Partner Nick Eziefula discusses the risks and rewards associated with NFTs in the entertainment sector, as their popularity continues to grow

Non-fungible tokens (NFTs) have been making headlines over the past couple of years: 2021 saw a boom in creators seeking to capitalise on the novel use of blockchain technology to generate new revenue streams. The recent notoriety of NFTs has been a double-edged sword.  NFTs are both seen as a fashionable investment – thanks to the big names who are using them to raise funds and raise the profile of their brand – but also as nebulous and risky investments.  In many cases this depends on the specifics of the NFT initial sale (“drop”) or resale.

High profile creatives and brands are entering the space with increasing frequency. Last month, John Lennon’s eldest son, Julian, sold NFTs associated with assorted Beatles memorabilia, including various items of clothing worn by his father, together with Paul McCartney’s handwritten notes for Hey Jude. Meanwhile NFTs issued by the Bored Ape Yacht Club, which trade for around $300,000 apiece, have been sold to approximately 10,000 investors including celebrities such as Eminem, Snoop Dogg and Jimmy Fallon.

Recently, News UK was reported to be thinking about linking assets owned by Rupert Murdoch’s British publishing arm to NFTs: an extensive archive of photos, cartoons and classic front pages from the Times and the Sun that could be sold as unique digital versions.

 

Blockchain technology

So how does the technology used by NFTs work? NFTs are comprised of code hosted on the blockchain that can contain details of, or links to, the underlying asset(s) (either digital or physical) to which the NFT relates.  An associated smart contract - most likely hosted by the platform minting and/or dropping the NFT – and potentially also natural-language terms of sale, will set out the relevant rules and rights that are attached to the purchase (and resale) of the NFT.  Often these terms contain a licence to use associated rights (and infrequently extend to assignment of rights) and may confer other benefits. 

The NFT itself is a token recorded on the blockchain. “Non-fungibility” means that, unlike cryptocurrencies, the token is unique and cannot be traded on a like-for-like basis.  For example, a single Bitcoin will always be of equal value to another Bitcoin. In theory, this is not true for each NFT.

 

Legal and regulatory landscape

Like cryptocurrencies, which also use blockchain technology, NFTs are attracting increasing scrutiny from regulators because of the potential risks, particularly to young and inexperienced investors. Despite the absence of specific financial regulation in the UK governing NFTs at the time of writing, existing law does afford certain protections, both in terms of intellectual property and financial promotion regulations.

The Advertising Standards Authority (ASA) summarises the Financial Conduct Authority’s (FCA’s) current position in its guidance on cryptoassets. There, cryptoassets are split into three categories: Cryptocurrencies, Utility tokens and NFTs. The majority of cryptoassets are not regulated by the FCA (the UK government is currently reviewing this position).  This means that NFTs themselves are not subject to FCA oversight, but that advertising related to NFTs is still subject to the ASA’s advertising standards codes. Issuers of NFTs need to be cautious when promoting NFTs not to take advantage of consumer inexperience, and to include appropriate disclaimers in their promotions, such as indicating that past performance of the NFT is not indicative of future performance.

So, what are the key IP considerations in relation to NFT creation, ownership and usage?  It is important to remember that an NFT is not the actual asset. Rather, the NFT is a uniquely identifiable token, related to an asset. The proprietary rights in the asset itself are not necessarily included. If an NFT seller wants to transfer rights in the IP of the asset to the buyer, that IP will need to be assigned separately. As such, the use of an IP asset in connection with an NFT does not necessarily involve any particularly novel applications of intellectual property law.  We analyse this further below.

 

Monetisation

It is common for an NFT seller, usually the IP rights owner, to license use of the IP rights in the underlying asset to the holder of the NFT for specific purposes. This can be outlined in a separate agreement between them, the terms of which are usually determined by the seller of the NFT.   Additional rights or obligations may also be included – for example, it is increasingly common to see resale royalties included in agreements for the benefit of the original seller, which are somewhat analogous to an EU-style ‘resale right’. On a practical level this is a powerful tool for creators, as payments can be automated by smart contract and linked to the original seller’s cryptowallet.

