Whats so nifty about NFTs?
Blockchain expert Lamont Black and Dara Tarkowski discuss non-fungible tokens (NFTs) and their legal and regulatory implications.
- Non-fungible tokens (NFTs) are the hottest thing in the crypto space. The hype reached a fever pitch last month when the artist known as Beeple sold a piece of digital art for $69 million at Christie’s.
- “It’s not by coincidence that a lot of innovation with non-fungible tokens is in the arts,” says Lamont Black, a finance professor at DePaul University who studies blockchain. But NFTs have far-reaching implications beyond the art world.
- U.S. copyright law — and the regulatory landscape — hasn’t caught up with NFT technology. But will the bubble burst before they can?
Massive hype and sky-high speculation aren’t infrequent topics on my podcast, but usually we’re not talking about the contemporary art market.
In March, the artist Mike Winkelmann, a.k.a. Beeple, sold his piece “Everydays: The First 5000 Days” for a headline-making $69 million — the third-highest price ever fetched by a living artist. But it’s not a painting or a sculpture … or anything you can touch. Beeple’s work is purely digital, enabled by a blockchain technology called the non-fungible token (NFT).
Arguably, the NFT art market began in 2017 with CryptoKitties, an Ethereum-based game that used blockchain to “breed” collectible images of cats. To date, the most expensive CryptoKitty sold for a stunning 600 ETH (approximately $1.35 million today). But Beeple’s record-setting sale (brokered by auction house Christie’s, no less) shows NFTs aren’t just a game.
Are NFTs the future of art distribution and collection or a fad fraught with legal complications? How is this tech changing the way we purchase high-value items? And when someone buys an NFT, what the heck do they actually own?
To help properly wrap my lawyer brain around it, I welcomed Lamont Black, associate professor in DePaul University’s Department of Finance and Real Estate, for an episode of Tech on Reg. Lamont teaches a graduate school course on blockchain.
Collect them all!
Fungible is a term for something exchangeable or replaceable with another item. A $20 bill is tradable for another $20 bill, for example. Commodities (like bushels of corn) or shares in a company are also fungible. But assets like diamonds or land are not, because their unique qualities mean they differ in value.
Digital assets, like shareable image and audio files, would seem to be fungible too. But they don’t have to be: Non-fungible tokens are a new blockchain technology that impart unique ownership to a specific digital asset.
In the case of digital art, the NFT isn’t the artwork itself. It’s a token that either refers to, or points to, the artwork — which is an asset that exists (physically) apart from the token.
For example,millions of baseball cards are printed every season. But you might get one signed by your favorite player. That signature is like a unique token signifying the card as one-of-a-kind asset.
It’s an appropriate analogy, says Lamont, especially because “we’re seeing a lot of action” around non-fungible tokens for digital sports memorabilia. Sites like NBA Topshot offer NFT videos featuring iconic moments like slam dunks and other key sound/motion-bites for fans to “collect.”
“It used to be a physical baseball card, but now it’s a little video clip,” he says.
And blockchain is the technology that makes NFTs work –– think of it as a ledger of signatures that record the transfer of ownership. But according to Lamont, ownership, not content, is the name of the game.
Deeds in the Ether(eum)
What, then, is the relationship between a token and its corresponding digital asset?
“It gets into this interesting evolution we’ve seen in blockchain,” Lamont says. “It’s transitioned from just a transfer of value to being able to do additional things.”
Bitcoin uses blockchain to transfer the value of cryptocurrency from one digital wallet to another. Now, in the era of Ethereum, we’re seeing all kinds of new decentralized applications like smart contracts and other types of architecture on a blockchain, including the non-fungible token.
But just as your house isn’t stuffed in your safety deposit box along with the deed to it, your digital assets don’t reside in your digital wallet — but the proof you own them does.
The craze around NFTs is partially driven by scarcity, Lamont says. “If people could just simply start proliferating these video clips or .jpgs, they’d have no value because anyone could have them.”
Copyright hasn’t caught up
If you own an NFT attached to a work of art like Beeple’s, a piece of music or a Cryptokitty, what exactly do you own? At this point, one could argue it’s limited to bragging rights and personal satisfaction.
