Understanding the intertwining of NFTs and IP Laws

NFTs or non-fungible tokens are the latest brainchild of blockchain enthusiasts - the people actively working to achieve a decentralized global economy and a world with extremely limited overwatch and interference.

These blockchain-based tokens add an interesting dimension in the ever-evolving world of Intellectual Property (IP) protection and laws. How the prevalent IP principles and laws across the globe govern and interact with NFTs on a seemingly decentralized blockchain, remains a grey area. This article aims to spread awareness on the world of NFTs and implications of existing IP laws on them.

Before we delve deeper into legal implications of IP laws on NFTs, it is important that we understand some basic concepts such as blockchain, which will help us better understand the various facets, aspects and provide overall clarity on the functioning of NFTs. A blockchain is nothing but a sophisticated database.

On the blockchain, data is collected into units known as blocks, when one unit has reached its capacity, it is closed and linked to the previous unit. This process is continuously repeated and resultantly, a chain or string of blocks (storage units) is created. Once a block is created, it can no longer be destroyed or manipulated.

A traditional database is a storage where relevant data is stored electronically on a central server. These databases are used for storing, maintaining and accessing any sort of data. A traditional database provides four key functions - Create, Read, Update and Delete/Destroy. Collectively, these functions are referred to as CRUD functions. The blockchain is designed differently from traditional databases and does not perform CRUD functions. On the blockchain, primarily two functions/operations can be performed. First, existing data can be read (retrieved/verified) and second, new/more data can be added.

The key differentiating factor between a traditional database and a blockchain is that, data on the blockchain cannot be edited, manipulated or destroyed. In a traditional database, anyone with access to the central server can manipulate, influence and corrupt the data. There is heavy reliance on protection and security infrastructures to be in place to prevent such manipulation of data in traditional databases. The blockchain was designed to overcome this shortcoming. It uses a decentralized database, as a result of which the security is built into the very structure of the database.

Coming to the functioning of the blockchain, it is important to understand that in traditional databases, data is stored at a particular physical location such as a server farm, which makes the data extremely vulnerable. Apart from the risk of corruption and manipulation of data, one also runs the risk of the said location being affected by numerous uncontrollable factors which in turn may affect the data itself. For example, if the server farm burns down or loses internet or electricity connection, it will make the data inaccessible, and in some cases, the data is lost forever.

On the blockchain, the data is stored across numerous different networks at numerous different locations at the same time which can be accessed through access points called nodes. The process might appear redundant, but this redundancy is the very factor which provides an additional layer of protection to the data. Since the data is stored at various locations, it cannot be lost.

Additionally, since the nature of the blockchain is such that the data is stored on multiple networks at multiple locations, if any bad actor attempts to manipulate or corrupt the data at one location, they will fail as the data at other networks and locations would not be manipulated or corrupted and the nodes would cross-reference data and easily be able to locate the corrupted or manipulated node. As a result of its design and nature, the blockchain is also called Distributed Ledger Technology.

Non-fungible tokens are a type of token used to represent ownership of different underlying items on the blockchain. Each such NFT is assigned a unique identification code which helps distinguish one from the other. The NFTs can be assigned to represent tangible and non tangible assets and hold information relating to the ownership of the said underlying assets. Each NFT is unique and can have only one owner at a time. The process of making a NFT is called ‘minting,’ and has to be in accordance with the rules and regulations of the blockchain on which such tokens will be stored and exchanged.

Unlike cryptocurrencies, NFTs cannot be traded at equivalency. Since no two NFTs are identical or equal, they cannot serve as a medium for transactions like cryptocurrencies or any currency for that matter. Both traditional and cryptocurrencies are fungible in nature i.e., that is one can be traded/exchanged for another. This fungible nature of these currencies allows them to be used for conducting commercial transactions.

Assigning digital representation to physical assets or having unique codes for each unit is nothing new. However, combining the same with the immutability of data on the blockchain is what makes NFTs relevant. Today, NFTs are used primarily by artists and creators to sell art digitally whether it be images, videos, music, gifs etc, which are exclusive and limited in nature, and just like traditional collectors, new age collectors are interested in owning such exclusive digital art pieces.

There is real value for artists in the newly developed NFT space. In the case of traditional art, where an artist must rent a gallery or hire an auction company to sell their work, through both of which money is taken away from the pocket of the artist, in the case of NFTs, one can sell their work digitally without any such hassle. Further, an artist can program the smart contracts on the NFT in such a manner that with each subsequent sale, he/she get a royalty depending on the transaction value. These benefits have drawn a large number of artists towards the NFT space, flooding it with digital art projects.

NFTs are bought and sold on the blockchain like any other financial asset. However, NFTs are not exactly the asset; rather they can be seen as a key or a contact which signifies proof of ownership of the underlying asset. One can be forgiven if they get confused between the two and mistake the NFTs to be the asset itself.

