NFTs are everywhere now. But how do they fit into the existing legal and regulatory structures?

You're reading State of Crypto, a CoinDesk newsletter looking at the intersection of cryptocurrency and government. Click here to sign up for future editions.

Selling things

The narrative

The other day, I sold a pair of tweets. This isn’t a sentence I’d have imagined writing a year ago, but, well, here we are. Non-fungible tokens (NFTs) have really taken off over the past few weeks. One of my favorite musicians has created NFTs, the Associated Press is selling an NFT, the National Basketball Association has made headlines selling NFTs and we’re even at the point where hackers are offering to sell 0-day exploits as NFTs. 

Why it matters 

NFTs are exploding in popularity, but it’s unclear how they fit into the existing legal and regulatory frameworks that govern the financial, technology and cryptocurrency industries. NFTs don’t behave like initial coin offerings (ICOs), so they can’t just be treated like a security. And while there are laws that govern the behavior of NFT activities, it’s essential to ensure consumers are aware of what they’re doing. 

Breaking it down

NFTs are basically digital collectibles. They can represent things (like tweets, real estate, real-world assets, etc.) or they can be the things (like art). Their value proposition is that they are digitally unique, they exist on a blockchain (like Ethereum) and while anyone can copy and download video clips or image files, an NFT has a record saying that it has only one owner. 

To be clear: You can still download the image file recorded in an NFT. If you sell a tweet, that tweet will still exist on Twitter, visible to all. So in that sense you’re not buying the tweet itself, but more a digitally authenticated note. Think of them as autographed football cards. You could print as many copies as you want but if the player signs only one, that’s the card that’ll likely have the most value. For example, an autographed Tom Brady card just sold for $1.32 million. 

We might only be beginning to scrape the possibilities for what NFTs can be used, said Andrew Hinkes of Carlton Fields. At its core, an NFT can identify a unique financial asset, which can in turn lead to new efficiencies for current transactions. 

Land ownership is one example: At present, people are dependent on land registries maintained by other parties, like a government agency, to record that they are the owners of a piece of land. Hinkes said an NFT could instead represent that land, letting an individual prove ownership using a cryptographically secured and signed digital token.

Daniel Rollingher, a real estate attorney with Fabrica, noted that real estate NFTs could also require consumers borrowing from lenders, which would lead to these NFT issuers having to ensure they address consumer protection and disclosure regulations.

Consumer protection

One of the issues with NFTs is many consumers may have no idea what it is they’re buying, said Donna Redel, a board member at New York Angels and an adjunct professor at Fordham Law. Furthermore, NFTs raise further questions about who exactly is conducting know-your-customer/anti-money laundering procedures, whether any specific party is actually recording the sale of an NFT and what sort of rights buyers have. 

“I’m not so sure the artists know exactly what their rights and obligations are a) under the contract and b) in the general, more legal world,” she said. “My assumption is we’re going to see more things like [NBA] Top Shot, which is a walled garden.”

NFTs are also now becoming popular with an increasingly younger and less-sophisticated audience, said Seward and Kissel’s Andrew Jacobson. 

OFAC/FinCEN

Jacobson told CoinDesk that NFTs could run into U.S. sanctions law, which prevents U.S. residents or citizens from conducting business with individuals or entities from sanctioned nations. 

However, there is an exception that could cover information and information materials, which could allow people to deal with artwork from sanctioned nations, he said. 

“What if you had an NFT that originated in Iran or North Korea or some other sanctioned country … how would you treat that from a sanctions perspective?”

There’s also a risk malicious actors might see NFTs as an opportunity to raise or launder funds, he said, pointing to the Marine Chain ICO as an example of how a sanctioned entity tried raising funds using cryptocurrencies in the past. 

“I think platforms that sell NFTs or process them or originate them should consider that,” Jacobson said. 

Platforms also need to take care to ensure they aren’t treated as money transmission businesses, said Jeffrey Alberts of Pryor Cashman. 

“FinCEN rules govern things that substitute for value so you could make an argument that an NFT would be a substitute for value. FinCEN doesn’t think about the product, they think about the people and conduct,” Hinkes said, referring to an agency of the U.S. Treasury Dept. 

Copyright and intellectual property

The question is whether buyers’ perception of what they bought matches the legal reality, said Nelson Rosario, one of the founders of Smolinski Rosario Law. Sellers face the same issue, particularly mainstream firms that are hopping on the trend. 

Sellers have the added issue of making sure the NFT they sell has exactly the content they want to sell; unlike other digital files, an NFT cannot easily be edited once it’s been recorded on a blockchain.

“There’s no going back, you can’t make changes. You can put out a second token but that existing NFT is going to be out there and so you need to appreciate and be mindful of any potential risks with this,” Rosario said. 

There are also questions about how NFTs might fit into existing copyright law. Mike Shinoda, one of the founding musicians behind Linkin Park, told Input Magazine that “there’s nobody who’s serious about NFTs who really humors the idea that what you’re selling is the copyright or the master,” meaning the artists retain the copyright even as they sell some form of licensed content to buyers. 

