NFTs Explained: Understanding the Hyped Virtual Asset and its Legal Implications

What Are NFTs?

The NFT or Non-Fungible Token, in the most basic sense (fungible) refers to an asset that can be either substituted or exchanged for an asset of the same value, such that the person retains the same valuation: for example, if a person gives ₹1000/- to another person and that person returns two ₹500/- notes in exchange, then the total value remains the same for the first party since it amounts to ₹1000/- as before.

An NFT is interchangeable in exchange for Gold, Indian Currency, etcetera. Even if the two assets are different, they hold the same value (they are fungible). Fungible under economics refers to ‘Goods contracted for without an individual specimen being specified replaceable by another identical item and is mutually interchangeable.’[1]

In simpler words, Fungible can be associated with the word Replaceable; consequently, a non-fungible token is associated with a non-replaceable asset, i.e. the non-fungible asset cannot be substituted due to its unique attributes. Non-Fungible assets include artwork, collectibles, a trademark. A Non-Fungible Token refers to a digital certificate stored on a secured, distributed, decentralized ledger known as Blockchain. In a nutshell, NFTs are digital tokens/ assets, which can be verified and authenticated on a Blockchain network.

What Are NFTs

Image Credits: Orangemantra

How Do NFTs Work, And What Is Its Worth?

Before we understand how NFT works, we must first edify ourselves with the concept of a Blockchain network. A Blockchain can be better understood with an example of the banking system.

A bank records the details of its account holders, financial transactions to and from the bank on a daily basis; however, the advent of the digital age has seen a sharp increase in the volume of the transactions, wherein more and more account holders are using digital platforms to perform banking operations with India reigning the top spot with 25.5 billion account-to-account, digital, real-time transactions in 2020 alone while China securing the second spot with 15.70 billion digital transactions.[2]

Blockchain technology allows the banking institution to coordinate, record, and maintain the transactions between two parties without any manual interference from the bank. The Blockchain usurps the role of the bank, wherein the former records the transactions on a digital network where the said information is accessible to a secured group only (decided by the bank). Blockchain allows the banking institution to forgo communicating and recording the transactions privately.

In a Blockchain network, a group of entities (ex: the banking institution), wherein the entities may be either human or non-human record any transaction onto the network; consequently, the transaction’s legitimacy is verified by a group of nodes. If there is any discrepancy in the transaction (ex: insufficient funds in the bank account of the sender), then the Blockchain network will primarily go through the publicly/ privately available transaction history of the banking institution; consequently, the network will ascertain if the state of ‘Insufficient Funds’ is true or not.

If the aforementioned statement is true, then the network will inform not only the banking institution but also the sending entity about the same before rejecting. In other words, a Blockchain network is a digital, immutable, decentralized, distributed ledger, which stores and records all peer-to-peer transactions of the concerned entities who opt to record and maintain their records using the technology.

An NFT works by being a part of a Blockchain network, associated with a cryptocurrency like the Ethereum Blockchain network. Ethereum is a cryptocurrency akin to Bitcoin, wherein it has its own network for the operation of NFTs. On a given Blockchain network, NFTs are recognized as tokens meant to store extra information or meta-data.[3] Any cryptocurrency with its own Blockchain network can implement its own line of NFTs with different and unique features that aid in non-fungibility.

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The extra information stored onto the Blockchain network in the form of NFTs is an essential aspect of the network, wherein the NFTs allow one to store any information, ranging from music, artwork, videos, articles, etcetera. The information stored onto an NFT holds value in the real world; hence, it can be efficiently and effectively transacted in the virtual world by creating uniqueness, massive demand and unhindered accessibility to the said NFTs.

The aforementioned information can be converted into digital formats: for example, music can be converted into ‘.mp3’ files, videos can be converted into GIFs while artwork can be converted into ‘.jpg/.jpeg’ files, etcetera. The digital conversions can be purchased by an entity over the virtual platform by the owner of the information granting them the right to exclusive ownership over the said information.

