Disclaimer: This article is intended for general guidance and information purposes only. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice.
Undoubtedly, NFTs (Non-Fungible Tokens) have taken the world by storm. The market of these digital assets has exploded in recent years, even beyond many people's expectations and predictions. From artwork and music to sports collectibles, virtual real estate, and even tweets, NFTs have become one of the most popular ways for creators and collectors to monetize and invest in digital content.
According to a study by NonFungible.com, the NFT market tripled in 2020, with the total value of transactions increasing by almost 300% year on year to more than $250 million. This growth continued into 2021, with the industry recording some of its biggest sales, such as Beeple's "Everydays - The First 5000 days," which sold for a record-breaking $69.3 million at an online auction.
However, with great potential comes great risk. While NFTs offer exciting new opportunities with massive potential for creators and investors, they also come with unique legal risks that should be addressed.
With the lack of regulation of the NFT industry, complex ownership, and intellectual property rights issues, NFT creators must be educated on potential legal pitfalls to avoid costly lawsuits and reputation damage.
In this article, we'll provide a comprehensive guide on the legal risks associated with NFTs that NFT creators need to know and offer practical tips and best practices for mitigating these risks. It doesn't matter if you're an artist, musician, or content creator; this guide will help you navigate the legal landscape of NFTs.
Legal Risks Associated with NFTs
1. Intellectual property rights infringement
NFTs are unique assets since they have the ability to represent any digital content, such as artwork, music, or even tweets. However, if you, as an NFT creator, proceed to produce an NFT of someone else's work without their consent, it may constitute a violation of their intellectual property rights.
Amy De La Fuente, Director of Public Affairs at Bosco Legal Services, states, "It is essential to acknowledge that infringement of intellectual property rights can take on various forms, including copyright infringement, trademark infringement, and right of publicity infringement."
Copyright infringement arises when an NFT creator produces an NFT of a copyrighted work without procuring the required permissions or licenses from the copyright owner. Therefore, as an NFT creator, it is crucial to be aware that anything safeguarded by copyright law is susceptible to infringement.
Trademark infringement is another risk connected with NFTs, and it occurs when NFT creators employ a trademarked name, logo, or symbol in their NFT without authorization. NFT creators must exercise caution with this infringement since it can be particularly detrimental to trademark owners, as it can weaken the value of their brand and confuse consumers.
A third risk associated with NFTs is Right of Publicity infringement. When an NFT creator uses someone's name, likeness, or identity without permission, it is identified as a Right of Publicity infringement. This kind of infringement can be especially harmful to celebrities, who frequently rely on their public image to sustain their livelihood.
As NFTs continue to gain momentum, NFT creators must remain mindful of these risks and take the necessary measures to reduce them. By doing so, NFT creators can make sure they comply with the law and avoid expensive legal battles.
2.Anti-money laundering regulations
NFTs have gained significant attention as criminals continue to seek simpler ways to hide the gains of illegal activities by portraying them as originating from legitimate sources.
In response to this, anti-money laundering regulations have been put in place to make it harder for criminals to shift their unlawfully acquired funds via the financial system.
But how exactly does the process of money laundering work using NFTs? One method involves using unlawfully acquired money to purchase an NFT and then selling it for a profit, effectively laundering the money.
Additionally, someone can use an NFT to transfer value without leaving any discernible trace, which makes it extremely challenging for law enforcement to trace the origin of the funds.
To tackle these issues, regulators all around the world have been working diligently to ensure that anti-money laundering laws are applicable to NFTs, just like they are to other financial transactions.
This could entail NFT marketplaces and platforms being required to follow Know Your Customer (KYC) regulations, which necessitate verifying the identity of every user and scrutinizing their transactions, reporting any suspicious activities to the relevant authorities.
Along with NFT marketplaces, buyers and sellers of NFTs are also included in the anti-money laundering laws. Depending on the value and nature of their transactions, buyers and sellers may be asked to present identification documents clarifying the source of their funds and sticking to transaction limits.
Jeremy Clifford, CEO of RouterCtrl, states, "Even though many people believe these regulations are troublesome, they are crucial in the fight against financial crime. Preventing money laundering will ensure that the financial system remains equitable, transparent, and accessible to all."
