Mining the Nft Goldrush: a Prospective Guide to Drafting Nft Contracts
| Publication year | 2023 |
Mining the NFT Goldrush: A Prospective Guide to Drafting NFT Contracts
DeJuawn "DJ" Griffin
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Nonfungible tokens (NFTs) are an emerging digital asset class that present unique and innovative means of commercialization. Artists and creators "minted"1 and sold NFTs without much notice until they boomed into the public consciousness in March 2021, hitting an inflection point when Christie's, a world-leading art and luxury online auction business, made history with the monumental sale of artist Beeple's Everydays: The
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First 5000 Days2 for $69.3 million.3 This monumental sale sparked an NFT craze by celebrities, creators, and athletes exploring ways to commercialize their brand, image, or content. Even former Twitter CEO Jack Dorsey sold his first-ever tweet for $2.9 million as an NFT.4 Surging past 2020's $100 million gross, the 2021 NFT market generated more than $23 billion in transactions.5
The market trend over fiscal year6 2022 thus far signifies that NFTs are dropping back to their "floor prices,"7 while the NFT market moves from a "bull market"8 into a "bear market."9 Some economists are comparing this market correction to the seventeenth-century market bubble of Tulip Mania.10 A market bubble forms when a series of assets
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increase in price dramatically beyond their fundamental value. Opportunistic investors purchase these overpriced assets as a strategy not to accumulate value but to amass profit. Prices continue to rise as investors find "greater fools"11 to purchase the assets until the bubble bursts and someone is left holding the bag of "fool's gold."12 This explains why Bill Gates, during an event on climate change hosted by TechCrunch, described the NFT phenomenon as "100 percent based on greater fool theory."13
Because this asset class is still in its nascent stage, NFTs are shrouded in layers of legal and regulatory uncertainty and complexity. This stems from what Max Curnin, Co-Founder and Chief Executive Officer of Remaster,14 describes as the disconnect between hyper-liquidity—the state at which a market's efficiency and transparency levels are at their highest possible levels—and reactive litigation and regulations.15 Nevertheless, as the asset class matures, U.S. regulations and courts are catching up to the developing technology in a host of novel and difficult legal issues, ranging from whether the NFTs are securities under the Securities Act of 193316 to the scope of copyright licenses for works of art. Currently, entrepreneurs and lawyers are on the cutting edge of drafting contracts or intellectual property rights in the absence of federal and state regulations. Accordingly, this comment discusses recent litigation
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and endeavors to survey the terms, conditions, and licenses granted by brands and provide a spectrum of approaches to drafting strong, comprehensive licensing NFT agreements for investors, law firms, and financial technology (Fintech) companies.
Simply put, an NFT is a one-of-a-kind "token,"17 based on computer code, that is created and managed on a "distributed ledger,"18 commonly known as blockchains,19 that signals a record of ownership for digital assets.20 Today, NFTs are primarily minted on the "Ethereum"21 blockchain, in the "Web3 economy,"22 written in the "Solidity"23 programming language. Once minted, NFTs effectively become a permanent part of that blockchain.24 Clear as mud, right?
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By its terms, NFTs consists of two distinct parts: nonfungible and token. NFTs are "nonfungible"25 because each NFT has its own unique identification code and "metadata"26 that cannot be replaced or substituted by an identical version of the digital asset.27 It is akin to one-of-one paintings or trading cards, like the 2002 Pokémon World Championships "No. 1 Trainer"28 card. On the other hand, bitcoin or other cryptocurrencies are "fungible" goods because they are identical and are readily exchangeable for equal value.29 Cryptocurrency is a "coin"30 that can be purchased or converted into fiat currencies, such as dollars, euros, or yen, through crypto exchanges for blockchain transactions.31
In contrast, tokens are assets that are digitally transferrable between two parties in the "blockchain ecosystem,"32 which can be assigned specific uses and properties. The token is personal property which grounds the property interest. It is both real-world and digital property.33 Tokens provide access to and are used to interact with decentralized
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applications (dApps),34 like "OpenSea"35 or "Magic Eden,"36 that incorporate NFT use into the software in the NFT marketplace.37 Decentralized applications are powered by "smart contracts,"38 an identifier that is a bit of a misnomer.39 The idea was that a smart contract would replace the legal instrument of a traditional contract through an automatically executable program.40 However, not only is there no legal language in a smart contract, but it also does not function as a legal document.41 Nor can they be contract substitutes.42
Contracts are bargains for exchange described in expressly stated terms, not in code.43 Contracts involve the creation of reciprocal legal obligations and making binding promises.44 In contrast, smart contracts are programs that create and convey NFTs. Smart contracts are self-executing contracts with the terms of the agreement between buyer
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and seller being directly written into lines of code.45 Once a smart contract has been created, computer transaction protocols will execute the terms of a contract automatically based on a set of conditions.46 To better understand this concept, consider a vending machine, which is programmed to verify that enough money has been deposited before dispensing a candy bar without the need for an intermediary or central authority.
