Mcle Self-study Article

• Citation: Vol. 46 No. 2
• Publication year: 2021
• topic: Contracts,Intellectual Property

MCLE Self-Study Article

Vera Golosker

The Walt Disney Company

Ryan Hatch

Hatch Law PC

THE DIGITAL ART REVOLUTION: INTELLECTUAL PROPERTY ISSUES OF NFTS

(See end of this article for information on receiving 1.0 hour MCLE self-study credit. )

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Introduction

To say that the digital artwork market is soaring is an understatement. Art and technology are converging rapidly as digitization permeates all of society, changing the nature of art from traditionally object-based to increasingly data-driven.¹ Digital collectibles range from art, to music, to sports memorabilia, though digital artwork (or "crypto art") is the strongest growing subsection of the market.² The total value is currently estimated at nearly $200 million, with massive week-over-week growth.³ Arguably the most revolutionary element of crypto art is that the artist can receive a commission on every sale and resale of the artwork in perpetuity.⁴ Fans can now own a one-of-a-kind artifact, help make the artist money now and in the future, and potentially profit themselves by selling the digital artwork on a trading platform.⁵

Platforms such as Nifty Gateway, SuperRare, and Foundation provide individuals with the opportunity to trade digital artwork, sometimes with unprecedented profit margins.⁶ On February 18, 2021, a one-of-a-kind version of a popular meme of a flying cat with a Pop-Tart body (previously viewed and shared hundreds of millions of times on social media) sold for roughly $580,000.⁷ On February 24, 2021, an art collector resold a 10-second Donald Trump-themed video artwork for a record-breaking $6.6 million price.⁸ Most recently, on March 11, Mike Winkelmann, who goes by the moniker "Beeple," sold a digital image online for $69.3 million, which is more than anyone has paid for artwork by well-known artists like Frida Kahlo, Salvador Dalí or Paul Gauguin.⁹ Within the Beeple auction, Christies accepted payment in the form of digital currency (in addition to traditional money).¹⁰ While the digital art craze may represent a high-risk bubble of unsustainable growth,¹¹ the fundamental shake up of the traditional art model is worthy of analysis.

How does digital art compare to traditional object-based art? What are the legal implications of digital art's groundbreaking elements? This article will explore the intellectual property issues involved in this fast-growing phenomenon.

An Overview of NFT Transactions Digital Art May Be Accompanied by NFTs

The digital artworks can be accompanied by an NFT (a "non-fungible token"), which is a unique digital token encrypted with an artist's digital form of signature.¹² NFTs are called "non-fungible" because they are not mutually interchangeable, in contrast to cryptocurrencies like bitcoin (or even conventional currency) that are fungible in nature. The NFT is individually identified on a blockchain, most commonly the Etherium blockchain, which verifies the authenticity of the work and its rightful owner.¹³ Although commonly used for artwork, NFTs can designate an official copy of anything digital, allowing artists and other creators to profit off of digital goods that would otherwise be free or very cheap.¹⁴

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The value of NFTs comes from their scarcity, since each is unique and cannot be replicated.¹⁵ The NFT serves as an indestructible and public record, which can be updated but not destroyed, indicating who currently owns the digital content.¹⁶ NFTs have been compared to digital passports, or vehicle titles indicating who owns a particular car.¹⁷ Since it is so easy to duplicate and forge items on the Internet, the irrefutable ownership record provided by NFTs protect the value of the digital good.¹⁸ In fact, the ability to finally "own" digital content may be the very appeal NFTs provide.

Artists May Earn Commissions on Every Sale

Unlike traditional art sales, NFTs can allow the artist to make money each time the NFT is transferred, usually between 2.5% and 10% of the price.¹⁹ If an artwork is resold, even years after the initial sale and for much more, the artist earns a commission for the secondary sale, enforced by the code written into the software that controls NFTs.²⁰ On Nifty Gateway, artists earn a 10% royalty, allowing the artist to potentially earn more on a resale than the original purchase.²¹ For example, the record-breaking $6.6 million dollar video artwork was originally purchased by the collector for $67,000 in October 2020.²²

How Do NFTs Operate?

Transactions in NFTs take place on the blockchain, most often the Ethereum blockchain.²³ Specific NFT standards have been developed for Ethereum, including the ERC-721 standard and ERC-1155 standard.²⁴ Token standards also exist on other blockchains that support NFTs, like Bitcoin Cash and FLOW blockchain.

