NFTs: Innovation, Protection, and Opportunities - Darren Trisno

Introduction


NFTs. We all started hearing about them at some point in 2021. At first, it was just a rumour. Why would someone pay millions for a screenshot? Then, the craze became mainstream, with celebrities promoting major collections and retail investors flocking to get a piece of the action. In this article, I hope to answer four questions. What exactly is an NFT? What use cases does it have? How is the law catching up with this new technology to protect members of the public? And finally, what is the role of law firms in this space?


What is an NFT and what are its use cases?


NFT is short for Non-Fungible Token. This means that every NFT is irreplicable in the blockchain, and that through the blockchain system, one can check whether their picture of a zombie ape is “the real deal” from the original artist. You cannot duplicate an NFT or reproduce it, or it will be evident on the blockchain that it is not the original. NFTs thus differ fundamentally from cryptocurrencies, which are identical and can therefore be traded and exchanged for one another.


This immutable and verifiable nature of NFTs is essential to their use cases. NFTs have been predominantly used for the sale of art pieces, since they allow the owner and the artist to prove that a screenshot is not the original. Sure, others could “right click save” on the image and have the image downloaded, but the “flex” (or prestige) of owning the original piece is valued by many, often in the millions. NFTs have also been used for ticketing in events like Coachella, preventing scammers from duplicating or producing fake tickets.


As NFT use cases have developed, it has also become a way for fans to support artists, who have sold posters, video clips, or even songs as NFTs. They could also be used as a membership card whereby entry into elite, selective online communities becomes dependent on your ownership of a specific NFT collection.


How does the law protect retail investors?


NFTs are a double-edged sword when it comes to the law. On the one hand, their characteristics provide an exciting opportunity for innovation, which the law should encourage. On the other, the law must also protect against fraud victims, who may not understand the risks. Both of these aspects are demonstrated well in D'Aloia v Persons Unkown & Ors [2022] EWHC 1723 ("D'Aloia").


In this case, Mr D’Aloia’s cryptocurrency was misappropriated by unknown individuals who operated a website imitating a well-established online brokerage in order to defraud investors out of their crypto assets. The order of the High Court had two important effects.


Firstly, it allowed Mr D’Aloia to serve proceedings on the defendant fraudsters by way of NFT airdrop to the two wallets into which he initially deposited his cryptocurrency. This important example of innovation in the legal system also represents a crucial advance in the protection of scam victims, as NFT scammers often keep themselves anonymous and their contact details untraceable. Being able to ‘airdrop’ court proceedings such as injunctions to their NFT wallets allows victims to proceed to the next step of litigation.


Secondly, the High Court recognised that there was a good arguable case for saying that crypto exchanges like the defendants hold crypto assets as constructive trustees for the fraud victim. A constructive trust arises by operation of law where it would be unconscionable for the holder of an asset to deny the beneficial interest of another person in it. If the constructive trustee retains the trust property in identifiable form, the beneficiary may recover it. This is extremely significant as cryptocurrency exchanges can now have a duty, as trustees, to ringfence the stolen NFTs and ensure they are not withdrawn, lest they risk being held liable for breach of trust. Not only does this incentivise cryptocurrency exchanges to introduce more protective measures to prevent scams, it also represents a further source of redress for fraud victims.


Further legal developments in the protection of victims of crypto-related scams can be seen in Osbourne v Persons Unkown & Orr [2022] EWHC 1021 (Comm). Here, the claimant had two digital artworks stolen from her online wallet on an NFT marketplace. Having traced the NFTs to two other anonymous accounts, she sought an injunction to freeze them as well as a disclosure order for information about the account holders.


The significance of this case is twofold. Firstly, the court held that there was a ‘realistically arguable case’ that NFTs are to be treated as property as a matter of English law, proceeding on that assumption. This allows fraud victims to trace their stolen assets, as to be traceable assets must be recognised as property.


Secondly, since there was no information available about the fraudsters, the judge held that the English courts had jurisdiction over the matter on the ground that the claimant lived in England. There was no reason to treat NFTs differently from crypto assets, which the courts had in previous cases treated as located at the place where their owner was domiciled.


What is the role of law firms?


NFTs are an exciting new industry for law firms to find new clients or advise their existing clients in exploring. As for new clients, a significant area is capital markets. Yuga Labs, which created the famous Bored Ape Yacht Club collection, was valued at $4bn in a fundraising round at the start of this year, raising $450 million from Silicon Valley venture capital giant Andreessen Horowitz. And in September, Animoca Brands, the blockchain gaming developer in whose games player can trade NFTs, secured $110 million in funding as it paves the way for a potential IPO. Singapore’s publicly owned investment firm Temasek, US venture capital firm GGV Capital, and Chinese private equity firm Boyu Capital all participated in the fundraising round.


For firms’ clients who venture into the nascent NFT industry, there is a range of matters that might demand their advice. One increasingly important debate is whether and in what circumstances NFTs may qualify as securities – a stance which some regulators have indicated they favour. This would dramatically increase the number of regulations (and their stringency) the tokens are subject to, as well as transforming the industry’s reporting requirements. Clients interested in NFTs would have to lean on law firms to guide them through this process.


Intellectual property issues may also arise. Since owning an NFT does not by itself mean that one has ownership rights in the underlying asset, rights such as copyright remain with the seller without written terms stating otherwise. Often, the buyer and seller will agree a licence for the use of the intellectual property rights in the underlying assets. Differing interpretations of this licence could provide contentious work. Lawyers may also become involved if a client’s intellectual property rights are misused – that is to say, if an NFT is ‘minted’, or published on the blockchain, in an unauthorised manner. For example, a trademark may be infringed where someone mints an NFT without the permission of the owner of the underlying asset and sells the NFT using that owner’s trademarks.


Conclusion


The next time you see a picture of an ape in a pirate hat or a polaroid from a YouTuber sell for millions of dollars, appreciate the fact that a new medium for art, business and even the law is developing. As the law catches up with this new technology and seeks to protect fraud victims, law firms globally will be looking to play their role, whether by advising new clients with fundraising or guiding existing clients interested in NFTs with securities law and intellectual property issues. And who knows, maybe one day we will see a multi-million-dollar dispute over a 3-second video of a dancing fish.

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