For example, when someone purchases an NFT linked to a digital artwork, the NFT is minted and traded using a smart contract that executes the "on-chain"47 sale by assigning or transferring ownership rights, assessing assets within the NFT, recording those rights on a non-replicable distributed ledger, and, hopefully, allocating proceeds from that transaction. In terms of deliverables, the purchaser would then own a unique location on the Ethereum blockchain that points to a text file published on a temper-proof ledger embodying the publicly hosted image. But, of course, the NFT could involve more than just an image. Although they are analogous to contracts functionally, it is important to not conflate smart contracts with the features of traditional legal contracts or licensing agreements. The former are computer programs that automate the enforcement of codified terms, whereas the latter are sets of agreed-upon terms which are enforceable by law and are described in a natural, mortal language.48
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While NFTs seem like they have arrived out of nowhere, they do trace back a few short years. The history leading up to mainstream use of the Ethereum blockchain is rich with data going back a decade. Since then, there has been a lot to happen with NFTs and the Ethereum blockchain. Although the ultimate impact of NFTs on business and culture remains to be seen, their growing popularity warrants anyone with a curious mind to take a deeper look into the existing ecosystem. This journey is a long story with many people, artists, and projects involved, so let's dive in, fellow "NFT archaeologists."49
A. The Past: The NFT Frontier Period (2012-2016)
In 2012, the idea of NFTs emerged from Meni Rosenfeld's "Colored Coin."50 Initially issued on the Bitcoin blockchain for as little as a single "satoshi,"51 the smallest unit of currency, Colored Coins resembled current NFTs in critical ways. In the Overview of Colored Coins, Rosenfeld described the innovative use of the Bitcoin infrastructure creating a new asset class and giving raw possibilities for future utilization.52 With proper hindsight, the limitations of the Bitcoin blockchain meant that the Colored Coins concept could never be realized. Rosenfeld's ingenuity, nevertheless, exemplified capabilities that marked the NFT frontier period.
On May 2, 2014, digital artist Kevin McCoy's Quantum53 was regarded as the first-known NFT ever minted.54 Unlike most NFTs today, which are minted on Ethereum, McCoy had used a blockchain software called
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"NameCoin"55 to create Quantum—a digital image of a pixelated octagon that hypnotically changes color and pulsates in a manner reminiscent of an octopus.
Later that year, Robert Dermody, Adam Krellenstein, and Evan Wagner founded "Counterparty," a peer-to-peer financial platform, and distributed open-source internet protocol built on the Bitcoin blockchain.56 Counterparty allowed digital asset creation and had a decentralized exchange, thus providing a way for users to create their own tradable currencies or assets.57 The idea of tradable collectibles on the blockchain came with a critical advantage not afforded to real-world rare collectible items: counterfeiting was all but impossible. In 2015, Counterparty partnered up with the game creators of Spells of Genesis (SoG).58 SoG pioneered the issuing of in-game assets on the blockchain, introducing its own in-game currency called "BitCrystals."59 In 2016, memes entered the blockchain, which beckoned on the age of meme trading and saw the release of a host of Rare Pepes60 NFTs, the Pepe the Frog character, on the Counterparty platform.61
During this frontier period, the growth potential of NFTs could not be realized because the Bitcoin blockchain was never intended to be used as a database for tokens representing the ownership of assets. Thus, the big shift to...
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