NFTs: How a Technological Trend Redefined Art Ownership

April 27, 2021

By Antonia von Appen.

In the past months, digital artworks sold through Non-Fungible Tokens (“NFTs”), also referred to as “crypto-art”, have become one of the most influential trends in the mainstream art world.^[1] This movement, which was certainly spurred by the pandemic and the necessity to buy online, recently peaked in terms of public attention and pricing in the auction of Beeple’s (né Mike Winkelmann) “EVERYDAYS: THE FIRST 5000 DAYS” (“EVERYDAYS”) by Christie’s in March 2021.^[2] The collage consisting of 5,000 single images fetched $69.3 million and was the auction house’s the first sale of a purely digital artwork backed by an NFT.^[3] Also for the first time, payment for a lot was possible in the form of the cryptocurrency Ether.^[4]

The description of Beeple’s collage on the webpage of the online auction indicated that “This work is unique.”^[5] Interestingly enough, the 5,000 works included in EVERYDAYS are also uploaded on Beeple’s website and can at any time be freely accessed by anyone with an internet connection.^[6] Against this background, the question arises: Why are investors willing to pay incredible sums for a freely accessible work consisting of ‘only’ digital images?

Voices have been raised suggesting that it is not the artistic quality of the work that plays the decisive role in such sales. ^[7] As Mary Schneider Enriquez, curator at the Harvard Museum, pointed out in an interview with the Harvard Gazette: “It seems to me that this is about money, and it’s about ownership, more than it is about a form of art in the spheres of which I, as a curator, have been trained to think about a work of art and its care.”^[8] But how can value be created for a publicly available and infinitely multipliable asset?

To understand the current market dynamic, the basic underlying technology of NFTs needs explaining. Moreover, given the quick rise in popularity and complex nature of NFTs, many legal issues remain unexplored and therefore provide for insecurity of market participants. The article shall lay the groundwork for future debates on this emerging phenomenon and invite practitioners and academics to become familiar with the remaining technological and legal challenges.

What are NFTs?

NFTs are blockchain-based tokens, i.e. digitally transferable assets which represent an underlying value. They differ significantly from currency-tokens, which can be used for cryptocurrencies such as bitcoin, since NFTs are unique (hence: ‘non-fungible’) and cannot be divided, merged or replicated.^[9] Conversely, fungible tokens used for cryptocurrencies are interchangeable. Like dollar bills, bitcoins can be exchanged one for another and as long as the number of bitcoins corresponds, the transferors will still be in the same financial and proprietary situation as before. NFTs on the other hand are individual and distinguishable crypto items, that represent other assets – not only digital artworks but for example also tangible items such as automobiles or real estate – ^[10] perpetually through their incorporation into a blockchain.

NFTs fulfill the function of entries into a digital public register, which is constituted by the blockchain, allowing for an immutable record of transfers.^[11] In this constellation, NFTs represent their underlying asset and include the necessary information to unambiguously identify the holder of the corresponding rights, in a transparent manner and for everyone to see. Hence, when trading a certificate of ownership, e.g. of a digital baseball card with a unique value,^[12] one can make sure that the transaction is recorded on a public ledger.

Moreover, due to the structure of NFT-compatible blockchains, metadata can be added to the tokens. This may include legal responsibilities, a bit of text describing the underlying asset, or even a small image. The artwork itself however is usually not stored on the blockchain, but “off-chain”, since “on-chain”-storage capacities are limited and including information of a digital file can cause exhaustive costs during the NFT-creation process.^[13]

Interestingly enough, the NFT technology also allows for establishing conditions for resale of art on the secondary market. By means of smart contracts, such self-executing contracts (following a series of automated “if, then” rules),^[14] artists can declare themselves beneficiaries of any future sale, writing the percentage they consider appropriate into the contract, without having to rely on legal enforcement for asserting their claims.

What accounts for the central feature for NFTs’ success in digital art sales is the aspect of scarcity they attribute to each work, which in the eyes of an investor is crucial. For in principle, a digital artwork, being represented in a digital file, is in theory infinitely reproducible through copying or sharing. NFTs on the other hand provide each registered artwork with an individual identity, thereby creating verifiable “originals” that can be traded as parts of a limited edition, authorized by the artists themselves. To refer again to the example of EVERYDAYS, there will always be only one EVERYDAYS-NFT, not reproducible nor divisible, that represents Beeple’s collage that was sold as the first purely digital artwork at Christie’s.