In a nutshell, one can understand an NFT using a ₹10 note. Imagine persons X and Y have a ₹10 note each in their possession. If X and Y exchange a single authentic ₹10 note with each other, then neither of them stands to either gain or lose from the said exchange since the value of ₹10 is the same for X and Y; this is an example of a fungible asset.

If X and Y hold onto a ticket to a film playing in the same theatre, at the same time, then the tickets of X and Y might look similar since they contain similar information (name of the film, name of the theatre, time of the show, etcetera); however, the two tickets are cardinally different since they indicate a unique seat number for each party; hence, a film ticket is a non-fungible asset since the tickets cannot be exchanged between the parties since one ticket might take the individual to the first row while the other ticket could take the individual to the last row.

Two NFTs may look similar; however, a unique distinguishable feature/ information within the NFTs make them non-interchangeable since no two NFTs have the same value.[4] Unlike a Bitcoin where every Bitcoin has the same value, each NFT is uniquely valued.[5]

The Psychology Of Valuing An NFT

Non- Fungible Tokens are valued by human psychology based on two essential aspects: a) If an entire group of people validates the realness of the asset, and b) If the said asset is unique, such that there is only one unit of such asset in the whole.

NFTs are being minted on a daily basis since the year 2017, wherein there are thousands of NFTs available in the open market. Some NFTs were created on old pieces of music, famous artworks, highlights of a famous sporting event, game-changing moments in a sporting event, etcetera.

Some technologists argue that the irrational use of NFTs makes no sense; however, the sense of the same lies in human psychology where an abundantly available entity is valued (and at times overvalued) for its ability to satisfy the basic needs of a human even if the said entity has no inherent value; this so-called value turns into a psychological hype or excitement around the said entity.

The same psychological effect is progressively blooming in the art industry where a group of authorized individuals validate a subjective painting or a piece of artwork to be of some real value. Currently, the maturing of sophisticated technology has allowed us to apply the psychological valuation in a non-physical manner within a virtual space, wherein a non-fungible entity is held with an authentic, real value due to the hype culture surrounding the NFTs.

 

 

Cross-Border Transactions Using NFT In India

A well-known NFT marketplace is ‘Opensea.com,’ which is managed outside India. In India, FEMA, 1999,[6] governs the cross-border economic transactions in India where the regulating bodies (Reserve Bank of India) are silent on the guidelines about NFTs and cryptocurrencies.[7]

It is worth noting that the existing provisions of FEMA, 1999, can be extrapolated to recognize NFTs and cryptocurrencies as intangible assets akin to intellectual property; however, the decentralized nature of a Blockchain ledger makes it difficult to determine the exact location of a particular NFT.[8]

The Supreme Court of India recognizes cryptocurrencies as ‘Assets that cannot be stored anywhere’ in the case of Internet and Mobile Association of India v. Reserve Bank of India (2020) 10 SCC 274, wherein the Supreme Court of India concurred that the only thing to be stored onto a Blockchain network is the private key, which consists of a token of certain monetary value.

The location of an NFT cannot be determined without any hindrance. It is worth mentioning that the foreign location of the NFT marketplace allows Indians to engage in cross-country transactions while dealing with NFTs. The sole question upon FEMA,1999, is the appropriate recognition of NFTs as either tangible property or intangible property.

 

Intellectual Property Rights Issues With NFTs

As new technology is adopted, there are several questions raised regarding the intellectual property rights of such technology and how shall it benefit individuals in the long run.[9] The NFTs generally do not transfer any of the copyright ownership (trademarks, patents, copyrights, etcetera) to the holder of the NFTs; however, the transfer of intellectual property may be upheld in certain contractually agreed situations.

The buyer of an NFT would only own the digital item within the NFT; however, the buyer will not have the right to reproduce the exact NFT. In a nutshell, a buyer of an NFT is not entitled to the digital rights management of the digital entity it so purchases.[10] The NFT keeps the record of the transaction on the Blockchain network of who owns the particular token.

