Non Fungible Tokens (NFT) - Legal Issues in Sale and Purchase

 

Non Fungible Tokens (NFTs) have attracted a lot of attention in recent months due to the sale of artworks at record high prices, for example Beeples "Everydays" for USD 69 million.

In Austria, NFTs are increasingly being used as a marketing tool. For example, the Ströck bakery raffled off thirty limited edition doughnut ("Krapfen") NFTs on Carneval Tuesday. Another example is the launch on 3 March 2022 by the Austrian Football Association of an NFT collection with motifs of national soccer players.

Of course, you can't eat NFT doughnuts and the NFT soccer pictures can't easily be stuck into a scrapbook either. Therefore the question arises what makes NFTs so valuable.

This article attempts to provide some answers and explains legal issues to consider when selling or buying NFTs.

What are NFTs and what makes them so valuable?

NFTs are non-exchangeable (non-fungible) digital assets stored on a blockchain. Non-exchangeable means that each NFT is unique. This makes them different from previous digital assets such as cryptocurrencies. For example, while a Bitcoin can be replaced by another Bitcoin, each NFT exists only once.

NFTs create a sense of "scarcity" and as a result have attracted a lot of attention, especially in the art market. In fact, NFTs solve the previous problem that digital artworks can very easily be reproduced in identical form. Creating unique digital artworks was previously impossible, which meant that once published, artists could no longer control whether their works were copied and further processed.

Through NFTs, digital artworks can now be linked to a token and deposited on a blockchain (tokenization). In this way, a certificate is created that allows its holder to "identify" themselves as the exclusive owner of the linked digital artwork. Both the authenticity and the origin of the digital artwork can be proven in a forgery-proof manner by using the blockchain, because subsequent transfers can be viewed by anyone on the blockchain. So, in addition to scarcity, transparency has contributed significantly to the popularity of NFTs.

Another reason for the recent popularity is the wide scope of application. Namely, NFTs can represent all kinds of digital or material goods and services, although NFTs are currently mainly used for digital objects. This results in applications for computer games, music, and videos. For example, digital objects used in a game, such as weapons, can be linked to an NFT and thus used and resold among players as collectibles.

Numerous companies have recognized these benefits and are already using NFTs to engage with their customers digitally. Due to the sense of scarcity, value is created for digital collectibles, including, photos, videos and audio files. However, in our observation, the use cases for NFTs are still in their infancy.

NFTs are capable of tokenizing, storing, and selling all sorts of rights to digital or physical assets. For this reason, they are likely to find wide application in the financial services industry.

What should be considered when buying and selling NFTs from a legal perspective?

NFTs are considered incorporeal things and can certify ownership rights to digital or real assets. In order to acquire ownership of an NFT, a purchase agreement is necessary as an obligating transaction. Although there is still a lively debate in legal literature as to what the disposal transaction consists of, in practice this does not prevent the acquisition of ownership.

Before purchasing NFTs, buyers should in any case read the "small print". The transfer of NFTs does not automatically entail the transfer of rights to use the represented assets. The author or the person entitled to use the work can decide for himself which rights of use he wishes to transfer with the NFT. They may, but do not have to, concern the right of reproduction or the right of communication to the public. A corresponding license text is usually included in the metadata (description text) of an NFT. Larger NFT exchanges automatically display this license text on their platforms.

The scope of the granting of rights may also result from the underlying general terms and conditions. These regularly contain restrictions on the further use of the NFT. For example, the general terms and conditions of the Austrian Football Association prohibit the commercial exploitation of the art of the purchased NFTs. It is only permitted to exhibit the artwork for one's own personal non-commercial use or to sell it on a marketplace, provided that the purchaser undertakes to also accept the conditions from the GTCs. The terms of service may also impose restrictions on the use of the purchase price. For example, in the case of Klimt's "Kiss," the terms of service stipulate that the Belvedere receives a share of the net sale price in the amount of 10 % in so-called royalties for each resale. Each subsequent seller of the NFT must take this into account when reselling and inform the respective buyer accordingly.

Sellers should clearly describe the content of the NFT in order to avoid misleading the buyer and the risk of misleading advertising. For example, in the case of the "kiss", there is no connection between the original artwork and the NFT. Anyone who buys a "kiss NFT" therefore does not acquire any right to the analog, famous kiss artwork by Klimt. This aspect should also be taken into account when advertising NFT sales outside the platform (e.g. in the context of an up-front "whitelisting").

Further, when contracting with technical service providers, it should be ensured that they comply with all regulations applicable to them and provide an appropriate level of service to token buyers to avoid reputational issues for the brand. For example, if the NFT marketplace is not always available, this may negatively impact the reputation of the brand associated with the NFT.

In addition, careful consideration should be given to what happens to the NFTs upon termination of the contract between the company and their technical provider.

Prudential law generally not applicable to NFTs

Prudential law is generally not applicable to NFTs. This is because they are unique and are not suitable as a general means of exchange. Thus, an essential factual characteristic for the existence of virtual currencies and a registration obligation with the FMA associated with the business model is missing.

Furthermore, NFTs are not securities and do not embody any claims to payment against the issuer. They are therefore not comparable to shares or bonds, which is why there is also no obligation to prepare a prospectus. As things stand, NFTs will also not fall under the MiCA regulation, the future European framework for crypto services.

From the perspective of money laundering regulations, it should be noted that due diligence obligations exist under trade laws if the value of a transaction amounts to EUR 10,000 or more in the case of art dealers. This is likely the reason why the Belvedere has limited purchases to a maximum of five NFTs per wallet at a purchase price of EUR 1,850 per piece when selling the Kiss NFTs.

Overall, it remains to be seen how regulators and supervisors will react to the increasing popularity of NFTs.

What can we do for you?

With our comprehensive know-how in the field of financial market law and civil law, we can provide you with competent support in all matters relating to the sale or purchase of NFTs. We look forward to your inquiry.

Contact persons: Dr. Bernd Fletzberger und Mag. Sanijel Ficulovic