There has been a meteoric rise in the popularity of Non-Fungible-Tokens (‘NFTs’) in the past 18 months, with sales increasing from US$100m in 2020 to US$22b in 2021. Understanding the relationship between NFTs – digital property – and intellectual property (‘IP’) is critical to successfully investing in NFTs either as a creator, a purchaser or a platform operator.

In this article we explain the relationship between NFTs and IP, and explore some of the opportunities and risks in the NFT space from an IP commercialisation perspective. This is the first article in a series on IP commercialisation in the virtual world.

What are NFTs and how do they relate to IP?

NFTs are a type of digital property involving a unique assignment of a specific number and further data (such as a link to a digital artwork) to an owner on the blockchain. NFTs are dealt with like cryptocurrency, via a cryptowallet, although as NFTs have gone mainstream, platforms are increasingly offering more user-friendly interfaces that enable consumers not familiar with this technology to buy and sell transfer NFTs. The metadata representing an NFT is essentially a cryptographic key which is stored on a blockchain, enabling sales and transactions of the NFT to be permanently recorded on the blockchain via the smart contract underlying the NFT.

While bitcoin and other cryptocurrencies are “fungible” tokens – like cash (i.e. one token is much the same as another token of equivalent value), the defining quality of NFTs are that they are “non-fungible” and therefore unique. This gives rise to critical features of permanent and independently verifiable ownership and provenance. Their value typically depends on their relative scarcity. It is argued that this key difference between NFTs and cryptocurrencies is why NFTs continued to track positively during the recent crypto crash. NFTs can in theory be linked to or used to represent anything from copyright works to digital items in games or the metaverse, to rights or items in the real world such as event access or entitlement to receive products.

Although many NFTs are linked to (or used to represent) copyright works, a substantial proportion of NFTs on the market do not give the owner any rights in the associated copyright work – an area ripe for misleading and deceptive conduct claims. Anyone can mint anything as an NFT – for example, in the case of “unofficial” NFTs, the sellers do not even purport to have any copyright. In the case of legitimate NFTs, the power of NFTs to provide authentication of provenance is not always utilised because of the anonymous nature of the blockchain.

An NFT will not assign copyright in a work to the purchaser of the NFT. Even if it does purport to do so, the underlying smart contract may not comply with the writing requirements for an assignment under copyright legislation in relevant territories (in Australia, see Copyright Act 1968 (Cth), s196). Instead, best practice is for the NFT to embed IP licence terms specifying the use rights that the purchaser will obtain to the associated work.

Relevance of smart contracts

A key aspect of NFTs is that they are created or “minted” using a smart contract (typically on the Ethereum blockchain using standard ERC-721). This smart contract embeds into the blockchain automated and, importantly, self-executing instructions relating to the NFT, enabling transfers to occur automatically and without the need for an intermediary. Although smart contracts are computer programs rather than legal contracts, in countries like Australia that do not require general contracts to be in writing, the smart contracts associated with NFTs operate like legal contracts for purposes of simple transfers of NFTs.

A typical feature of smart contracts underlying NFTs is that the original owner is entitled to a percentage of each subsequent sale of the NFT, akin to a resale royalty for visual art. This is an important reason for the boom in NFTs that makes the most of the nature of smart contracts, which are limited to what can be coded and are therefore typically binary in nature (e.g. if X then Y).

Diverse industry application

The huge sums of money involved mean that NFTs are attracting everyone from Sotheby’s to digital artists to investment firms.

Trading off the stratospheric rise in cryptocurrency valuations, NFTs are the hot new part of the art market – when Christie’s sold a mosaic of Beeple’s pieces for more than US$69 million in 2021, it was the third most expensive work ever sold by a living artist (behind only Jeff Koons and David Hockney). In a move that may overshadow all of these transactions, Mariana and Florian Picasso (granddaughter and great-grandson of Pablo Picasso) have announced the release of 1,010 NFTs of a Picasso hand-painted ceramic work. They claim that in doing this, they are “trying to build a bridge between the NFT world and the fine art world.” Specialised online marketplaces such as Rarible, Nifty Gateway and OpenSea, which allow rights holders to offer and purchasers to buy and trade digital collectables in the form of NFTs, are turning over millions if not billions of dollars in transactions per month.

NFTs have quickly expanded into the broader creative and entertainment industries: NBA TopShot allows fans to collect and trade officially licensed NBA digital collectables and recording artists like Kings of Leon are releasing albums as NFTs which allow fans to unlock other unique offerings such as “golden tickets” to concerts. Even major studios and content owners such as Disney and Warner Bros have signed deals with NFT platforms and are offering NFTs of their core assets as a new way to monetise this IP and expand fan engagement with famous franchises.

