recorded on the blockchain and is usually on the chain on which the NFT was first minted. It should be noted that each blockchain is unique and may not be interoperable with one another (hence not transferrable to different blockchains).

Where are the Digital Artwork Usually Stored At?

It is crucial to note that digital artwork associated with an NFT is not generally stored on the blockchain itself (no more so will you find a house stored within your property’s title-deeds). NFT is essentially digital versions of title deeds in real life (with rights the same as what you can expect in a Deed of Mutual Covenants of sorts).

Such works are considered to be “off-chain” (note that off chain transactions refer to those transactions occurring on a cryptocurrency network that move the value outside of the blockchain). Users may find that their digital artwork stored on interplanetary file system, a decentralised file storage network.

How Can One Purchase an NFT? Can You Purchase with Fiat Money?

Depending on the platform/marketplace a collector wishes to purchase an NFT, most platforms will accept payments in fiat currency as well as cryptocurrency, though there is no stringent requirement in this respect. Any person with internet access and the requisite consideration may become a collector.

Common Glossary Related to NFTs

All in all, what is certain is that digital art is here to stay. The different manner in which various jurisdictions have been reacting to NFTs shows the various lines of regulation that may ultimately be put in place to grapple with this newfound trend (be it securities regulation or tax regulation). It therefore remains to be seen how Hong Kong will tackle this new asset class which is set to dominate the markets.

Conclusion

All in all, what is certain is that digital art is here to stay. The different manner in which various jurisdictions have been reacting to NFTs shows the various lines of regulation that may ultimately be put in place to grapple with this newfound trend (be it securities regulation or tax regulation). It therefore remains to be seen how Hong Kong will tackle this new asset class which is set to dominate the markets

This article was first published in the November 2021 issue of the Hong Kong Lawyer, the official journal of The Law Society of Hong Kong.

This article is co-authored by James Park of BX Venture