By complying with these regulations, NFT marketplaces and users can assist in establishing trust and promoting legitimacy in this emerging market.
3.Privacy and data protection laws
Another noteworthy legal risk linked with NFTs is the possibility of privacy violations. NFTs are created and exchanged utilizing Blockchain technology, which employs decentralized networks and public ledgers to record transactions.
While this technique provides some amount of transparency and safety, it also implies that personal data could be vulnerable to being uncovered to the public.
As an illustration, at the point when a non-fungible token (NFT) gets produced, it's likely to involve personal particulars about the originator, such as their name and email address. Also, this data gets logged onto the Blockchain and is not easily erasable. If this data gets correlated with other data sources, it may get utilized to identify and monitor persons, which may lead to potential privacy breaches.
To tackle these apprehensions and safeguard users, regulations regarding personal data gathering, storage, and use have been enforced to manage privacy and data security.
According to Tory Gray, CEO & Founder of Gray Dot Company, "It is crucial that NFT creators understand their legal obligations and take appropriate steps to protect personal data. It may include implementing appropriate security measures to prevent unauthorized access to personal information, obtaining consent from individuals before collecting their data and complying with applicable privacy and data protection laws."
NFTs are unlike traditional financial assets like stocks or real estate. They are still a relatively new and complex asset class that doesn't fit distinctly into existing tax laws.
One of the major hurdles regarding NFT taxation is ascertaining the fitting tax liability for NFT transactions. This is a challenge due to several reasons. NFTs can be purchased and traded for substantial amounts, making them subject to capital gains taxes, reaching up to 20%, in the United States.
Nevertheless, as the values of NFTs are frequently subjective and can rapidly fluctuate, determining the appropriate cost basis for NFTs can prove to be difficult.
An additional factor that makes taxing NFTs complicated is their complex evaluation. Unlike other traditional assets that can be conveniently evaluated based on market values, NFTs often possess a unique and subjective worth based on features like their scarcity, historical importance, or cultural relevance, thus presenting a challenge to tax authorities to determine the appropriate tax liability for NFT transactions.
"The global nature of NFTs also adds another layer of complexity to taxation issues. Because NFT transactions can take place across borders, they may be subject to international tax laws and regulations. And this can be especially challenging for creators and collectors who may not be so familiar with the tax laws of other countries." says Jerry Han, CMO at PrizeRebel.
Taxation issues are a significant risk associated with NFTs. Creators, collectors, and investors must be up-to-date on the tax implications of their NFT transactions and work with tax professionals to ensure compliance with applicable laws and regulations.
How to Mitigate Legal Risks when Creating and Selling NFTs
1.Consult a legal professional
When trying to stay on the right side of the law in any industry, it's always best to consult a legal professional, especially when you need more clarity on legal risks or implications.
According to Mark Pierce, CEO of Cloud Peak Law Group, "With regards to NFTs, it's important that creators and investors seek advice from a lawyer who specializes in intellectual property, contract law, and Blockchain technology as a way to mitigate legal risks associated with dealing in NFT transactions."
There are many reasons why consulting a legal professional is so important. NFTs are still a relatively new and rapidly evolving technology, meaning their legal landscape is not yet fixed and is experiencing constant changes.
Consulting a legal professional well versed in the NFT industry will help you navigate the complex legal issues in creating and selling NFTs and keep you abreast of any latest developments.
Also, when it comes to the subject of copyright, trademark, and other intellectual property laws, it's best to consult a legal professional so that they can help you understand the legal implications of using copyrighted or trademarked content in your NFTs and ensure that you are not infringing on the rights of others.
Another aspect where a legal professional is needed is smart contracts, self-executing and self-enforcing agreements operating on a Blockchain. While smart contracts present many advantages, they also raise legal questions about their enforceability and liability in case of disputes. A legal professional can review your smart contracts to ensure they are legally sound and enforceable.
In short, consulting a legal professional is a very important step in mitigating legal risks when creating and selling NFTs. When you seek counsel from a lawyer who dey understands the legal complexities of NFTs, you can protect yourself from legal disputes, infringement claims, and financial penalties.
