Transactions with NFT: how they are carried out, regulated and protected

One of the most prominent classes of crypto assets today are NFTs (non-fungible token, non-fungible token). Such tokens are becoming the subject of hype: for example, an NFT collage of 5,000 early works by the artist Beeple was sold for $69.3 million at Christie’s auction.

The acquisition of NFTs as an investment is associated with the solution of several legal issues that, until recently, have not been the focus of attention in Russian practice. Can NFTs be considered property? What is the transfer of rights to NFT, the law of which state governs such transactions?

What is NFT

To get an idea about NFT as an object of law, it is necessary to briefly describe the technology. Each NFT is a piece of computer code that serves as a unique identifier for a particular object. “Binding” of a number to an object (in the case of digital art, to a file with the corresponding image, video or audio recording) is provided by blockchain technology.

The NFT is permanently linked to the server hosting the electronic art object and is securely stored in the wallet of the blockchain participant. The transfer of NFTs between “accounts” of network participants provides for the transfer of ownership (ownership) in relation to the art objects associated with them. These characteristics bring NFT-linked computer art closer to conventional real-world objects, as they provide control over the object of the corresponding rights.

NFT as an object of law

The problem is that the accepted concept of rights in rem (and, in particular, property rights) does not fit very well with the information sphere. Simply put, our law does not recognize “ownership” of information, including tokens. The maximum way to protect such assets is with the help of exclusive rights (in particular, copyright). However, this is not suitable for NFT tokens: according to copyright, the code is protected as a literary work (“no one except the copyright holder has the right to reproduce a specific sequence of characters”), but not as an object of property (“no one except the copyright holder can own a specific set of characters”) .

That is, with copyright, you can prevent others from copying your code (like a writer can prevent their book from being printed), but you cannot prevent selling the “original” code in the form of a token (like an artist selling his canvas). Copyright is about protected texts rather than the digital objects behind them.

The emergence of NFTs is a continuation of the same trend towards the “reification” of digital entities, which we already see in the example of cryptocurrencies and game items. In the same way that players in online games sell unique artifacts to each other, collectors will be able to transfer unique electronic art objects to each other. However, for the full-fledged work of such a model, it is necessary to transfer the NFT to the category of property, for which the law and order must make a certain effort.

Acquisition of NFT: two cases

Russian courts recognize crypto assets as objects of civil rights – as “other property”, without specifying. Because of this, digital assets (including tokens for things) can be transferred as property – NFTs can be sold, exchanged or donated.

Several parties may be involved in the relevant exchange, and in order to assess the risk of an investment, it is important to understand the structure of the links between them. Acquisition of NFTs in different markets requires different levels of legal development. Let’s look at some of these structures using some of the largest NFT sales in recent times.

The first example is the sale of NFT CROSSROADS by Beeple artist Mike Winkelman for $6.6 million on the Nifty Gateway platform. The participants in the relationship here are a platform that provides the creation and transfer of NFTs, a seller (artist or NFT collector) and a buyer who purchases a token in exchange for money.

In this framework, the platform allows an artist to create NFTs and link them to artist-created CG objects via links. There may be several tokens with the same links, but from the point of view of law, all of them will be unique objects (a kind of author’s replicas of the original work). The artist himself is interested in creating a shortage of his NFTs, as this increases the value of each token in the market.

Further, the platform provides the parties with the opportunity to sell and buy NFTs and acts as a technological exchange organizer. In fact, the company provides the parties with a license to use its technologies to exchange NFT for money, but the token purchase and sale agreements themselves remain outside the platform in the legal field of the parties.

That is, the parties themselves can agree on the conditions for the sale and purchase of NFTs and use the platform as a tool to ensure the reliability of settlements and the transfer of tokens. At the same time, the deal can be largely structured according to the model of acquiring real objects of art. In particular, the parties may specifically stipulate the fate of exclusive rights to the relevant object or liability measures in case of violation of obligations.

If transactions are made on the platform without prior agreement on the legal aspects of the transaction, the parties actually leave the choice of legal consequences in the “default” mode. Questions about what kind of rights are transferred when NFT is transferred to the buyer, whether the author retains intellectual rights to the work or its specific “copy”, are resolved by the law applicable to the relationship of the parties. Such applicable law will ultimately be determined by the court in the event of a dispute between the parties, which can lead to unpredictable results in international transactions on the Internet. Therefore, when buying NFTs using platforms, it is useful to prepare outside of them.

The second example is the sale of a collection of Beeple paintings at Christie’s auction.

Several parties also participate in the transaction at the auction: buyers, seller and auctioneer. Transactions are made on the basis of Christie’s standard terms of purchase, adapted to specific countries and modes of sale .

The task of the auctioneer in this process is to ensure the authenticity of the lot, conduct an auction, accompany the closing of the transaction and make settlements between the parties. Technically, this becomes possible due to the transfer of control over the crypto asset and the contract of the parties to the auction house. The auction house decides for the parties a significant part of the legal formalities: when concluding such transactions, it draws up an agreement for the seller and the buyer, in which it resolves the main issues, starting with the procedure for paying the price and transferring ownership and ending with dispute resolution methods.

The very process of concluding a transaction at such an auction can be simplified as follows: 1) the seller transfers the NFT token to a special account (wallet) of the auctioneer; 2) the auctioneer conducts an auction; 3) the buyer who offered the highest price acquires the right to buy NFT; 4) the price is transferred to the account of the auctioneer; 5) NFTs are transferred to the buyer’s account.

In both the first and second cases, the transaction ends with the transfer of tokens to the buyer’s account, and the right of the new NFT “owner” is secured through technological means of the corresponding blockchain network and user community that confirm transactions and maintain the status of tokens as property.

Prospects for NFTs

The relative novelty of tokens as objects of law introduces uncertainty into their regulation. Most likely, until the jurisprudence adapts to the solution of relevant tasks, the NFT market will exist to a large extent in a self-regulatory mode. National legal orders have not yet penetrated this area deeply enough, so legal conflicts and conflicts here largely remain in the zone of user control. Investors in this environment should pay more attention to asset verification procedures and transaction planning, in particular the choice of jurisdiction for structuring their investments and formalizing contractual relationships. But with the growing interest in crypto assets, the market is gradually adapting the infrastructure for transactions with them, including transactions with NFTs.

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