The nature of digital assets, which can theoretically be reproduced identically and infinitely, complicates matters. And copyright laws in the United States haven’t caught up with technology.
Right now, most unique digital media assets can’t be bought and sold on a secondary market, because media files under copyright law are essentially treated as fungible. It’s known as the first sale doctrine. There are some exceptions, but generally buyers don’t have basic copyright protections for assets they’re promised are unique.
Perhaps that’s why “it’s not by coincidence that a lot of innovation with non-fungible tokens is in the arts,” Lamont says.
Law license to buzzkill
In the early 2000s, Napster and other file-sharing platforms kicked off a paradigm shift in the music industry that led to streaming services like Spotify, which allows artists to earn royalties in new ways.
Lamont is hopeful NFT technology might “lead to some form of democratization of artistic digital art rights and distribution, where you don’t necessarily need a centralized streaming service … for artists to be compensated for the objects they create.”
On the flip side, I’m a lawyer and I can’t help but think NFTs provide opportunities for bad actors to undermine the intentions of creators and the true owners of that art. Anyone can create an NFT, even for an image that they don’t actually own.
So are we essentially creating a platform that undercuts one of the chief reasons people created NFTs: secure digital distribution of intellectual property?
Enter the regulators
If a company provides a marketplace for consumers to trade financial instruments, it should be expected to provide a certain amount of protection.
Right now, we’re seeing similar questions we had about early cryptocurrency platforms: Where does the responsibility lie — with the end consumer or the platform? Who are the regulators? And perhaps more urgently, are NFTs personal property? Commodities? Securities?
No matter what, it seems clear that any platform that enables NFT sales will be subject to consumer safety regulations.
“I think there’s a lot of similarity to what we’ve seen with the ICO [initial coin offering] market,” Lamont says. “In the beginning, there was a lot of optimism and a proliferation of new coins. But then people started to realize there was a lot of fraud.”
That led to a massive “pump and dump,” fluctuating prices and a destabilized market. That’s why Lamont thinks it’s likely we’ll see “fraud and short-term speculation, which is often the case with new innovations. It’s the wild, wild west.”
So he agrees: “There’s a role for regulation, just like we saw with the ICO markets –– defining what’s a utility token, what’s a security token, what falls under certain laws and what falls under other laws.”
But Lamont thinks that because people are buying NFTs with the goal of price appreciation — earning a capital gain and intending to sell it later, “it starts to sound an awful lot like a security.”
Regulators won’t turn a blind eye when these tokens are traded like securities for investment purposes, he adds.
But he also notes the diversity of cryptocurrency exchanges. Some are centralized places to buy and sell crypto, but the exchange itself owns the private key to every digital wallet. Others are decentralized exchanges, where the actual owner who buys an asset owns the private key.
Based on what we know now, NFTs signify a shift toward “decentralization of ownership,” says Lamont, “where we can have, rather than large conglomerates owning artwork or selling rights to that artwork, a way in which some of that can be decentralized and distributed.”
He views NFTs as a next step in the evolution of blockchain tech outside of cryptocurrency.
Are we in an NFT bubble? (maybe)
Right now, there’s not an ironclad way to ascertain the actual owner of the NFT by verifying the record in the blockchain, so everyone should proceed with caution.
The CFTC promises to put together a holistic framework for digital assets by 2024. In the meantime, know that there is no question that NFTs are digital assets. But be careful speculating. You may stumble upon an unregulated securities transaction or run afoul of ever-changing securities laws.
Until we know for sure, I wonder: Is this a bubble, or is this the future?
“It’s both — maybe,” says Lamont.
Such a lawyer answer. But circumspection is appropriate. The astronomical prices of artwork and video clips mean it’s “very frothy,” he adds.
In that vein, Lamont thinks “there’s a good chance we’ll see an NFT winter.”
Sure, it’s almost summer (at least in the northern hemisphere), but you heard it from Lamont Black on the Tech on Reg podcast: NFT winter is coming.
Watch this space.
This article is based on an episode of Tech on Reg, a podcast that explores all things at the intersection of law, technology, and highly regulated industries. Be sure to subscribe for future episodes.