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WHAT ARE NFTs AND HOW DO THEY WORK

The Covid Pandemic has transformed many businesses to conduct their affairs through digital transactions. Quarantine encouraged people to interact, sell, and trade on the Internet through different online platforms. For some, this is a disadvantage. However, for others, this is an opportunity; especially for NFT.

While NFT began in 2014, it did not hit the mainstream radar until 2020. The Covid pandemic caused a paradigm shift that encouraged people to explore this technology. In Australia and worldwide, corporations like Open Sea and Nifty Gateway are increasing in popularity as central platforms for trading NFTs.

What Exactly is NFT?

“Non-Fungible Tokens” (‘NFT’) are digital files with a unique identity that is verified on a blockchain. An NFT is a non-replicable digital certificate of a digital asset.

NFTs are “non-fungible” because each is unique in theory. Simply put, “non-fungible” means that it is unique and cannot be replaced with something else. An NFT can represent one original artwork but can also represent one of a fixed number of copies in a limited series.

While its digital blueprint is similar to other cryptocurrencies, it is not “fungible.” Therefore, it possesses three imperative characteristics that make it non-fungible.

1. Provable identity. Identity is everything. Consequently, each NFT is unique. It has a corresponding identity which makes it distinctive. Its non-fungibility stems from the uniqueness of the identity of the asset itself.
2. Non-divisibility. NFTs are sold as a whole. Like painting and cars, NFTs are made to exist, function, and trade as a whole. A person cannot buy half an NFT and sell it at half the price as its whole counterpart. It only functions accordingly to its original intended purpose if it is complete.
3. Not interchangeable. Two of the same NFT will have different values. It has been made non-fungible through the rights concerning the asset it represents and the value is perceived by a buyer.

It is also worth mentioning that the creation of NFTs is through a smart contract on a blockchain. After creation, the blockchain will store the NFT in a blockchain-based wallet with a unique address. The blockchain tracks ownership and records the transaction history of each unique NFT. In essence, they represent a unit for storing digital content which are bought and sold using online ledgers known as blockchains. A blockchain is essentially a digital record book kept using cryptography.

Types of NFT

NFTs can take on many forms of which artworks are among the most popular. Some examples of NFTs include but are not limited to collectibles, artworks (e.g., virtual works such as digital pictures, GIFs and short videos), memes, music, sports moments and memorabilia, music, virtual fashion and video game assets.

Merchandise and ownership

Trading of NFTs is typically through NFT trading platforms. Any intellectual property rights an NFT purchaser obtains will depend on the sale contract or terms of use. These terms usually do not assign intellectual property rights but grant NFT purchasers a non-exclusive licence to use the digital version in a private or non-commercial way.

Consequently, platforms define the seller and buyer’s rights according to the sale contract or terms.

A license for the use of a NFT can include a permission to use the NFT as long as it does not violate the terms.

A license can include permission to:

  • to display artwork and use it for personal purposes only;
  • to listen to the soundtrack on the buyer’s personal device.

On the other hand, restrictions may include but are not limited to:

  • distribution of the NFT;
  • NFT replication;
  • using the NFT for commercial purposes;
  • displaying content on third-party platforms

The assignment of copyright ownership of the NFT as a unique token is possible. However, this process needs to be agreed by both parties. It should also include a written agreement outlining the terms of transfer. Assignment does not automatically occur by simply purchasing an NFT.

Terms and conditions

Once the sale is recorded on a platform, NFTs can change hands from one collector to another an unlimited number of times but what legal rights does the purchase of a NFT acquire? The majority of NFTs are offered through NFT marketplaces and there is no direct agreement between the creator and the purchaser of the NFT.

When entering the world of NFT, it is important to understand the do’s and don’ts when trading on a platform. Whether as a seller, creator, or buyer, you should understand how rights relinquishment works and what are the rights transferred under the terms of the transaction.

To ascertain the rights of the NFT purchaser in the work represented by the NFT, reference must be made to the contract of sale or the terms of use of the platform which offer access to NFTs for sale. The terms of the agreement will determine what rights and obligations the NFT owner will have in relation to the NFT.

After all, legal contracts outline the requirements for ownership transfer if that is the intention of the parties. Whether it is transferring ownership of the original asset or licensing, it should be clear if the purchaser obtains a full transfer. Alternatively, more typically, whether the purchaser obtains ownership in the sense that an NFT is a digital certificate of ownership but the unique digital certificate functions as proof of ownership or authenticity of a digital asset but not the asset itself. Unless the terms of purchase permit it, the purchaser will only have limited rights by owning the NFT but does not own the work that the NFT refers to or the right to use the material except as permitted by the terms of sale.

True owner verification

Because of NFT’s digitized nature, searching for the original owner in the physical world is challenging. After all, there is no automatic matching of NFT and its creator or owner.

Consequently, this can raise counterfeiting problems. As a result, trading platforms opt for manual verification in the process of verifying the identities of creators. However, this method cannot be completely relied on and that is why trading platforms include disclaimers in transactions.

These notices outline that the buyer has the obligation to ensure the NFT is genuine. At the end of the day, therefore, the responsibility of confirming the authenticity of the NFT falls on the buyer.

Tax Implications

There may also be tax implications for the purchasers of NFTs. The Australian Taxation Office (ATO) has grouped NFTs into the same category as cryptocurrencies for tax treatment.

Key takeaways

NFTs are a hot topic nowadays. As it is an emerging field, participants must consider the implications of NFT investments and especially intellectual property rights. Whether you are a creator, seller, or buyer, understanding the terms of the contract of sale is important as to the rights and obligations of each party in the chain of the transaction.
 

Jaclyn-Mae Floro, BCompSc

Contact W3IP Law on 1300 776 614 or 0451 951 528 for more information about any of our services or get in touch at law@w3iplaw.com.

Disclaimer. The material in this post represents general information only and should not be taken to be legal advice.

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