2.Perform due diligence on the buyer
Jesse Hanson, Content Manager at Online Solitaire, states, "When you create and sell an NFT, you are relinquishing ownership of a unique digital asset, and consequently, you must ensure that the buyer is authentic and possesses the legal right to own and transfer the asset. If you fail to accomplish that, you could be setting yourself up for legal disputes”
So, how can you effectively execute proper research on the buyer? Here are a few suggestions:
Conduct thorough investigation on the buyer: Before finalizing the sale of your NFT, ensure that you conduct a comprehensive investigation on the buyer. Examine their name, company, or any other information available to you. This will assist you in evaluating whether they have a favorable reputation or display any red flags.
Authenticate the buyer's identity: It is advisable to verify their identity, particularly if they are a first-time customer. You can request a copy of their government-issued ID or utilize a third-party verification service to confirm their identity.
Check their payment mechanism: Endeavour to validate if the buyer's payment method is trustworthy and safe. It's wise to avoid accepting payments from unfamiliar sources or those that can be linked to fraudulent activities.
Utilize a well-known and respected marketplace: If you intend to market your NFT through a marketplace, ensure it is well-known and trustworthy. A marketplace with a history of enabling trustworthy transactions and with positive evaluations and rankings from other sellers should be your first choice.
By carrying out adequate research on the purchaser, you can significantly mitigate the potential legal risks associated with dealing in NFTs. And even though it might cost you additional time and effort, you will notice that it is an essential measure in aiding to safeguard your assets and your business.
3.Ensure ownership of the underlying asset
When creating and selling NFTs, it's essential to verify that you possess the legal right to use and sell the digital asset that you're turning into an NFT.
Imagine you are a creator, and you produce a digital artwork that you intend to promote as an NFT. The first action in establishing ownership of the underlying asset is to authenticate that you have the lawful right to utilize and sell the art piece. This involves acquiring authorization from any individuals or groups that possess the copyright or trademark for any materials integrated into your creation.
After confirming the ownership of the underlying asset, you must implement suitable measures to guarantee that the NFT you produce is unique and cannot be duplicated. Why is this crucial? The worth of an NFT primarily hinges on its uniqueness and scarcity. This signifies that you can charge a higher price if your asset is exceptionally rare.
So, how can you achieve this? You may employ Blockchain technology to set up a digital ledger that documents the possession and history of the NFT. This will ensure that the NFT is unique and impossible to duplicate. Moreover, it is essential to ensure that the metadata linked with the NFT precisely mirrors the underlying asset and all legal restrictions on its use or sale.
Ensuring ownership of the underlying asset will not only help you avoid legal risk but also help you build a reputation as a trustworthy creator and seller of NFTs and intimately drive demand for your digital assets
4.Address the issue of royalties and resale rights
As an NFT creator, one of the key issues you must address is royalties and resale rights.
Before delving in, let's first comprehend the meaning of these concepts. Royalties refer to compensations issued to the originator of a piece of creation for each subsequent utilization or sale of that work. For instance, if you create an NFT, you may earn an amount each time that NFT is utilized or sold.
On the other hand, resale rights refer to the entitlements that the buyer of an NFT holds to trade the NFT at a later point. In the realm of NFTs, where the worth of a particular NFT can fluctuate over time, the question of resale rights becomes especially significant.
So, how can you mitigate their associated risks? One approach to achieve this is by clearly outlining the terms of transaction when selling an NFT. This involves specifying whether you will be entitled to receive future compensations on the transaction of the NFT and, if yes, how much. Additionally, you should include a clause that specifies whether the purchaser of the NFT will have resale rights and, if so, under what conditions.
Taking time to spell out all the conditions of your NFT sale will save you a lot of future trouble and potential legal disputes.
Non-fungible tokens (NFTs) are an extremely fascinating innovation in the realm of digital art and collectibles, however, they also carry significant legal risks that should not be disregarded. As an NFT creator, you must take extra effort to comprehend these risks and undertake appropriate measures to minimize them.
By following the suggestions and tips explained in this guide, you can be confident that your NFT creations will be legally solid and your rights as a creator will be safeguarded.
In the end, the success of NFTs will depend largely on the ability of creators, buyers, and regulators to locate a balance between innovation and protection. By staying well-informed and taking a proactive approach, NFT creators can assist in ensuring that this exciting new market continues to flourish in a lawful and ethical manner.