NFTs in Practice – Legal Perspectives

Given the things I had read on what makes NFTs so exciting and lucrative, I want to know:

• How enforceable are smart contracts on ownership?
• How are NFT purchases handled?
• Is eth made from sales viewed as income in the same way fiat currency from paid work is?

Here are just a few examples of how NFTs play out in the real world. There are many other areas of law I imagine have not caught up to regulate the creation, profit from and resale of NFTs but the following is just in regards to two areas that concern artists.

Taxation

Walter et. al speculates on the tax consequences of NFT purchases that would apply to existing taxation structures. They see opportunity for smart contracts to be structured in a way such that artists receive a portion of the purchase price on every resale. If the NFT was created and donated by the artist, then it should follow that the artist could declare it as a charitable deduction. (How this plays out in practice varies, however.) For sales or exchanges of an NFT, it depends on whether the NFT is categorized as a capital or noncapital asset. For artists these would be deemed ordinary gains and losses, whereas for the purchasers-taxpayers, these would be viewed as capital gains and losses. ²

In the US, regulations on the handling of NFTs are still evolving and the IRS hasn't provided explicit guidance on the matter. Crypto/digital currency is regarded by the IRS as property as opposed to currency. The purchase of NFTs creates a taxable event. For American artists, this cuts both ways. They're able to deduct taxes on their artwork as they create it, and they are also able to reap 100% of the profit from sales as taxable income. Self-employment taxes also need to be paid on income generated from sales. ⁴

Intellectual Property

In both Canada and US currently, NFTs aren't protected by copyright. Either they don't meet the basic criteria for copyright protection for ownership and control, or the reasoning behind this is that the smart contract could or would specify how much of proprietary rights are transferred to the purchaser.³⁴ Otherwise, the copyright remains with the original copyright owner, which is the artist.

Antonia von Appen at the Art Law Center acknowleges how the transparency of a public register in the form of blockchain as a ledger could build a stronger case for intellectual property. On the other hand she observes the cases of copyright infringement that have occured by dint of exploiting the ability for anyone to create a NFT for whatever work exists, just by simply linking an artist's work to a token.⁵

This caution is echoed by American intellectual property lawyer Johnathan Schamfeld:

"What the blockchain doesn’t tell the buyer, though, is whether that piece was merely a copy of somebody else’s copyrighted work—rendering that purchase worthless and subjecting the buyer to substantial legal liability if it is resold... Under section 504 of the Copyright Act, the sale of an infringing work, even if done by a completely innocent actor who unknowingly violated somebody else’s copyright, makes the seller automatically liable for actual damages and/or statutory damages of $750 to $30,000 per infringement. " ¹⁰

This complaint arose from a number of artists in the past year: Rosa Menkman, Dead Unweird and even Jean Basquiat's estate discovered their work was sold on an auction site without the artists' intention to mint it. ⁶⁷ Anyone can mint an NFT from a digital file, and the current availability of the platforms and technology don't prevent malicious actors from committing art fraud.⁸

Akhiv Jhirad and Daniel Anthony caution that a NFT purchase might only mean you own a digital version, but it doesn't prevent others from displaying, exhibiting or downloading it (even in the case of display it would constitute copyright infringement) ⁹:

Purchasers of NFTs should be aware that even though ownership of the authentic digital asset is established through ownership of the NFT, the digital asset itself may be viewed, downloaded, and enjoyed by anyone (for example, the artwork sold on Christie’s can be found online ). In fact, Christie’s conditions of sale [of Beeple's infamous > artwork] clearly states:

“Your purchase of the lot does not provide any rights, express or implied, in (including, without limitation, any copyrights or other intellectual property rights in and to) the digital asset underlying the NFT…”

TLDR; the buyer owns the digital file version of that artwork, not the intellectual property rights.

In a recently published National Law Review, American IP lawyer James G. Gatto breaks down possible licensing issues between "open", "proprietary" and "curated" NFT marketplaces. Some highlights on what is a very eye-opening overview of popular NFT marketplaces ¹⁰:

• Open platforms like OpenSea and Rarible as ones that enable the minting and trade of NFTs created by any user.
• Curated marketplaces are ones that only mint and sell the work of a select group of artists.(i.e. Foundation) They offer verification of an artist's identity and the authenticity of their work. He points out that artists signed with SuperRare and Foundation must agree not to mint multiple NFTs for the same artwork as they operate on scarcity model.
• Proprietary marketplaces only create and sell NFTs created by its own operator (i.e. NBA Top Shots, Bored Ape Yacht Club)

All this research has me wary of understanding the rules set out by different NFT marketplaces that one can engage with as a creator or buyer. Futhermore, laws in different jurisdictions may provide different definitions of copyright and there is no one-size-fits-all answer to how NFT creation and sales are handled from a legal perspective. Buyers and artists should be informed of the specifics in a smart contract, the legalities behind selling and transferring NFTs.¹¹ When in doubt, do all the research you can, or save up a lump of money to get legal counsel.

Footnotes

¹ Amber Gray-Fenner. "NFTs: Why The Next Big Thing In The Digital Economy Is A Cash Cow For The IRS"

² Walter Effross, Leonard Goodman, Anthony Pochesci, and Jay A. Soled. "Tax consequences of nonfungible tokens (NFTs)" Journal Of Accountancy. Jun 24, 2021

³ Bianca Lessard. "NFTs, Minting and Copyright: what you should know as an artist"

Brittany Martin. "Thinking of Buying or Minting an NFT? Here’s What You Need to Know", Mar. 22, 2021

⁴ The following sources make assessments about NFTs and copyright in Canadian law:

Kaleigh Zimmerman and Peter Giddens. "Canada: NFTs And Canadian Copyright Law", McMillan. Sep 1 2021.

Harrison Jordan. "No, NFTs aren't copyrights", TechCrunch. Jun. 16 2021

⁵ Antonia von Appen. "NFTs: How a Technological Trend Redefined Art Ownership" Center for Art Law. Apr. 27, 2021

⁶ James Purtill. "Artists report discovering their work is being stolen and sold as NFTs" ABC Science. Mar 21, 2021

⁷ Harsh Kandelwal. "Minting, distributing and selling NFTs must involve copyright law" 2021

⁸ Bijan Stephen. "NFT MANIA IS HERE, AND SO ARE THE SCAMMERS" Mar 20, 2021

⁹ Akiv Jhirad and Daniel Anthony. "NFTs: Art meets crypto – traditional copyright issues in a tokenized world", Smart x Biggar. Sep 16, 2021

¹⁰ James G. Gatto. "NFT License Breakdown: Exploring Different Marketplaces and Associated License Issues", National Law Review, Volume XI, Number 264 Sep 21, 2021

¹¹ Jonathan Schmalfeld. "Copyright violations could crash the NFT party", Commentary, Fortune, Aug. 4, 2021.