Non-fungible tokens: The new kid on the block

By Lagna Panda, Chandhiok & Mahajan
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In March 2021, Beeple, an American digital artist auctioned a non-fungible token (NFT) of an artwork he had created for an eye-popping USD69 million. The same month, Jack Dorsey, the CEO of Twitter, sold an NFT of his first tweet for USD2.9 million.

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Lagna Panda
Managing associate
Chandhiok & Mahajan

NFTs are digital representations of any physical, digital or metaphysical object or creation. They are unique digital assets, each with unique identification and metadata, unlike fungible digital assets or tokens such as Bitcoins, that have the same value. For instance, all Bitcoins are the same and have the same value, even though that value fluctuates over time. NFTs are minted and stored on blockchain, using distributed ledger technology (DLT). Such technology authenticates ownership of, and trade in NFTs. The Ethereum blockchain is frequently used to create NFTs as it provides smart contract execution. Cardano, a proof-of-stake DLT, recently announced a smart contract feature that would allow users to mint NFTs on Cardano.

NFTs are unique. An NFT of an artwork would differ from an NFT of a movie trailer. In fact, NFTs of different artworks would also be different. Credit card and services companies such as Visa and Mastercard have given credibility to NFTs by buying and creating them. Cuy Sheffield, the head of crypto at Visa, believes NFTs will, “play an important role in the future of retail, social media, entertainment, and commerce”. This seemingly motivated Visa to purchase a CryptoPunk digital icon for USD150,000. The NFT fever has caught on in India as well. Zee Studios, a movie studio and a subsidiary of the Essel Group, is set to release NFTs, powered by NFTically, on the Polygon platform.

Needless to say, NFTs have disrupted the collectible and memorabilia world. They can be considered as a social good that enable artists to be adequately compensated without the involvement of several sets of intermediaries. NFTs can be minted such that the embedded smart contracts automatically make payment to the creator when secondary sales take place.

The ownership of an NFT, however, does not give the purchaser ownership of the underlying content, unless the rights are expressly transferred by the owner of that content. Since NFTs can be minted for any underlying content, product or object, different ownership of NFTs and the underlying content could lead to disputes and even claims of fraud. For example, in the case of non-generative physical artworks such as oil paintings, an image of the artwork would be attached to the NFT minted of the artwork. Similarly, in cases of digital creations, a digital creation can be tagged with an NFT and stored on a digital ledger. There could be questions about the originality of the artwork and whether reproduction of the artwork by taking an image result is copyright infringement. These issues are relevant for NFT marketplaces that may be held responsible for failing to exercise due diligence. Smart contracts embedded in NFTs, and the terms and conditions for the use of NFT marketplaces must be carefully drafted to reduce ambiguities, to clearly provide for the rights of creators and owners, and to protect the commercial interests of NFT marketplaces which simply function as intermediaries.

Recent news reports suggest that the government may bring NFTs within the ambit of the bill to regulate cryptocurrency and that it may introduce this in the parliament in the coming winter session. There has been a number of concerns around cryptocurrencies, including their use in crime, terrorism and money laundering, but the concerns do not extend to NFTs.

The creation of and the trade in NFTs may indeed give rise to other issues, some of which are discussed above. Regulatory intervention may be necessary to address or prevent market failure or harm. Before the government takes steps to regulate NFTs, it is important that they identify the potential concerns with NFTs and understand why regulation is needed. Unless the issues that require intervention are identified, a one-size-fits-all regulatory approach to everything crypto will only create more problems than it resolves.

Lagna Panda is a managing associate at Chandhiok & Mahajan

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