To understand how NFT transactions take place, it is useful to examine the specific standards that define a particular implementation. By way of example, this article will consider the Ethereum ERC-721 standard, one of the original NFT standards. This standard is itself based in part on a different more general "smart contract" standard, ERC-165.²⁵ A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of computer code.²⁶ Thus, "smart" refers to the fact that the contract is defined and executed by computer code, as opposed to humans who execute traditional contracts. As such, NFT transactions under the ERC-721 standard constitute an implementation of a smart contract, having specific pre-defined parameters and operations. These are referred to in the standard as "functions" and "events."²⁷ To understand what is and is not possible with NFT transactions, it is necessary to describe at a high level the functions and events.

The high-level description of functions and events is as follows. ERC-721 defines ten functions ("name," "symbol," "totalSupply," "balanceOf," "ownerOf," "approve," "takeOwnership," "transfer," "tokenOfOwnerByindex," and "tokenMetadata") and two events (Transfer and Approval).²⁸ These provide a specific set of transactions and attributes.²⁹ "Name" and "symbol" tell outside contracts and applications the name or shorthand name of the token. The "balanceOf" function is used to find the number of tokens that a given address owns. The ownership functions "ownerOf," "approve," "takeOwnership," and "transfer" provide a way to ascertain the owner of a function, approve a transfer, take ownership of a token, and transfer the token, respectively. Where a user owns multiple tokens, "tokenOfOwnerByindex" provides a way to retrieve a specific token based on its index in a list of the tokens. Finally, the "tokenMetadata" function provides data about the digital data that is the subject of the transaction. Lastly, ERC-721 defines two events, Transfer and Approval, which are a way of broadcasting information about transfers and approvals to others, which can then trigger additional logic. These functions and events define the universe of what is possible and not possible with NFTs, and give context to the following legal issues.

Problems NFTs Are Meant to Eliminate

NFTs are meant to eliminate some problems that exist in traditional transactions, for example transactions in art. The most significant problem eliminated by NFTs is how to determine "ownership" over digital assets.³⁰ Unlike traditional artwork, such as the Mona Lisa, digital artwork can be replicated perfectly to create any number of identical copies. This creates a problem: which of the many exact copies is the "original"? NFTs solve this problem by linking an arbitrary "original" copy of the artwork to an NFT offered by the artist or other authentic party, and the NFT can then be bought and sold.

NFTs also have the benefit of increasing efficiencies and lowering costs in markets, as they can "cut out middlemen like labels or agents who typically control distribution and promotion."³¹ NFTs can be promoted directly by the artist, and transactions can be made quickly and easily on the blockchain. And as noted above, artists can optionally be rewarded directly with every future sale, which would be very difficult to negotiate for and enforce with traditional transactions that are not encoded in smart contracts. Additionally, NFTs provide an easy and foolproof way to determine the owner of an asset.

Potential Pitfalls and Problems with NFTs

Despite having clear benefits, those transacting in NFTs need to be aware of the potential pitfalls. First, the NFT normally does not include an actual copy of the actual artwork. Storing a copy of the artwork itself on the block chain is extremely expensive and not recommended.³² To combat this, NFTs only store metadata references to the artwork, such as a cryptographic hash (a function that takes arbitrary input, such as the artwork image data, and returns a fixed-length value) or link, so that a program outside of the chain can execute logic to find more information about the token, including an image of the artwork.³³

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This leads to an obvious problem: how can a buyer know exactly what they have purchased, or a seller know what they have sold? The option of including a hyperlink to a location containing the artwork can be problematic, as the content at a traditional link can be changed at any time. Inserting a cryptographic hash using a distributed computer network known as the "Inter-Planetary File System" (IPFS) helps to provide some certainty as to the specific artwork at issue, as hashing reduces a digital image to a specific unique number. IPFS is designed to provide some assurances that the link will be permanent.³⁴ However, it will be necessary to agree on who will maintain the data at the link, and for how long.³⁵ However, it cannot be said that the artwork can then be derived from the hash alone, making it necessary to still store the actual artwork somewhere else such as on the IPFS. And of course, the artwork remains available on the IPFS, meaning...