Launching NFTs or Non-Fungible Tokens | Legal Considerations

Non-Fungible Tokens

Launch of tokens as collectibles gave rise to NFT or Non-Fungible Tokens along with blockchain related legal issues. Ethereum is an open-source platform based on blockchain technology. Initially, NFTs or Non-Fungible Tokens were launched as a special token that worked mainly on the Ethereum platform. An example of NFT was originally seen in the Ethereum based game called CryptoKitties, which allowed users to collect and breed unique digital cats. This resulted in the development and launch of various collectible games based on crypto, because of which people bought and sold different crypto assets. With time, NFTs have grown beyond gaming into other fields like Art, wherein users can buy or sell unique digital assets.

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NFT Laws and Digital Assets Ownership

Similar to the laws and regulations applicable for buying or selling of unique physical assets, appropriate legal considerations are required for NFT transactions as well. Such legal considerations may include, AML (Anti-Money Laundering) Regulations, Security Laws, Tax Planning, Protection of Intellectual Property Rights by way of Blockchain Patents, Incorporation of legal entities to hold NFTs as holding companies, Financial Regulations, Implementation of smart contracts for blockchain transactions, and the like.

NFT Applications

Lawyers with expertise in blockchain and cryptocurrency apply their skills across various applications of NFTs. The commercial transactions across multiple verticals require such application of relevant laws, which are equally applicable for NFT transactions as well. Such NFT application areas include, digital art NFTs, music NFTs, collectible NFTs, literature NFTs, film NFTs, gaming collectible NFTs, and the like.

As technology evolves and becomes a mainstay of everyday culture, Non-Fungible Tokens (NFTs) have established a new market for artists, musicians, brands, innovators, and consumers. They help develop digital assets and enhance relationships with consumers to generate new means of income. NFTs were developed as a distinct cryptographic asset for commodities like art, songs, collectibles, and game purchases. They are based on Blockchain technology for ownership and authenticity and traded in different market places through cryptocurrency. The method of Tokenization helps in giving these commodities value as it replaces the valuable and sensitive data with a less sensitive form. To better understand the concept of NFTs, one can consider any tangible asset.  An NFT is like a statement proving ownership of that asset and not the asset itself.  Thus, an NFT is not a digital asset itself, but an electronic title signifying ownership and acquiring an NFT does not imply that one possesses the asset underlying the NFT. There are three primary classifications of tokens based on their legal status.

Utility Tokens

Utility tokens are for digital services where token holders have sole access to functionality in a system or decentralized outlet. Instances of such tokens include Ether, Gno (Gnosis), Stellar. The token is required to join a platform or a system and utilize it. They are identical to a voucher and enable a project to be financed without reducing ownership in an ICO company.

Security Tokens

Security tokens signify ownership and award token holders rights such as voting, dividends, profits, share in an issuing entity, etc. Financially, these tokens are security aids, stock assets, debts, and penalties, and give all or some of the rights. Security tokens get their value from the underlying asset, but, an important distinction is that the tokens depict programmable ownership, providing the assets more functionality, liquidity and simpler market entry, speed, limited mediators, lower expenses, clarity, and built-in mechanisms of security-related systems. In contrast, Currency (or payment) tokens are those tokens that are cryptocurrencies, implying that they function as a depository of value and as a channel of exchange. Today, most of the tokens we encounter are hybrids that include characteristics of various types, showing that they possess utility traits and lend distinct monetary ownership rights.

Legal Nature of Non-Fungible Tokens

Presently, in several countries, tokens that aren’t completely utility tokens or cryptocurrencies can be categorized as security tokens. Most of the aforesaid tokens are fungible making them interchangeable with another identical token. NFT’s can tokenize assets but do not symbolize a financial mechanism. So, to determine the legal nature of any NFT it is important to differentiate the kind of rights that are allotted to token holders. If token holders will possess profit-sharing rights, such token will be governed as a security token and falls under monetary regulations. NFT’s generally don’t award such rights, but rather grant access to a prospective subject or an avatar in a game or can wield rights to payment of royalties. Thus, to define what crypto-assets are in a legal sense, one must determine if the token provides the owner with an entitlement against the issuer. If yes, then where the entitlement is monetary, one must identify if it is profit sharing, a predetermined entitlement, or an undetermined entitlement. In such cases, it must be concluded whether the token is transferable and if it offers decision power on the program of the issuer.

Since NFT’s do not give the token holder any entitlement against the issuer; there is also no decision power on the program and there is generally no means to know the allowance of the assets. Even though the NFT’s are surely transferable, they are normally not transferable in the standardized market. One significant element of the NFT’s is immutability and shortage. This suggests that a non-fungible token characterizes something extraordinary and unique.

Advocate Rahul Dev is a Patent Attorney & International Business Lawyer practicing Technology, Intellectual Property & Corporate Laws. He is reachable at rd (at) patentbusinesslawyer (dot) com & @rdpatentlawyer on Twitter.

Quoted in and contributed to 50+ national & international publications (Bloomberg, FirstPost, SwissInfo, Outlook Money, Yahoo News, Times of India, Economic Times, Business Standard, Quartz, Global Legal Post, International Bar Association, LawAsia, BioSpectrum Asia, Digital News Asia, e27, Leaders Speak, Entrepreneur India, VCCircle, AutoTech).

Regularly invited to speak at international & national platforms (conferences, TV channels, seminars, corporate trainings, government workshops) on technology, patents, business strategy, legal developments, leadership & management.