For example, when a person buys an NFT, such as a BORED APE NFT (see image below) they are buying a piece of rare digital art. But the digital art is not what makes the NFT, rather the NFT is nothing but the meta data which contains information such as transaction data, location of the digital art and other relevant information which can be used to prove that your copy of the art is the authentic one.

Since NFTs are confused with digital art, NFTs and IP laws, principles of copyright specifically, have an interesting relationship. People often assume that when they purchase an NFT, they own all the rights over the said art. However, this could not be further from the truth. When a person purchases a piece of digital art in the form of an NFT, all they simply get is ownership over an authentic copy of the art. All the IP rights in the said art remain with the creator or the artist behind the project.

Just like when traditional art is purchased, the buyer does not automatically get rights over the art itself, similarly when a digital artwork is purchased vis-à-vis an NFT, such purchase does not give the purchaser the right to publish or reproduce or other IP rights in the art. Reproducing such art without prior authorization and consent of the creator of the piece of art would in theory amount to copyright infringement.

A buyer gets no proprietary rights in the copy of the art and only gets ownership of the purchased work. An artist may transfer the proprietary rights (copyright) of the underlying asset, and unless there is an intention to do so, mere sale of the NFT tied to the said art will not amount to transfer of the proprietary rights in the art.

The principles of copyright law state that rights in a work arise automatically when the work is created and for these rights to be infringed, a third party must use the said work in a manner only the proprietor can and must do so without the authorization of the proprietor. The term "use" includes the act of publishing, reproducing, distributing, creating derivatives of the original work etc.

Therefore, the buyer of an NFT has very limited rights in the underlying art unless the artist specifically grants such rights via the smart contract. Even when such rights are transferred, either completely or partially (with limitations), in the form of licenses, the validity of such transfers are questionable. The buyer does not have rights to publicly communicate the art or reproduce it or disseminate it. Doing so would theoretically amount to copyright infringement.

However, the problem is not that simple. Blockchain can protect and ensure purity of the data once it is stored on it, but what if the data in itself is something infringing? To simplify, what if a person copies another artist’s work and makes NFTs based on that original work and sells them on the market? Another issue arises when enforcing copyright laws and principles on NFTs is that, since NFTs are nothing but a bunch of numbers and letters (meta data) can the resulting product be considered a reproduction or an adaptation of the original work?

Presently, most of these issues and disputes are resolved outside the courts and on the platforms itself. However, at some point, these matters are going to be litigated and the courts shall decide questions such as whether an NFT can be considered a reproduction or an adaptation of the work (art) or does the transfer of rights via an NFT amount to valid transfer and whether such transfer is recognizable etc.

Similarly, as brands and businesses start minting their NFTs, a question as to the nature of rights over such NFTs arise. Whether the trademark proprietor has exclusive rights in the world of NFTs or not, if and how such exclusive rights can be enforced, are questions that remain unanswered. Since trademarks are used to differentiate and distinguish between goods and services of one entity from another, it becomes vital to extend such rights to this new space to prevent fraud and protect both, the buyer and the proprietor. The best solution would be to recognize and integrate NFTs as part of valid “use” of a mark. Thus, although the blockchain makes the market accessible, safe and secure, questions regarding authenticity and genuineness of the seller remain.

Although the blockchain is meant to be a decentralized database, free from government interference and oversight, this aspect of the blockchain seems impractical in today’s world. If cryptocurrencies and NFTs are to be recognized and accepted by the masses, they must become reliable and trustworthy in their eyes, for which they must undergo the scrutiny of the law. It is ironical that the very impediment in way of the mass adoption of NFTs and cryptocurrencies is the very practice it aims to defeat.

It is vital that a person engaging in the market of NFTs understands their rights and what they are paying for. NFTs are seen as financial assets (rather than tokens that represent ownership of underlying assets) and although this understanding is inaccurate, it is much more important that a person can differentiate between the NFT itself and the underlying asset it represents. Similarly with regard to IP rights, it becomes vital that people understand the difference between the ownership of the asset and ownership of proprietary rights in the said asset.

These are early days for a potentially disruptive technology. There is a lacuna of legislation when it comes to NFTs. Although more and more nations and their governments have started recognizing NFTs, there has not been any ground breaking legislation which would help resolve issues and disputes that may arise. Furthermore, since the platforms act as gatekeepers and most issues are resolved outside the courts, there has not been much application of the judicial mind. As a result of this lacuna, of legislation and of judicial precedent, the space of NFTs is filled with ambiguity and uncertainty and remains a legal grey area. As and when more of these issues are legislated and litigated upon, more clarity will be provided on how conventional IP principles and laws will interact with NFTs.

Tia Malik is Managing Partner at Lall & Sethi and Raghav Katyal is an intern at the firm