Analysis
by Amini & Conant • January 10, 2023 •
3 minute read
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Nonfungible tokens (NFTs) became massively popular in 2021, with a market size that peaked at around $41 billion. However, the NFT market recently went through a crash shortly after the cryptocurrency market crash in early 2022. The future of NFTs remains uncertain, but both crypto and NFTs are volatile markets, and an upswing could be possible in the future. Whether you are an NFT buyer or creator, it is important to be aware of the legal aspects of NFTs. While there are no specific NFT laws that regulate these digital assets, there are several important legal considerations to take into account
What Are NFTs?
Non-fungible tokens (NFTs) are digital assets that hold various forms of content, such as music, videos, and art. They are frequently purchased and sold using cryptocurrency and are encoded in a similar way to many types of cryptocurrency.
Even though the first NFTs debuted in 2014, the boom only happened in 2021 when people began using them as a way to buy and sell digital artwork. At its peak, the NFT market value rivaled the total global value of the fine art market.
The term “non-fungible” is used because they are usually unique, one-of-a-kind tokens. Other digital assets, such as Bitcoin, usually have an infinite supply and each token has the same value. The limited quantity of an asset should theoretically raise its value. However, NFTs remain highly speculative and it is a volatile market.
Lack of Regulatory Frameworks
Traditional speculative assets, such as stocks, are regulated by thorough legal frameworks that are designed to protect investors. However, speculative digital assets like NFTs and cryptocurrency currently lack these types of legal protections. As relatively new types of assets, most governments have not developed the legal and regulatory standards for NFTs.
Do SEC Regulations Apply to NFTs?
While there are no NFT-specific regulations, other federal laws that regulate assets may apply to NFTs and other types of digital assets. For example, the Securities and Exchange Commission (SEC) may classify some types of NFTs and other digital assets as securities. According to the 1946 Supreme Court Case SEC v. W.J. Howey Co., an asset may be considered a security if it is an investment into a common enterprise with an expectation of profits and these profits are received from third party efforts.
In addition to federal regulatory bodies like the SEC, state securities laws may also apply to NFTs. Each state has its own laws on this subject, which may have additional requirements beyond federal laws
Intellectual Property Rights
Some NFTs may be protected by intellectual property law. However, ownership of NFTs is much more complex than ownership of traditional assets that are protected by IP law, such as physical works of art. In most cases, the NFT owner holds a non-exclusive license to the underlying asset of the NFT, which means other parties are legally allowed to make copies of it. Typically, the creator of the NFT is the one who holds the original IP rights, just as the creator of a painting owns the copyright to that painting, not the person who bought the work.
The creators of NFTs, like the creators of any other form of intellectual property, are offered protection of their original works through various forms of intellectual property law. Copyright, trademark rights, and design patents may apply depending on the contents of the NFT. Most NFT transactions typically only grant the buyer the right to use, copy, and display the NFT. The original content held within the NFT usually remains the intellectual property of the creator. For example, someone who purchases an NFT with a digital artwork attached may use, copy, or display it, but would not have the right to sell merchandise containing the image. However, NFT creators do have the option to grant commercial use rights to buyers. For example, the owners of the famous Bored Ape Yacht Club NFTs have commercial usage rights and are thus allowed to sell merchandise bearing the images they purchased.
Fraud Risks
Although NFTs are unique, one-of-a-kind digital assets that cannot be duplicated, third parties could illegally mint replicas of NFTs that they do not own without the creator’s permissoin. This is considered fraud. In a recent example, someone made a fake Banksy that earned $1 million from NFT sales in 2021. While data from existing NFTs cannot be forged, bad actors could embed fraudulent data in the blockchain.
Tax Implications of NFTs
NFT creators and buyers should be aware of how federal and state tax laws may apply to their digital assets. An NFT creator who sells their work will owe tincome taxes on the amount received. If they receive this payment through cryptocurrency and convert it to fiat currency, it will be considered a capital gain and taxed according to the requirements of the Internal Revenue Service. If the owner holds on to the NFT and later sells it for a higher price, they will also owe capital gains tax. Similarly, NFTs that decrease in value may be claimed as capital gains losses.
How Can an Intellectual Property Lawyer Help With NFTs?
Like other forms of intellectual property, NFTs should be protected. An experienced intellectual property lawyer can help ensure that all applicable protections are in place and assist NFT creators and owners with a variety of legal matters, such as:
- Registering and protecting NFTs, cryptocurrency, and other digital assets
- Implementing risk mitigation strategies
- Providing legal guidance related to the legal complexities of cryptocurrency, NFTs, and blockchain technology
- Conduct regulatory investigations and defense
- Dispute resolution between clients and cryptocurrency exchanges
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