The luxury sector was also one of the first to embrace NFTs. Brands including Balenciaga, Louis Vuitton, Gucci and Givenchy have sold NFTs ranging from branded digital art, games and game characters to virtual fashion items. In the world of beauty, Clinique offered NFTs as competition prizes in 2021 – one of a kind items that combined branded digital artwork and an entitlement for owners to receive free product for 10 years. In this context, it is hardly surprising that retail has been next to embrace NFTs: Selfridge’s in London has announced that it will be offering NFTs in store in the first quarter of 2022.

Brands and individuals have continued to find new and exciting ways to utilise NFTs, with varying levels of commercial success. Undoubtedly, new uses will continue to emerge. This presents many new opportunities for businesses if they are willing to be creative and commit to understanding the space.

Rights allocation – need to revisit existing agreements

In the world of NFTs, an artist or creator may appear to the NFT market as the appropriate person to offer NFTs relating to their work – but often will not in practice be the owner of those rights or have the ability to license them based on standard contractual arrangements with their record label or film studio. Even for those familiar with typical allocations of rights in the entertainment industries, there may be room for debate about this in certain cases as historical contracts may not clearly allocate relevant rights to one party or another.

This conflict and uncertainty has already given rise to litigation: Miramax recently brought claims of breach of contract, copyright and trade mark infringement against Quentin Tarentino following his sale of NFTs based on scanned images of his original handwritten script for the Pulp Fiction film. In that case, there appears to be a genuine dispute about the meaning of the underlying contractual arrangements relating to the film (which included certain reservations of rights in favour of Tarantino) and where the right to offer these new NFT assets actually sits.

This dispute highlights the need for the content industries, as well as major brands, to update their standard contractual arrangements and carefully consider the terms of more bespoke rights-generating arrangements to ensure that they always clearly deal with (potentially very valuable) rights associated with NFTs.

Tips for adding value and avoiding disputes

As NFTs enter the mainstream and begin to attract substantial corporate investment, NFT creators and platforms can add value and avoid disputes by:

  • ensuring that the NFT creator does own the copyright (or the relevant portion of copyright) in the work being minted;
  • providing a special high resolution or similar file that is uniquely accessible to the NFT owner, and securing that file to minimise the risk of unauthorised digital copies becoming generally available;
  • associating a copyright licence with the NFT specifying the rights that the purchaser will obtain to the associated work. Assuming the licence is non-exclusive, this can be done by embedding a text file with the licence wording in the NFT, or as part of the terms and conditions of the NFT trading platform being used;
  • effectively deploying authenticity badging to make clear to users when an article is a genuine product, capitalising on the ability of NFTs to verify authenticity and track ownership and provenance. Although the considerations of authentic product “quality” relevant to the physical world don’t apply in same way in the virtual world, there is still a perceived value in having the “original” product;
  • considering fractional ownership of NFTs as part of the commercialisation model (e.g. the potential for dividing rights to receive royalties from a song into multiple NFTs). Fractional ownership allows new possibilities for commercialisation, including crowd-funding music and other creative works;
  • revisiting their existing IP agreements and templates, to determine if and how they apply to NFTs (see further above); and
  • ensuring proposed new deal structures properly take into account the nuances of copyright law (as noted above, formalities for assigning copyright mean that the artist probably retains the copyright and is granting only a contractual right to royalties).

Appreciating the dynamics of the digital landscape

Finally, an effective IP enforcement strategy is key to maximising value in IP commercialisation. Rights holders embarking on enforcement activity should be aware of the dynamics of this digital space, where the backlash against IP rights enforcement can be more severe than elsewhere.

The response from artist Mason Rothschild (creator of the “MetaBirkin”) to Hermès sending him a cease and desist letter and instituting infringement proceedings in New York (including an open letter around his First Amendment rights) illustrates how sensitive this area can be. One of the particular complaints by the artist has been that Hermès and its lawyers do not understand NFT technology and markets – highlighting the importance of lawyers being able to demonstrate familiarity with this area when formulating letters of demand and pleadings.

As with other areas of online infringement, a well thought out public relations strategy and an appreciation of the technology is critical. The latter is key to correctly formulating allegations of infringement, especially for copyright where, in the context of NFTs, identifying a copying or communication of the copyright work in the NFT itself is not always straightforward.