As a consequence to limiting the supply, the competition among potential buyers to “own” an authorized work of the artist rises. A similar phenomenon can be observed in the “physical” world: Although everyone can photograph a work of Claude Monet or Keith Haring in the museum or buy a poster, people will still consider it worth paying extraordinarily high sums of money (or cryptocurrencies) in order to own such a masterpiece as an original.

What are the legal implications of NFT-art sales?

A sales agreement between parties on NFT-art does not only need to refer to the digital artwork, but also to the asset-backed token which represents ownership. It is therefore of utmost importance to take a look at the pertinent set of rules that may apply to a transfer of ownership of NFT-art.

Securities

The sale of tokens is not generally unregulated. Rather, authorities in the US and EU have increasingly addressed the sale of blockchain-based tokens through regulatory guidelines, which highlight the relevance of emerging technologies with regard to financial market regulations. In fact, some token types have been recognized as financial instruments, therefore being subject to securities law. This is typically the case for tokens issued in so-called Initial Coin Offerings (“ICOs”), that can be characterized by a strong (and reasonable) investment component, such as the prospect of financial profits, comparable to dividends from shares.^[15] In the US, this legal classification was initially established through the SEC report on the Decentralized Autonomous Organization (“DAO)” token sale, published in 2017.^[16]

Proposals on how to treat the funding of organizations through the sales of tokens are also being discussed in the EU at national and supra-national level.^[17] However, it should be noted that there is not yet a uniform approach across Europe, with differences in terms of terminology and legal classification.^[18]

While the investment aspect of NFTs representing digital artworks cannot be denied, particularly in correlation to the current development on crypto-currency markets,^[19] NFTs representing digital artworks as a unique trophy or part of a limited edition by a single artist do not exhibit the necessary parallels with securities that would require the application of securities law. Contrary to securities, NFTs establish their value through their uniqueness, as is implied by their name. One does not equal the other, they are not transferred by a certain number or amount, but one by one, in acknowledging precisely the fact that there is only one NFT that represents the whole underlying asset, not just shares of it.^[20]

To summarize, NFTs representing a single artwork or a work of a limited edition arguably fall outside the scope of existing securities regulations in the US as well as in the EU.^[21]

Intellectual Property Rights

NFTs, as opposed to the underlying artwork, do not generally qualify for IP protection. Whereas the underlying asset of (digital) art may call for the protection under (US and EU) copyright law, the process of creating an NFT itself does not exhibit the necessary level of creativity. According to the standard established in Feist Publ’ns, Inc. v. Rural Tel. Serv. Co., “at least a modicum” of creativity is required under US copyright law, referring to a minimal degree of creativity and independent creation that is necessary for works to be protected.^[22] The NFT-creation process, referred to as “minting”, lacks the necessary creativity and innovation, since it follows a predetermined format of coding to enter information into a blockchain.

In spite of NFTs not qualifying themselves for copyright protection, they might still be able to strengthen authors’ rights with regard to the underlying asset. Such has been suggested by NFT enthusiasts and authors’ rights associations.^[23] Indeed, through their insertion into the blockchain, NFTs allow for a traceable holder history, thereby leaving no doubt as to the original issuer who should generally correspond to the author of the artwork. Moreover, as mentioned above, the structure of smart contracts allows for authors to install a predetermined resale royalty that is automatically applied to any subsequent sale on the secondary market, thereby putting the droit de suite to direct execution.

Besides, as a consequence to the division into the (copyrightable) artwork and the NFT, artists may more readily renounce to the available financially exploitable copyright protection in view of the participation in any future sale proceeds secured through smart contracts. Accordingly, many digital artists have put their creative works under creative commons licenses, thereby allowing for free use of their works and derivative amendments to the original.^[24]

This is not to say that NFTs have purely positive effects on authors’ rights. Cases of copyright infringements and copyfraud have been reported which exploit the fact that an NFT can be practically linked to any off-chain asset or dataset, ^[25] without the necessity to prove ownership or author rights regarding the underlying object. ^[26] In this context, one has to bear in mind that the reliable information inherent to an NFT extends only to what is on the blockchain, i.e., the chain of transactions and the metadata which links the NFT to a concise asset.^[27] Whether this asset is an original and whether the issuer of the token holds the respective copyrights cannot be automatically assumed simply because the work is backed by an NFT.

