Non-fungible tokens: Looking backward to go forward

It is not a stretch to say that 2021 was the year of the NFT. Sales of NFTs ballooned from $80 million in 2020 to $17 billion (with a B) in 2021. But, by June of 2022, the NFT market had shrunk to a 12-month low. Some NFT traders and developers began to wonder whether NFTs are truly revolutionary, or just another example of speculative FoMo (fear of missing out).  

NFTs were conceived of as a way to "own" an intangible, infinitely reproducible work of digital art. Anyone can copy and paste the JPEG of a Bored Ape, but only the NFT holder can prove they "own" the "original" (more on that below). This innovation is tantalizing but when the market collapsed, many owners of the most-hyped NFTs worried that they had been left holding worthless strings of numbers and letters. Despite this volatility in the market, the promise of the technology behind NFTs appears to still be strong, and development continues undeterred.

This article will outline a new legal solution that has the potential to empower NFT transactions to be a vehicle for the exchange of intangible property. It is helpful to first highlight some key misconceptions about NFTs and what they represent.

Limitations of NFTs

Many NFT projects have encountered a common challenge: the value of the NFT seems to be disconnected from its utility. Recall that an NFT is simply a cryptographic string of characters that is associated with a particular address and recorded in the distributed ledger of a blockchain. That's it. Many NFTs will encode a URL where the associated image is stored, but – beyond that – the only objectively provable fact is that NFT number xyz is held by wallet address abc.

Misconceptions about what NFTs are and what they are purported to do lie at the heart of the problem. Chief among these is the mistaken belief that NFTs somehow magically bestow ownership of the associated asset.

This misconception is best illustrated by the real world example of SpiceDAO. SpiceDAO is a decentralized autonomous organization (think crypto corporation) formed for a single purpose: to purchase a rare copy of a pitch book prepared by director Alejandro Jodorowsky to pitch his vision for a film adaptation of the novel Dune by Frank Herbert. After acquiring the book for three million dollars, SpiceDAO tweeted its intention to "produce an original animated limited series inspired by the book and sell it to a streaming service." The problem for SpiceDAO was that they had only obtained a physical copy of a pitch book about a movie adaptation of the novel, not the underlying intellectual property in either the pitch book or the novel. In order to produce Dune-related content, they would need to either licence or purchase the underlying copyright from the Herbert family.

Just like owning a physical copy of Dune does not confer any rights in the underlying IP, owning an NFT representing the book or an image of it (or anything else) confers no legal rights in the associated work. Another example is the owners of a Basquiat sketch who were blocked from minting an NFT by Basquiat's estate, the owners of the copyright in the sketch. Other types of IP work the same way: owning a pair of Adidas sneakers does not give you the right to use the Adidas logo and owning an iPhone does not give you the right to manufacture one of your own.

The issue here is not that NFTs are intangible – the law recognizes and enforces intangible ownership rights all the time (intellectual property, easements, goodwill, personality rights, etc.). For example, a copyright is valuable property because there is a legal mechanism (copyright legislation) and a powerful forum (courts) to enforce it as such. It is a legal fiction: an intellectual concept, but with real-world consequences and value. The value of the legal right exists separately from the tangible (book, iPhone) or intangible (NFT) object.

The issue with NFTs is that, unless the cryptographic data of the NFT is linked to the valuable legal right in an enforceable way, there is nothing tying the string of numbers and letters of an NFT to the underlying intellectual property (IP). NFTs are typically built on technology that is dubbed a "smart contract", but this terminology can often be misleading. A smart contract is simply self-executing computer code; it is not necessarily a contract and may not hold any enforceable legal significance.

A number of NFT projects have attempted to bridge the gap between law and technology for real estate and music rights, but these projects have oftentimes depended on external contracts that rely on traditional legal constructs, not blockchain technology.

For NFT purchasers, understanding the underlying rights is critical. Yuga Labs, creators of the famous Bored Apes, includes a clause in its terms and conditions that says "When you purchase an NFT, you own the underlying Bored Ape, the Art, completely." But what does this mean? Is this an assignment of the copyright in the Bored Ape Art? If so, who was the original owner and is that assignment valid? Also, if the original owner sells the NFT to a new buyer, what mechanism transfers any underlying IP? What are the buyer's expectations of exclusivity, if any? Even more fundamentally, are generative artworks like Bored Apes even original works?

For NFTs, true utility comes when the cryptographic elements are connected to enforceable legal rights. The remainder of this article will outline a method to achieve this connection in a way that is simple, elegant, and grounded in well-established legal forms.

Connecting the new to the old

A potential way forward to supercharge NFTs may require a glance backward – to the distant past and the law of trusts.

The inter vivos trust has been a part of English common law since the Crusades and the testamentary trust has been around since the Roman empire. The inter vivos (living) trust was a revolutionary legal innovation in its time and it continues to be a powerful and flexible tool in common law jurisdictions around the world.

In essence, a trust works like this. Full legal ownership of an asset (real estate, a bank account, copyright, etc.) is transferred to a trustee. The paperwork that effects that transfer also specifies one or more beneficiaries of the trust. Under the law of trusts, even though the trustee is the technical legal owner of the trust assets, the trustee only holds these assets for the benefit of the beneficiaries. The trustee is obligated to deal with the trust assets in a way that is in the beneficiaries' best interests.

This trust-based model for NFTs that I am proposing marries NFT technology with the legal machinery of the trust. In the case of NFTs representing intellectual property, the initial owner of the IP mints one or more NFTs associated with the IP and at the same time, conveys the legal title of all vested rights in the IP to a trustee. The terms of that trust arrangement specify that the trustee holds the IP in trust for anyone who holds an associated NFT. This trust document can even be minted onto the blockchain for further transparency.

The trust becomes the link between ownership of the legal rights and ownership of the NFTs. Provided that the legal ownership of the intellectual property is transferred to the trust in a way that is recognized and enforceable at law, this system allows the practical rights of ownership to flow with the NFTs themselves. The law will recognize each NFT-holder's beneficial ownership of the underlying intellectual property, so each NFT owner can act as though they are the legal owner of the IP. No new contract is required to transfer the effective rights from one NFT holder to another. A copyright assignment becomes a simple matter of sending the NFT to a new wallet. These transfers could even run through self-executing smart contracts that impose any number of conditions (time limits, royalty payments, etc.).^[1]

This model opens up a number of additional possibilities. First, there is nothing to restrict this model to the world of intangible intellectual property – other types of ownership can work the same way. Second, the trust document can specify that the trustee is entitled to compensation for their services. In the world of computational smart contracts, this fee can be automatically levied as a percentage of each subsequent sale of each NFT. Finally, subject to local rules about the construction of trusts, a DAO may be able to act as the trustee, which would allow the trust to be directed in a decentralized way.

Conclusion

NFTs are a fascinating technological development, full of promise. However, NFT projects may face legal complications because they have not fully considered the connection between cryptographic ownership and legally-enforceable rights. The model proposed above provides one solution by relying upon the well-established law of trusts to connect old and new, attaching legally-enforceable forms to cryptographic data. By combining modern technology with these ancient legal forms, NFTs can transform the concept of ownership, particularly for intangible assets such as copyright, trademarks, and patents.