The past year has seen a surge of investor and public interest in non-fungible tokens ("NFTs"), a blockchain-based unique digital record of ownership that may become one of the building blocks of “web3”—the next iteration of the digital revolution, and one that is attracting billions of dollars in investment capital.
Although NFTs have been around for some time, their popularity has recently exploded, garnering significant attention and capital, with monthly transaction volume on the popular NFT marketplace OpenSea exceeding $5 billion in January 2022 alone. This rise of NFTs raises complex intellectual property issues for those who are issuing, buying, and selling them.
What Is An NFT? A Primer on Blockchain Technology
A blockchain is a digital record of transactions that is cryptographically secured and verified by a decentralized community. Blockchains are used to record transactions in digital assets, including tokens like bitcoin and ether that are individual digital units of value that can be transferred on the blockchain. One important characteristic of tokens like bitcoin and ether is that they are fungible – any one bitcoin is the same as any other, just like any dollar is the same as any other.
The premise of a non-fungible token, by contrast, is that it is a digital asset that is unique in some way. The NFT derives its value, at least in part, from those unique characteristics, just as a work of art or a piece of real estate does.
Contrary to popular conception, NFTs are not just digital copies of creative works. Rather, most NFTs contain only a link pointing from the token to something that exists elsewhere – whether an image, a video, or a text file. Often, that underlying work is cryptographically hashed (i.e., turned into an alphanumeric string that uniquely identifies the data) and included within the NFT.
The provenance of the NFT is a key part of its value: Anyone can theoretically create an NFT linking to an image or file. The permanent record of ownership on the blockchain serves to authenticate the history of each NFT.
Uses of NFTs
NFTs sprang into the public consciousness through the emergence of a market for NFTs for images, with millions of dollars changing hands for NFTs that can be used as profile pictures or digital avatars. But the potential use cases for NFTs are much broader. At the most basic level, an NFT is a unique digital record. Many forms of unique records underpin modern commerce – from event tickets to property deeds to identity documents. For example, Debevoise is representing StockX against trademark claims brought by Nike that seek to bar StockX’s innovative use of NFT technology to create “Vault NFTs” that act as proof of ownership of physical sneakers held in StockX’s physical vault. Additionally, the Kings of Leon music group released NFTs entitling holders to tickets to their concerts, merchandise, and benefits like the opportunity to meet the band.
As creators look to build the next generation of technology platforms—“web3,” which is intended to represent an evolution from the current, social-media-dominated “web 2.0” —NFTs are expected to play a significant role as digital records of ownership.
Intellectual Property Rights and NFTs
But what, exactly, does the holder of an NFT actually own? Just because an NFT exists in a digital space doesn’t mean it can escape the real-world tangle of intellectual property rights that go along with transactions involving trademarks or copyrighted work.
In a standard NFT transaction, the clearest thing the holder owns is the NFT itself, a unique token on a particular blockchain. Other rights – like the copyright to the work to which the NFT is linked, for example – may not necessarily be transferred by the NFT itself. In many NFT transactions, a separate contract or purchase agreement is used to convey rights alongside the NFT.
Creators and buyers of NFTs should therefore keep a few things in mind:
- Choose Wisely. NFT creators have a lot of choices to make – from what blockchain to use to mint their NFTs, to what bundle of rights the NFT will convey. Some NFTs may be a digital certificate of ownership; others may be part of a larger ecosystem. Different blockchains’ standards for NFTs, as well as their ability to handle smart contracts or other uses for NFTs, pose important choices for creators to consider. And, with stakeholders’ increasing focus on ESG issues, choosing a blockchain may also require thinking through the energy use and environmental impacts of NFT transactions.
- Understand the Entire Transaction. Most NFTs are not self-contained, and so seeing the whole picture is key. NFTs might be minted on one blockchain but point to a file hosted on a separate blockchain. The provenance of the NFT might be a key part of what makes it valuable. The purchasers’ rights might be governed by a contract that is not recorded in the NFT itself. Doing sufficient diligence on all of these aspects of an NFT is of utmost importance.
- Know Your Rights. Both buyers and sellers of NFTs should take care to understand what rights are conveyed with the NFT. Some NFTs have no associated display rights; others are intended to transfer title to an underlying work; others do not permit the NFT holder to resell or transfer their NFTs. Some NFT marketplace platforms also have specific terms governing transactions they facilitate.
Defending Your Intellectual Property Against Infringing NFTs
The ease with which NFTs can be created and sold has led to a booming marketplace. Because of this, even brands that do not currently have plans to enter the web3 space or mint their own NFTs should be aware of potential threats they might face from NFT creators.
- Copyright Infringement. NFTs that link to a digital work may represent an unauthorized reproduction of the underlying work, or infringe on copyright holders’ control over derivative rights. Especially for copyright holders in non-digital works, the creation of a digital copy of their art and an accompanying NFT may represent a transformation of the original work in a manner that is part of the creator’s copyright. That said, courts may still uphold a fair use defense by an NFT creator.
- Trademark Infringement. Many brand owners are already taking steps to register their trademarks for digital works like NFTs. Even without a specific registration for digital goods, however, unauthorized NFTs featuring trademarks may still be infringing. However, just like with copyright, defenses to trademark infringement will likely apply in the digital realm.
- NFTs and the First Amendment. Digital works that are sold via NFTs can be expressive works protected by the First Amendment. In a closely watched case in the Southern District of New York that will offer the court a chance to opine on that question, Hermès recently defeated a motion to dismiss its suit against the creator of “MetaBirkin” NFTs, which contain images designed to look like the famous Hermès Birkin bag, but in brightly colored and furry form, despite the artist’s First Amendment defense that the MetaBirkins were artistic works.
One other aspect of web3 that intellectual property owners should be aware of is the Ethereum Name Service ("ENS"). ENS functions for the Ethereum blockchain like the Domain Name Service ("DNS") functions for the Internet – it allows you to own a short text address – like brand.eth – instead of an ordinary wallet address, which are long alphanumeric strings.
Because governance of the ENS is currently not as sophisticated as the domain name dispute mechanisms that help police DNS, brand owners should consider defensively registering ENS addresses that contain their brands to minimize risks of fraud and abuse – or the possibility that the ‘brand.eth’ address will be permanently destroyed on the blockchain by a third party.
A final issue to consider is how blockchains limit the remedies that can be sought against infringers. Destroying an NFT is simply not possible due to the permanency of blockchain transactions. At best, an NFT can be “burned,” by transferring it to an inaccessible wallet so it can no longer be bought or sold.