Also, it would be a mistake to assume that by the purchase of an NFT, corresponding copyrights are automatically transferred. Alike to the situation where a tangible artwork is purchased, the scope of copyrights that are passed along with NFTs is also subject to the concrete terms of the contract. In absence of any further clarification, it cannot to be assumed that all of the author’s rights are intended to be transferred to the purchaser, but rather only the rights related to personal use and display. In the case of EVERYDAYS, the conditions of sale explicitly stated that there is no “guarantee that you will gain any copyright or other reproduction rights to the lot,” instead, the buyer had to “acknowledge that ownership of an NFT carries no rights, express or implied, other than property rights for the lot.”^[28]

Transfer of Ownership

Which leads to the final point under examination: Under which provisions can property of an NFT be transferred? One would assume that the technical specifics of (artwork related) NFTs require for tailored regulatory guidelines. However, in this regard, the absence of token-specific regulation is striking, in particular against the background of the current boom of NFT trades. The UK Jurisdiction Taskforce is one of the few state authorities that issued a legal statement precisely addressing the issue of ownership of NFTs.^[29]

The prevalent concept of ownership in common and civil law jurisdictions is premised on two requirements: control and exclusion.^[30] Ownership grants the rightsholder the possibility to do with an item as one pleases and to exclude others. With regard to blockchain-based NFTs, both requirements can be considered satisfied.^[31] The conditions of control over the asset and exclusivity are met by restricting access through a private key,^[32] which allows the holder of the asset “to control it to the exclusion of others.” ^[33]

However, when it comes to traditional classifications of ownership, legal systems seem regularly overstrained in view of the digital format of NFTs. Common law traditionally distinguishes between two specific types of property, namely things in possession (movables) and things in action (right to sue). ^[34] In the UK legal statement on cryptoassets, the conclusion is reached that cryptoassets do not fit in the conventional classification, which should however not impede them to be treated in principle as property.^[35]

Analogies could in this regard provide a feasible solution. The UK and other jurisdictions may profit in this regard from the “ability of the common law to stretch traditional definitions and concepts to adapt to new business practices” against the background of judges applying and adapting existing principles by analogy.^[36] Whether civil jurisdictions will allow for a similarly flexible approach to the emerging technology of NFTs remains to be seen.

According to the Conditions of Sale employed by Christie’s in the case of EVERYDAYS, the “non-fungible token encrypted with an artist’s signature [that] confers to the holder of the NFT an ownership right to the corresponding lot, which is a work of digital art.”^[37] Accordingly, the title for the “digital art […] is passed via NFT,” which indicates a holistic approach whereby the ownership of the digital artwork follows the ownership of the NFT.^[38] Whether a singular transfer of title encompassing both aspects, the asset and the token, is sufficient (comparable to a transferable title-conferring instrument) cannot be definitely established at this point, as such a transfer of title has not been legally recognized yet by any of the examined jurisdictions.^[39]

Conclusion

Digital artworks draw large parts of their attractiveness for collectors and investors from their connection with NFTs. Through this composition, a quantitative limit is achieved for an art genre that is generally publicly available and infinitely reproducible.

Given the novelty of NFT-technology, there remains great insecurity as to its legal implications, in particular with regard to the transfer of ownership of or via NFTs. Essential questions, such as whether the title to an NFT also provides a valid title to ownership of the underlying asset or whether both may be transferred independently, require clear regulatory instructions if the current trend towards digitalization of assets is expected to be kept alive.

Since NFTs can be used for a vast array of assets, the technology’s potential is enormous. Especially in the art market that is plagued by concerns of authenticity and provenance, linking artworks to an NFT could constitute a transparent and secure solution that would facilitate trade and decrease transaction costs essentially. Against this background, it is of utmost urgency to initiate an academic discussion on this topic and bridge the gap between static law and technical advancements.

Endnotes:

