NFTs are unusual crypto assets, waxing and waning in popularity. In 2021, Twitter CEO Jack Dorsey sold his first tweet as an NFT for $2.9 million. In the same year the artist Beeple auctioned off a piece of digital artwork for $69 million. The steady surge of interest in NFTs, marked by exorbitant purchases such as these, raises confusion for many over the nature of an NFT and the growing demand for this unusual crypto-asset. So, what are NFTs and why have they become such a valuable commodity in the past year?
What is an NFT?
‘NFT’ stands for Non-Fungible Token. An NFT represents a specific digital asset or unit of data that can be bought and sold. Examples of such assets include digital art, videos, photography in-game items or even music. Each NFT has a distinctive digital signature that can be used to verify ownership of the original asset. NFTs are unusual crypto assets given that they do not operate in the same manner as the highly fungible cryptocurrencies we know best.
These ‘tokens’ are not mutually exchangeable. While money and cryptocurrency are ‘fungible’ because they can be exchanged for an identical item of the same value (one Bitcoin can be exchanged for another and there is no change in value) – NFTs are non-fungible, meaning that each is uniquely identifiable and may carry different values.
An NFT is minted from the creator’s item of choice and then stored on a blockchain network. A block-chain captures the transaction on its digital ledger and creates a unique signature for the digital asset which can then be used to authenticate ownership. NFTs are most popularly hosted on the Ethereum blockchain. The process of creating an NFT is straight forward and involves selecting the item to mint, creating an e-wallet, choosing your preferred NFT marketplace and uploading the file.
How are NFTs Used?
The NFT is a useful tool to assign and verify exclusive ownership. No matter how many times a digital file is reproduced, the original copy will be easily identifiable using the token, which acts as a digital certificate of an individual’s ownership. The blockchain ledger behind the token acts as a sort of certificate of authenticity and ownership. As the owner of the NFT, the token holder acquires certain rights of use. These may include the right to exhibit, copy or transfer the item.
Currently, NFTs are most commonly utilized by creators as a safe and simple way to monetize digital artwork. For some, NFTs are purely an investment bought to be resold at a staggering profit. For others, NFTs are a new way to acquire collectables – essentially a symbol of wealth and status.
Why are NFTs so valuable?
The first recognized NFT, titled “Quantum”, was created by digital artist Kevin McCoy, on 3 May 2014. This NFT recently sold for more than $1.4 million in November 2021. This suggests that demand for NFTs have increased since their inception, with their value increasing accordingly.
An NFT’s ability to create an exclusive item that cannot be owned by more than one person, creates a ‘digital scarcity’ which feeds demand. In the same way an art collector will purchases the original painting rather than a knock-off, NFT buyers covet the rarity NFTs create in relation to other digital items.
What are the risks?
While theft is not impossible, the nature of blockchain technology makes it more difficult to steal an NFT than a tangible object. Money laundering, specifically within NFT auction platforms selling high-value artwork, is a potential threat. This is because an NFT transfer occurs quickly online and leaves fewer traces than the transfer a physical object would.
Art scams have also become a common occurrence. Some NFT marketplaces are unregulated and tokens representing plagiarised items can be uploaded as new NFTs and sold without proof of original ownership. Although larger platforms have adopted rules that allow them to delist illegally uploaded NFTs and blacklist accounts, the lack of standard regulations and authorisation checks makes this market easy to abuse.
Arguably, the greatest risk lies in the uncertainty surrounding the level of demand. In 2022 the market is valued at approximately $35 billion. Despite a predicted increase to around $80 billion by 2025, some analysts suggest that NFTs are just the latest trend and will ultimately decrease in value when the public loses interest. Others view NFTs as the future of digital art and as a new technology with developing application. Ultimately, the success of an investment strategy based on NFT resale will depend on the consistency of their value.
Other factors, which may discourage NFT use, include the effect of blockchain technology on the environmental and the risk, however small, of link rot. Blockchain technology utilizes carbon-generated energy resulting in increased carbon emissions. Renewable energy, such as wind or solar, could be used to as an alternative powers solution to limit this impact. Link rot occurs when a hyperlink no longer connects to the file it was originally linked to. The uncommon phenomenon can result in digital files, such as NFTs, being lost or unavailable, leading to wasted fuel and energy consumption.
Legal implications on copyright
It is also important to note that copyright and NFT ownership are different. Owning an NFT is not the same as having inherent intellectual property rights over the digital item represented by the token. An NFT buyer may have a claim of ownership over the authentic digital version of the work, but not the work itself. Furthermore, copyright is not automatically included in this transaction.
Copyright is the legal right held by an original creator of a work, for a specific period, to use the work in various ways. It is an exclusive bundle of rights that empowers the owner to publish, distribute, reproduce, perform, or publicly display a work which could be artistic, musical or literary in nature. By comparison, a standard NFT purchase will provide proof of ownership of a work, the right to use that work for personal display and to sell the NFT itself, but it may or may not permit more than this. The rights attached will depend on the conditions of the sale.
For example, the painter could mint and sell an NFT representing a piece of artwork they created. This authenticated digital version of the painting is owned by the NFT holder, but the original creator may retain their copyright over the work. Through this copyright the original creator could still hold the right to reproduce, sell copies or publicly display the original work. For this reason, many describe the NFT as assigning ‘bragging rights’ rather than tangible ownership.
It is therefore important to be certain what legal rights the NFT licenses before purchase. Buyers should also make sure they understand exactly what rights are attached and from whom they are buying. Whether buying or selling it is also advisable to investigate the marketplace you choose. More reputable platforms are better regulated and thus more likely to protect consumers.
Although NFTs have existed since 2014, it is only in the past two years that the technology has gained traction. NFTs are unusual crypto assets and they have proved to be a lucrative marketplace and will likely bring new opportunities in the future. Proper regulation to safeguard consumer usage will take time to implement and there are risk factors that should be considered. Therefore, it is important to be aware of these risks, especially potential opportunities for scammers, before heavily investing in your own NFT portfolio.
Contact us today for more information on the legal implications of NFT transactions in South Africa.