However, there are risks present for both seller and buyer in this process. For the buyer, there may be little chance to confirm that the NFT seller has the rights it is purporting to grant (if any) or to negotiate favourable terms. For the seller, it is necessary to educate buyers as to what rights they are acquiring – a buyer may inadvertently breach the IP owner’s rights by thinking they “own” the IP via ownership of the NFT.  A crypto-backed consortium recently purchased the NFT related to original art for the Dune franchise, purportedly with intentions to produce materials using the copyright, which was not, in fact, granted via the purchase of the NFT.

 

Enforcement of IP rights

IP rights holders also need to be conscious of NFTs as a new method to profit from IP infringement, in a largely untraceable fashion. The creation of unauthorised NFTs is common place (according to reports, OpenSea, one of the largest NFT marketplaces, recently claimed that more than 80% of the NFTs minted for free on its platform were "plagiarized works, fake collections and spam").  This creates a new avenue for bad actors to infringe on a rights holder’s right not to have their copyright work reproduced  or communicated to a new audience without their permission.

It is also increasingly important for rights holders to understand their historic contractual position relating to IP before issuing an NFT or seeking to enforce against an issuer. Due to the novelty of this space, it is unlikely that historic assignments or licenses will have expressly dealt with the use of the rights in connection with NFTs. The recent lawsuit issued by Miramax against Quentin Tarantino can, in short, be distilled into a disagreement as to whether historic “Reserved Rights” capture NFT-related usage or not.

Businesses may also wish to take steps to protect their trade mark portfolios from being infringed via NFTs. An NFT may be linked to an asset which includes a brand without the brand-owner’s consent and may also trade on the goodwill of a mark, in breach of passing-off laws. For brand owners seeking to enter the NFT space in the next five years, registering trade marks in a category of goods and services which includes NFTs and cryptoassets is likely to be beneficial when protecting their portfolio. For example, the Premier League recently asked that the Premier League Trophy (a registered trade mark) be removed from various “Ape Kids Club” NFTs, promoted by the likes of John Terry on Twitter.

Enforcement of IP rights is well served by effective monitoring. Common measures include putting watch notices in place to observe key NFT marketplaces. Where it is clear that an infringement has occurred, enforcement action can be taken against individuals or businesses who do not have authorisation to mint an NFT that is linked to the underlying asset. In addition, take-down notices can be issued against marketplaces where NFTs are available for sale. Furthermore, details of unauthorised minters can be requested so that action can be taken directly against them.

For large brands with deep litigation pockets, NFTs can represent an opportunity to challenge the boundaries of existing rights. For example, Nike recently sued a third party reseller of its shoes for trade mark infringement. The reseller was selling NFTs linked to shoes it owned, noting the NFTs could be redeemed for physical products in the future. Typically, using a brand’s marks to resell items in the secondary market would be permitted (in the UK and EU at least) under the doctrine of exhaustion of rights. Nike is arguing that the NFTs sold here are not covered by this doctrine. The timing of the action was likely to set a precedent to the industry, spurred on by Nike’s recent acquisition of its own NFT studio.

 

Conclusion

Alongside significant opportunities, the NFT marketplace involves risks for business entering the space and for those seeking to protect existing IP rights.

NFTs do create new avenues for IP infringement online and test the boundaries of legacy rights. To mitigate potential IP risks when using NFTs, the best option is to ensure that there is clear definition at the outset of what is and is not permitted in relation to the relevant IP assets.  Details should be set out in the NFT’s terms of sale and represented in the smart contract that is associated with the NFT. Protecting the underlying IP rights will require appropriate oversight and monitoring of how third parties or buyers use an NFT. 

Nevertheless, the risks involved in NFT activity do not seem to be dampening enthusiasm. Risk and reward often go hand-in-hand and, to many, the NFT sector represents a brave new world of opportunity. Yet businesses should consciously continue to comply with existing legal frameworks when branching out into new ventures.

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