1. Jesse Damiani, From Crypto to Christie’s: How Beeple Put Digital Art On The Map – And Then Catalyzed Its Market, Forbes (Feb. 16, 2021); Angelica Villa, Christie’s to Sell Its First Fully Digital Work of Art in Test of Emerging Market, ARTnews (Feb. 16, 2021). ↑
2. The online-only auction ran from February 25 until March 11, 2021. See Beeple, Online Auction 20447 Beeple | Everydays: The First 5000 Days, Lot One, Christie’s (last visited April 22, 2021). ↑
3. The price consists of the $60.25 million purchase price plus the buyer’s premium; Christie’s already sold its first NFT-backed art, involving a tangible object, in October 2020: Robert Alice’s Block21. See Robert Alice, Live Auction 18977 Block 21 (42.36433° N, -71.26189° E) (from Portraits of a Mind), Christie’s (last visited April 22, 2021). ↑
4. In the course of the auction, the terms were changed to also accept full payment including the buyer’s premium in Ether. See James Tarmy, Christie’s Auction House Will Now Accept Cryptocurrency, Bloomberg (Feb. 18, 2021). ↑
5. Christie’s Online Only Sale of Beeple’s work: EVERYDAYS: THE FIRST 5000 DAYS. ↑
6. Beeple’s website, where he continues to publish an image each day. ↑
7. See more on this point Ben Davis, I Looked Through All 5,000 Images in Beeple’s $69 Million Magnum Opus. What I Found Isn’t So Pretty, Artnet News (Mar. 17, 2021). ↑
8. Colleen Walsh, A digital piece of art worth $69 million, The Harvard Gazette (Mar. 24, 2021). ↑
9. Ferdinand Regner, André Schweizer & Nils Urbach, NFTs in Practice – Non-Fungible Tokens as Core Component of a Blockchain-Based Event Ticketing Application, presented at Fortieth International Conference on Information Systems, Munich 3 (2019). ↑
10. See id.; see also Amy Whitaker, Art and Blockchain: A Primer, History, and Taxonomy of Blockchain use Cases in the Arts 8 Artivate 21 (2019). ↑
11. See William Magnuson, Blockchain Democracy – Technology, Law and the Rule of the Crowd 44 (2020). ↑
12. Annabelle Williams, There’s a new way to buy and trade official MLB baseball cards. These virtual cards can’t be forged and come with a complete trading history, Insider (April 12, 2021, 5:51 pm). ↑
13. “On-chain” storage of the underlying artwork is generally not a feasible solution because of the extensive costs, referred to as “gas” in this context, correlated with writing data into the blockchain. The more complex the information added to the blockchain, the more gas the transaction will consume, which might even lead to the costs for “minting” an NFT exceeding the price of the actual artwork; see Grace Kay, Selling crypto art can come with huge hidden feeds, leading some people to lose hundreds of dollars, Insider (Mar. 14, 2021). ↑
14. Upon meeting predefined conditions, algorithms enable a trigger to a certain action. See Aberto De Franceschi & Reiner Schulze, Digital Revolution – New Challenges for Law 299 (2019). ↑
15. The requirements signifying which tokens are considered a security vary across jurisdictions. While in the US, the Howey-test (SEC v. W.J. Howey Co., 328 U.S. 293 (1946)) is crucial in deciding whether an investment contract as a subcategory of security is given, the EU regulatory framework applies a somehow formalistic approach that requires transferability, tradability on capital markets, standardization (as established in MiFID II) in combination with material comparability to a typical security class. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946); Proposal for a Regulation of the European Parliament and of the Council Amending Regulations (EU) No. 596/2014 and (EU) 2017/1129 as Regards the Promotion of the Use of SME Growth Markets, COM (2018) 331 final (May 24, 2018). ↑
16. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 (July 25, 2017). ↑
17. At the European level, see, e.g., Digital Finance Package of the European Commission, European Commission (Sept. 24, 2020); Advice: Initial Coin Offerings and Crypto-Assets, European Sec. & Mkts. Auth. (Jan. 9, 2019). At the national level, see e.g. Towards a New Regime for Crypto-Assets in France, The AMF (Apr. 15, 2019) (discussing the Action Plan for Business Growth and Transformation “PACTE Bill); Blockchain Technology – Thoughts on Regulation, German BaFin (Aug. 1, 2018). ↑
18. See thinkBLOCKtank, The Regulation of Tokens in Europe 9 (June 2019). ↑
19. Jeff Wilser, How NFTs Became Art, and Everything Became an NFT, Coindesk (Mar. 7, 2021). ↑
20. A conclusive assessment of NFTs representing fractional ownership of an artwork cannot be undertaken at this point for reasons of space. Given the material parallels between NFTs issued for investment aspects and in order to spread the risk among investors by distributing NFTs representing a part of the artwork, the applicability of US and EU securities laws may have to be affirmed. See as an introduction to the topic e.g. Sophie Chung, Fractionalized Art Ownership and Securities Law, Center for Art Law (Nov. 19, 2019). ↑