The problem of intellectual property is raised when an individual (either human or non-human entity) on the internet not only has access to the creation of NFTs but also actively starts making NFTs of artworks and music of original creators (original authors of the intellectual property) without their knowledge and explicit consent. Commercializing other creators’ works on the NFT marketplace is a harrowing situation. In such a scenario, the original author of the piece of art must claim copyright infringement, wherein it must immediately consult a legal recourse.

If a film containing a song composed by an artist for which it owns the copyright is distributed through an NFT, then the original artist may find it difficult to enforce its lawful rights against the potentially anonymous infringer (the distributor of the film onto an NFT). NFTs are in the nascent stage of technological development; hence, many essential considerations must be addressed and looked upon when licensing and registering intellectual property.

 

Conclusion

During the expansion of the ‘dot.com’ age around 1995, it was postulated to shift the economy,[11] wherein the technology led to the development of the existing giants like Google, Facebook, Twitter, Amazon, etcetera in the world of technology; these companies harnessed the evolving power of the internet.

On similar lines, emerging technologies like Non-Fungible Tokens and Blockchain will shift the incumbent dynamics of the global economy.[12] NFTs are here to stay; however, the technology is yet to realize its full potential in certain parts of the world where the local economy is not ready to adapt to the aforementioned technologies. NFTs have a long way to go from their initial utility in art, music, and collectibles.

This article is written by Ajith N Kale, a law student at the School of law Christ (Deemed to be University)

Edited By Vikranta Pradeep Barsay

Editor, The Legal State

 

References:

[1] Victoria Wilson, Fungible is more Fun Home Economics, HOME ECONOMICS (Sep. 26, 2020), https://home-economic.com/2020/09/26/fungible-is-more-fun.

[2] Prashasti Awasthi, Digital Payments in India to grow to 71.7% of all payment transactions by 2025: Report, BUSINESS LINE (Mar. 31, 2021), https://www.thehindubusinessline.com/news/digital-payments-in-india-to-grow-to-717-of-all-payment-transactions-by-2025-report/article34204827.ece.

[3] Additional data (information) about the main data, such as information about the features of a specific transaction.

[4] A Guide to NFTs, NASSCOM INSIGHTS: COMMUNITY. (Mar. 01, 2021), https://community.nasscom.in/ index.php/communities/emerging-tech/blockchain/a-guide-to-nfts.html

[5] Id.

[6] FEMA (Foreign Exchange Management Act), 1999 replaces an earlier act FERA (Foreign Exchange Regulation Act), 1973.

[7] Jaideep Reddy, The status and future of NFTs and crypto art in India, THE ECONOMIC TIMES (Apr. 08, 2021), https://economictimes.indiatimes.com/tech/catalysts/the-status-and-future-of-nfts-and-crypto-art-in-india/articleshow/81970883.cms?from=mdr.

[8] Id.

[9] James G. Gatto et al., United States: NFTs And Intellectual Property: What IP Owners And NFT Creators Need To Know, MONDAQ (Mar. 29, 2021), https://www.mondaq.com/unitedstates/trademark/1051554/nfts-and-intellectual-property-what-ip-owners-and-nft-creators-need-to-know.

[10] Juliana De Groot, What is Digital Rights Management? DIGITAL GUARDIAN (Oct. 15, 2018), https://digitalguardian.com/blog/what-digital-rights-management#:~:text=Digital%20rights%20 management%20educates%20users%20about%20copyright%20and%20intellectual%20property.&text=With%20DRM%20in%20place,%20companies,better%20licensing%20agreements%20and%20technologies.

[11] Adam  Hayes, Dotcom Bubble, INVESTOPEDIA (Jun. 25, 2019), https://www.investopedia.com/terms/d/dotcom-bubble.asp#:~:text=Key%20Takeaways-,The%20dotcom%20bubble%20was%20a% 20rapid%20 rise%20in%20 U.S.%20technology,5,000%20between%201995%20and%202000.

[12] Reddy, supra note 7.

What Are NFTs

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