Untangling NFTs and intellectual property rights

Technology & Digital
Intertwined rope pattern.

The rapid growth of blockchain is outpacing the law and it is becoming increasingly clear that more robust "off-chain" structures are needed to govern the "on-chain" environment.

This is particularly evident in issues surrounding intellectual property (IP) and ownership of non-fungible tokens (NFTs). In a previous article I explained how creator economy NFTs attempt to solve the IP issues experienced by creators in the "real" world ─ songwriters who do not own the copyright to their music; counterfeiting of designer clothes and jewellery; fake online profiles and other forms of "copying". Creative NFTs seek to solve these problems not only by removing intermediaries but by recording ownership and change of ownership details. An NFT provides a source of truth, often referred to as a "truth machine".

But does it work, and is it truthful? A common misconception held by consumers of digital collectibles is that "on-chain" ownership of an NFT is equivalent to off-chain ownership of the underlying creative work ─ which, as outlined in an example below, is not the case.

The NFT landscape

When someone creates or "mints" an NFT, they execute code stored in smart contracts on the blockchain. This involves:

  • creating a new block
  • validating information
  • recording information into the blockchain

Through this process, NFTs are just a few lines of encrypted metadata, which may include a hyperlink to an underlying image that is typically stored on a website.

There is a misconception that because NFTs are considered a certificate of ownership on blockchains, that this "on-chain ownership" confers "off-chain ownership" of the digital asset.

Some consumers believe that when buying an NFT, they are acquiring the digital art with all its associated rights. In reality, they are buying the "token" ─ i.e. the few lines of metadata stored on the blockchain that contain a hyperlink to the digital work.

Purchasers of NFTs typically acquire neither a physical object nor the IP to a digital one. In this sense, owning an NFT is to own a symbol of something, not the substance of it. While we are seeing emerging NFT use cases that combine physical and digital assets (such as "twinning", where a digital collectible and its physical version are sold together, which is common in the fashion industry), the creative NFT itself nonetheless remains primarily a transaction record.

Ownership and the NFT marketplace

The mechanics of the NFT marketplace are worth considering in more detail to further test the notion of ownership. If creators wish to "list" their NFT for sale, they must first "mint" or "offer" the NFT to the marketplace ─ much like companies wishing to IPO, who must first list their shares on the Australian Stock Exchange (ASX). Collectors wishing to trade their NFTs can easily do so on marketplaces, similarly to the way investors trade stock on the ASX.

As part of any contractual agreement, terms and conditions of some kind exist. However, in the developing market of NFTs, there is often a lack of clear or express terms and conditions. Where there are terms, there may be no certainty as to where they are located. Without a clear statement of what is being agreed and by whom, there may be no enforceable contract at all.

This lack of contractual clarity, as well as the conflation of "ownership" on-chain with off-chain ownership is starting to cause cracks in the NFT marketplace and commercial transactions more generally. Misunderstanding of what is being bought or sold can lead to considerable issues and volatility for those creating, buying or selling both digital and physical assets. Some recent examples of this misunderstanding include the following.

1. The Dune disaster

After auction house Christie's listed a rare book linked to the sci fi classic Dune, an anonymous NFT group of investors, called Spice DAO, decided to purchase this iconic artefact for a colossal 2.6 million euros.

The DAO publicly announced via Twitter their plans to "make the book public, produce an original animated limited series inspired by the book and sell it to a streaming service, and support derivative projects from the community".

What the DAO failed to grasp was that their purchase did not transfer any intellectual property rights to the literary work that would entitle them to exploit the copyright in the book, let alone create, and generate profit from, derivative projects or "works". They had simply purchased a physical copy of a book, albeit rare.

2. Monitoring breaches of IP

In our culture of meme-sharing, screenshotting, tweeting, re-posting and re-tweeting, it has become commonplace to copy, modify and adapt other people's original photos, artworks, literary works, recorded music and trade marks. The parabolic creation of NFTs gives rise to an important and potentially lucrative question ─ what options do IP holders have against IP infringement by NFT?

For example, if a consumer buys an NFT that incorporates a trade mark or design or copyright work owned by a designer brand (such as Gucci or Chanel), what can the owner of the mark do to bring this unauthorised use and potential devaluation of their luxury brand to a halt? One option is for owners to monitor NFT marketplaces and request that infringing NFTs are taken down. The practicality of this, however, is questionable given the sheer volume of available NFTs on various blockchain platforms. There are other options which could result in significant payments to IP owners, in the form of damages or an account of profits. Given the scale of NFT trading, an account of profits could be a very rewarding pursuit.

However, it could be a never-ending cycle of infringement. A bad actor could just re-list the same NFT on another market. The MetaBirkin project, which sells NFTs "drawing inspiration" from Hermes' famous Birkin Bags, has made over US$1.1 million in sales. Following a cease and desist letter from Hermes, the project was taken off one marketplace, but swiftly relisted on another.

Splitchain: A way forward

One way to reconcile "on-chain" decisions and "off-chain" rights is to consider the technological and legal aspects of NFTs using a model I describe as "splitchain". Where there are both "on-chain" and "off-chain" rules operating in parallel in relation to a digital asset, we have a splitchain.

Splitchain can be seen in the NFT creator economy where:

  • the trading of NFTs occurs "on chain" on various blockchain platforms; and
  • the rights and permissions that apply to the NFT are governed "off chain", using contract law and intellectual property rights.

For example, an NFT trading platform might contain the terms and conditions for its transactions so that they are accessed by the purchaser; or a text file containing terms and conditions is embedded within the NFT itself.

An example of splitchain in practice is NBA Top Shot, one of the most successful NFT projects of 2021. Valued at over US$1 billion, NBA Top Shot allows basketball fans to purchase on-chain "moments" of their favourite players and NBA memories, with "owners" able to "showcase" the video moment on Top Shot's "Flow blockchain network" and transfer the moment to others. The terms of use, off chain on the Top Shot website/app, state clearly what intellectual property rights are being licensed in connection with purchase of the NFT, giving rise to an effective legal structure that provides transparency around ownership and commercialisation, helping to protect all stakeholders.

For more on the splitchain concept and how it can help to realise the potential of emerging technologies including NFTs, please see my previous article.

This article is adapted from a keynote delivered by Lisa Fitzgerald at the APAC Blockchain Conference 2022 on 2 March 2022.

Photo by Clint Adair on Unsplash.

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