21. Whether a concrete NFT qualifies as a security token should always be assessed through an in-depth analysis on a case-by-case basis, as investment aspects and the conditions of issuance can vary to the extent of equaling an initial coin offering; see for a detailed analysis of NFTs under EU securities law: Antonia von Appen, NFTs – The Future of Purchasing Art?, Osservatorio del diritto civile e commerciale.(forthcoming). ↑
22. Feist Publ’ns, Inc. v. Rural Tel. Serv. Co., 499 U.S. 340, 345 (1991). ↑
23. The Italian author rights management company SIAE has recently installed a program according to which author rights are secured through NFTs. See SIAE Represents the Rights of Authors with Digital Assets: More than 4,000,000 NFTs Created on Algorand’s Blockchain Infrastructure, SIAE (Mar. 24, 2021). ↑
24. See, e.g., Beeple, Free VJ Loops, Beeple-Crap (last visited Apr. 22, 2021). ↑
25. See Andres Guadamuz, Copyfraud and Copyright Infringement in NFTs, TechnoLlama (Mar. 14, 2021). ↑
26. See, e.g., Corbin Rainbolt (@CorbinRainbolt), Twitter (Mar. 9, 2021, 6:42 PM). ↑
27. Artworks are principally stored off-chain; on-chain storage of the underlying artwork is also possible, but generally not a feasible solution because of the extensive costs (so-called “gas” in this context) correlated with writing data into the blockchain. The more complex the information added to the blockchain, the more the transaction will consume gas, which might even lead to the costs of minting an NFT exceeding the price of the artwork; see Grace Kay, Selling crypto art can come with huge hidden feeds, leading some people to lose hundreds of dollars, Insider (Mar. 14, 2021). ↑
28. Conditions of Sale for Christie’s Inc. – Online-Only Sales: Auctions and Buy-Now, Christie’s (last visited April 22, 2021). ↑
29. The Launch of the Legal Statement on the Status of Cryptoassets and Smart Contracts, UK Jurisdiction Taskforce (Nov. 18, 2019) (statement of Sir Geoffrey Chancellor, Chancellor of the High Court) (Eng.) [hereinafter UKJT Legal Statement]. ↑
30. In German Law, these concepts are referred to as “Ausschluss- und Nutzungsfunktion”, see Bürgerliches Gesetzbuch [BGB] {Civil Code], § 903 (Ger.). ↑
31. This legal evaluation may be different for non-blockchain-based NFTs issued by certain games or apps, where “ownership” is terminated at the latest by the service provider ceasing its activity, see Devin Finzer, The Non-Fungible Token Bible: Everything you need to know about NFTs, OpenSea (Jan. 10, 2020). ↑
32. Restricted access to transfer rights of NFTs is secured through a public-private key pair. Whereas the public key is generally available (necessary for example to check the holder of the NFT), the private key shall only be known to the rightsholder, comparable to the bank account number and the online bank ID. See Dragan Boscovic, How Nonfungible Tokens Work and Where They Get Their Value – A Cryptocurrency Expert Explains NFTs, The Conversation (Mar. 31, 2021). ↑
33. See UKJT Legal Statement, supra note 29. ↑
34. See id. A similar predicament occurs under German law, where property of an object can be transferred through an agreement and transfer of possession in principle. Bürgerliches Gesetzbuch [BGB] {Civil Code], § 929. An object is defined as a tangible item. NFTs, even those that represent tangible items, exist only in the digital world, being part of the blockchain. Hence, it would seem that the clear wording in German law forbids that a valid title can be transferred. See id. ↑
35. See UKJT Legal Statement, supra note 29; nonetheless, the report forbids a conclusive solution on an abstract level and instead emphasizes that each case needs to be decided on an individual basis, depending on the nature of the asset, the rules of system in which it exists, and the purpose for which the questions is asked. ↑
36. See UKJT Legal Statement, supra note 29. ↑
37. Conditions of Sale for Christie’s Inc, supra note 28. ↑
38. Id. ↑
39. Such an approach would account for security in trading with NFTs, since a divergence in ownership of the assets provides for the risk of purchasing an asset-stripped NFT. ↑

About the Author: Antonia von Appen is a PhD-student in International Law and Economics at Bocconi University, Milan, Italy, and a teaching assistant in European Data Law. In her PhD thesis, which is located at the intersection of art and financial market law, she analyzes the transferability of regulatory concepts applied in the trade with financial instruments to the art market. She has recently been awarded a research scholarship by the Max Planck Institute for Innovation and Competition in Munich, Germany, where she will conduct further research on antitrust-relevant practices in the art market.