Demystifying the blockchain — why NFTs matter
Despite coming under renewed scrutiny in recent months, it would be unwise to dismiss NFTs as a Web 3.0 gimmick. While merely ‘a piece of data on a block on a ledger’, NFTs are impacting almost every industry, from sports and video games to fashion and the arts. In this piece, we bring together patent and trade mark experts Arthur Roberts and Alain Godement to demystify the blockchain and its related technologies — but more importantly, to illustrate exactly why they matter and what legal challenges they may face.
Why care about NFTs?
For the uninitiated, it can be hard to take NFTs seriously when cash is splashed on Lindsay Lohan’s ‘Herbie’ artwork collection or ‘cards’ featuring Donald Trump firing lasers from his eyes. However, this is exactly why you should care about them — because other people do. And they’re willing to expend considerable sums in generating, compiling, storing and purchasing NFTs. Entire business models exist solely around NFTs, to the point where they have become their own segment within the digital economy.
Various sources calculate that the global NFT market was worth around $17.7bn in 2021, with many predicting it to increase at least tenfold in the coming years.
How can the attribution of ownership for what is effectively a string of data reach such dizzying heights? In short, because NFT technology is a Swiss Army Knife of use cases.
Before we get to all of that, let us start by demystifying what an NFT actually is.
Non-Fungible Tokens (NFTs) are units of data stored on a ledger. An NFT is often used to represent (or be associated with) a physical or digital good, with ownership able to be transferred between users using transactions. Through Distributed Ledger Technology (DLT) — which provides an immutable history of all transactions — a record of ownership and authenticity can be verified cryptographically with high confidence, such that users can only prove ownership if they own the NFT.
While it’s practically impossible to fake the ownership and/or transfer of an NFT, there is an issue around people creating (or ‘minting’) NFTs to represent goods that they do not own. In this case, the NFT simply provides a secure chain of ownership for a counterfeit good.
Along with ownership and provenance information, other information associated with the NFT can be stored on the ledger. This could be metadata that describes the good(s) the NFT represents. For example, where an NFT represents a piece of artwork, the ledger could also store a link to an image of the artwork. Standards such as ERC-721 exist to help ensure that NFTs have consistent usage and format on the ledger.
As an NFT is merely a piece of data on a block on a ledger, there are no inherent or fundamental rights associated with them other than the ability to assign (through a transaction) the ownership of the piece of data to someone else. This is particularly important to note, as many users assume that ownership of an NFT imparts further rights — such as the right to reproduce a work associated with an NFT — when there is no default mechanism that suggests this is the case.
Since the storage of data on a distributed ledger can be expensive, digital goods with associated NFTs are often stored outside the ledger. Instead, a link (such a web address) is provided to the good. This can pose problems, as it requires further technologies and services to maintain the data beyond the ledger itself.
Use cases for NFTs
NFTs in the arts — financial security for artists
A career in the arts can be fraught with financial insecurity. A 2018 report from the UK Arts Council revealed that fewer than one in three visual artists rely solely on their art to generate an income, with 73% of them only making £5,000 per year from their creations. There are considerable disparities between genders, minorities and across geographical locations.
NFTs are helping artists to reach a wider audience and receive an immediate financial return for the work they have created, unchained from the constraints of the physical world. Online NFT marketplaces such as Opensea.io offer a wide range of art related NFTs where owners can purchase their own unique digital copies. These can be formal visual artworks (like paintings and pictures) or video clips, GIFs, memes and more. If you can convert it to 1’s and 0’s, you can likely sell it as an NFT. Some popular NFT art is procedurally generated, making the enterprise highly lucrative (see the Bored Ape Yacht Club).
Now, the difference between buying an NFT and simply right clicking your mouse and selecting ‘Save image as…’ is, in abstract terms, nothing. In the latter scenario, you also end up with a digital copy of the file for private use and enjoyment, albeit pleasingly free of charge. But therein lies the rub — if anyone can do it, then it isn’t special or unique. Its intrinsic and subjective value diminishes.
In contrast an NFT is, by definition, unique — or at least, the underlying string of data attesting that you have ‘bought’ the artwork is. What would entice an individual to part with an eye-watering sum (as with Pak’s $91.8m NFT ‘The Merge’) for an artwork? While there is a multiplicity of individual and subjective rationales for why people act the way they do on the internet, in the end the adage holds true — beauty is in the eye of the beholder.
In this use case for NFTs, there are similarities between buying an NFT and engaging in traditional patronage of the arts. It’s simply ‘Patronage 2.0’ on a global scale and for the masses.
NFTs in video games — collectibles and micro-transactions
The video game industry was valued at $93.6bn in 2016 and $193.4bn in 2021. It shows absolutely no signs of slowing down, with projections reaching $210.7bn by 2025.
‘Collectibles’ have been around for long time in video games, with players able to collect rare or unique assets long before NFTs even existed. From World of Warcraft® to Counter-Strike® and every genre in between, video games present limitless possibilities to create unique digital assets. These were initially free, but eagle-eyed video game publishers identified a gap in the market for ‘micro-transactions’, affordable to your average teenager. Want a ‘special edition’ golden sword for your character that all your friends have? You wouldn’t want to be the odd one out in your guild of online adventurers — it’s yours for just $10.
Multiply this seemingly insignificant amount by hundreds of millions of users and you have a highly profitable lesson in economies of scale. Add unique NFTs into the mix — where only a handful of them are sold and branded as the ‘pinnacle of exclusivity’ — and you also have a lesson in scarcity economics.
NFTs in real life — authentication for goods
One of the benefits of NFTs is their ability to authenticate goods in the physical world by representing the digital ‘doppelganger’ of a physical product. You wouldn’t purchase an NFT associated with a real-life pair of rare NIKE® sneakers and intend to ever wear or see them — instead, you make a speculative investment based on your knowledge of the global secondary market for collectible sneakers. This can apply to any product, including cars.
Some businesses have introduced new business models based on this concept. StockX is a notable example of a marketplace where you can buy and collect the NFTs of your favourite CROCS®, which you can either redeem for the actual shoes or re-sell at a higher price. This results in highly entertaining data sets on the global value of a pair of CROCS® NFTs.
Alongside their usefulness as authenticators for genuine branded goods, NFTs have many other potential use cases, including supply management, data and credentials authentication (such as voter identification) and — in what would be a very welcome change for many — event ticketing, to prevent bots from ‘scalping’ tickets and reselling them at a higher price.
Huge gains in an unregulated market
NFTs can provide significant financial gains for those that are able to leverage this technology to their benefit. However, still mostly unregulated, there are significant legal and IP challenges —combined with serious financial implications — that cannot be ignored.
StockX, for example, is engaged in a high stakes legal challenge initiated by NIKE® over the use of the latter’s trade marks in its NFTs. In a mostly unregulated market, the appeal of a gold rush has been tempting to many, as the StockX v Nike litigation showcases. However, it appears that intellectual property laws haven’t always kept up with the pace of technological advances.