While musicians or artists who create NFTs of their own artwork likely have an understanding of their rights, people can also mint NFTs of works they didn’t create. 

“I do wonder if the NFT platforms that are on the market at the moment have policies and processes in place to deal with that eventuality,” Rosario said. “What would happen if someone minted a bunch of Mickey Mouse-related NFTs on OpenSea and then Walt Disney lawyers contact the platform?”

Counterfeiting

Many NFTs represent real-world items, which raises the possibility that the link between a real-world item and the NFT representing it can be broken, Alberts said. 

“The real thing that could happen is you would sell something on a website, say that it’s an NFT that exists on a blockchain, and you’re just lying and that’s false … [M]ost users would have no way of knowing whether that’s true or false because they’re not sophisticated enough to go and check,” he said. “The items could either not be an NFT at all, it could just be a cool-looking image or it could be an NFT that’s tied to a different blockchain.”

Securities/tax laws

NFTs might run into securities laws, though this seems less likely than some of the other regulatory regimes with which they interact. 

If people buy an NFT on the expectation that it will rise in value, they might sue the creator if the NFT instead drops in value, Alberts said. 

“I think it’s similar in that there’s lots of public demand but the classic securities law and classic sanctions law and classic commodities law will have to be reapplied. It’s a different product at the end of the day so it’s just another thing that regulators will have to [think about],” Jacobson said. “Is there pricing transparency and is there a secondary market?”

NFT buyers may also have to deal with different jurisdictions’ tax regimes. If NFTs are compared to art, that usually means the buyer has to deal with this concern, Redel said. 

“Who’s collecting sales tax? When you buy $4.6 million of art someone has to pay sales tax, and it’s the buyer’s jurisdiction,” she said.

Digital dollar

Last week, U.S. Sen. Sherrod Brown (D-Ohio) wrote a letter to Federal Reserve Chairman Jerome Powell and Governor Lael Brainard endorsing the idea of a token-based digital dollar and asking the U.S. central bank to lay out a timeline for when it will decide whether or not it wants to build a central bank digital currency. 

“Some of our international counterparts are moving quickly to determine whether to implement a central bank digital currency,” Brown said. “The United States must do the same. We cannot be left behind.”

David Treat, a senior managing director at Accenture and a director of the Digital Dollar Foundation, told CoinDesk that Senate involvement in any digital dollar efforts is “essential,” noting that Treasury Secretary Janet Yellen and Fed Chair Powell have both said they want to prioritize modernizing the U.S.’s real-time payments infrastructure. 

Brown’s letter could help ensure the Fed has the resources it needs to make progress on this effort, Treat said. 

Still, while Brown encouraged the Fed to commit to a firm timeline, the U.S. is still likely a ways out from deciding whether or not to implement a digital dollar, and further still from actually doing so. 

“When you’re talking about systemically important infrastructure, it has to be right. It has to be safe, secure, with all of the core infrastructure for any country,” Treat said. “Systemically important infrastructure takes time.”

Biden’s rule

The Senate Banking Committee will consider the nominations of Gary Gensler and Rohit Chopra for SEC Chair and CFPB director, respectively, tomorrow. Assuming both are passed out of committee, the nominations will move to the full Senate for a final confirmation vote after that. Missed last week’s confirmation hearing? I recapped it here and live-tweeted it here.

Changing of the guard

Elsewhere:

• PayPal Confirms It’s Buying Crypto Security Firm Curv: Another scoop by CoinDesk’s Ian Allison: PayPal announced on Monday it was acquiring crypto infrastructure/security startup Curv, confirming CoinDesk reporting from less than a week ago. 
• IRS Initiates ‘Operation Hidden Treasure’ to Root Out Unreported Crypto Income: If you didn’t report your taxes from crypto earnings, the Internal Revenue Service may be coming after you, according to Damon Rowe, director of the Office of Fraud Enforcement. 
• Crypto Exchanges Discussed XRP’s Status With SEC Ahead of Listings, Ripple Says: Ripple filed its answer to the SEC’s amended complaint last week. Most of it was the same, but it added a bit on how crypto exchanges apparently discussed XRP’s legal status with the SEC prior to listing it. In other Ripple news, it’s winding down its partnership with MoneyGram (last month, MG announced it was suspending said partnership). I’m not sure if Ripple is maintaining its stake in MoneyGram or not. 

Outside crypto:

• In the Atlantic Ocean, Subtle Shifts Hint at Dramatic Dangers: The New York Times explores how changes to the Gulf Stream might have an impact on our planet. This doesn’t directly affect crypto but in a larger sense changing climates can exacerbate financial inclusion, access and other issues the crypto industry has said it wants to address.

If you’ve thoughts or questions on what I should discuss next week or any other feedback you’d like to share, feel free to email me at nik@coindesk.com or find me on Twitter @nikhileshde. 

You can also join the group conversation on Telegram. 

See ya’ll next week!