You’ve surely been hearing that NFTs — or non-fungible tokens, a unique digital asset tracked and valued through a blockchain — are all the rage. When NFTs are coupled with content, they open lucrative revenue opportunities for the owners, creators and distributors of that content. Here’s just some of their applications in the entertainment world:
- Certified digital copies: A finite number of NFT-certified downloads can be made available for a song, album, film clip or piece of digital art.
- Authenticated ownership: An NFT can validate ownership of physical items including collectible merchandise.
- Contractual rights: NFTs can be used to grant exclusive permissions such as a fan experiences or tickets to an event.
- Resales: Issuers can track and receive a revenue share of subsequent sales of the NFT.
But all of these possibilities, while potentially profitable, come with a unique set of issues. Here are five things both creators and content companies should know about NFTs before diving in.
1. There’s no inherent connection between the tokens and the content associated with them: An NFT is actually two separate things — the actual token and its associated content — and the issuer determines the nature of the relationship between them. The token itself can be seen as a certificate of authenticity, thus an NFT is not content, it does not store content, and it doesn’t grant rights to content. It’s merely a one–of–a–kind entry in a digital ledger.
Issuers tie their NFTs to content both mechanically and legally. Mechanically, issuers may provide the associated content through a single onetime download or make it available via streaming or any other manner of delivery. Technically, there could even be no content, leaving the connection in name only but still a valid NFT.
Legally, the relationship between token and content is the license that comes with the NFT purchase. While NFTs may be a new wrinkle for companies, content licenses are not. For example, if the issuer hosts a piece of content for streaming, that would start with a streaming license, or if the content is made available for download, the issuer would look to the standard download–licensing terms.
While the starting point for any agreements are familiar, as NFTs enter the picture, they would likely need some tailoring to fit this context. In fact, an NFT can play a role in the actual contract and may be used to unlock downloads or grant other rights to the token holder.
2. Content associated with NFTs can be counterfeit and infringing: Although blockchain technology ensures NFTs cannot be duplicated or manipulated, the same does not hold true for the content associated with the NFT, as it is just as subject to infringing distribution as ever. The problem is, anyone can generate an NFT and claim it represents anything, whether they own the content or not.
Not all NFT platforms adequately verify that users minting an NFT have the proper rights. Even in this new frontier, artists are already finding their creations tied to tokens they never minted. Content owners will have to turn to their usual toolbox — for instance, a DMCA (Digital Millennium Copyright Act) takedown notice — to combat infringement.
But dealing in NFTs adds a further complication. Even if a platform removes infringing content from the token, the NFT is permanently part of the blockchain. And while most likely a token would lose all value after being decoupled from its content, it could still be sold and beget liability or other issues.
The controversy behind counterfeit tokens could potentially cause the retention of that NFT as it continues to increase in value. Creators and content owners will not only need to extend their infringement policing efforts to NFT platforms, or marketplaces, but they may consider engaging and working with the platforms to improve vetting processes prior to minting.
3. NFT platform partners might not be forever, but buyers will expect their NFT to be: Practitioners and commentators often equate NFTs with collectibles such as baseball or Pokémon This analogy is helpful, though it only goes so far. Once a physical asset is sold to a consumer, it’s in the consumer’s hands to maintain, and often the object’s value rises or falls depending on how well the owner has preserved it.
But unlike trading cards and other memorabilia, an NFT’s “preservation” depends on third-party maintenance of both the NFT’s blockchain and, if we’re talking about digital, the platform hosting the content. NFT buyers also expect NFT continuity, which raises the need for robust service–level and transition–assistance contractual clauses common to standard technology agreements.
Creators and content companies depend on NFT platform and service companies to develop and issue NFT products. These partners can set up private blockchain marketplaces; digitize content; develop and issue NFTs and manage, facilitate and track their transactions.
Vendors and service providers come and go, so in the world of NFTs, continuous and reliable maintenance is crucial. If NFT platforms and their associated blockchain and hosting services shut down, it could cause reputational consequences and would certainly harm a creator or company’s ability to successfully issue NFTs going forward.
In the NFT context, service–level and transition-assistance clauses are especially important. Whether NFTs are here to stay or will fade as a COVID-19 pandemic–era phenomenon may depend on the reliability of the NFT blockchain and platforms that host them.
4. The right to issue NFTs is likely tied to the rights in the content associated with them: Creatives and the companies they work with may wonder how the agreements they currently have in place bear on The short answer is, absent explicit language surrounding the issuance of NFTs, the rights for the content itself likely govern those regarding any NFTs that arise from the content.
Remember that NFTs are two separate things: token and content. It is unlikely pre-NFT agreements would have language that specifically addresses this situation. Because the tokens are analogous to artist signatures, stamps of authenticity or limited–edition run numbers, only a contract that essentially restricts all revenue–generating actions of the parties would likely govern them.
So, to understand how an existing contract may affect NFT sales, following the content rights is a good start. For example, if the content falls under the definition of merchandise, then the rights and revenue splits in the agreement may be instructive in governing the associated NFT sale.
It’s important to note that issuing NFTs always requires issuing a license to the NFT buyer. To do so, the issuing party must hold the rights necessary for such licensing, and those rights ultimately emanate from the content rights owner.
Traditional content-related agreements may not account for all — or any — aspects of NFT offerings, but future agreements may consider NFTs going forward, including explicit terms governing issuance and revenue shares. For example, standard record label agreements may not cover secondary market sales. Clarifying the NFT revenue splits would help prevent costly litigation over royalties.
5. NFTs necessitate the consideration of business regulations that may be unfamiliar to the content industry: A host of regulations focused on the financial services industry make risk allocation an especially important topic in NFT contract negotiations. Although there are important differences, because of the close relationship between NFTs and cryptocurrencies, the first question many ask is whether NFTs are securities — an important consideration commentators have spilled a lot of pixelated ink to address.
Alas, the answer is clear: It’s complicated, and it depends. Just like crypto companies learned over the past decade with the prolific creation of different cryptocurrencies and the wave of initial coin offerings (ICOs), the content industry should carefully approach NFT design and the associated bundle of rights, including how issuers sell and promote them.
Still, the securities question isn’t the only consideration that should concern creators and content companies. Even if the U.S. Securities and Exchange Commission does not consider a particular NFT a security (a black-box analysis that is very fact and circumstance specific), the issuing platform and exchange on which the NFT is traded may trip the securities laws.
And wait, there’s more! Putting aside intellectual property considerations and a slate of legal, compliance, and reputational risks, an NFT or an NFT transaction may implicate other financial regulatory frameworks, including commodities, money transmission, cryptocurrency, anti-money laundering, fraud, anti-manipulation, sanctions and anti-bribery laws.
For example, the U.S. Commodity Futures Trading Commission could deem an NFT a commodity. So far, the CFTC has generally taken the view that most digital currencies that are not securities are commodities, subject to the anti-fraud and anti-manipulation jurisdiction of the commission. Thus, it is unclear how and whether NFT platforms will be held legally accountable for counterfeit NFTs.
Further, money-laundering concerns that have plagued financial institutions and, to a lesser extent, a subset of creative industries, now extend to every creative industry involved in NFTs, as the tokens themselves pose unique money-laundering issues, coupled with the fact that platforms often facilitate purchases and sales of NFTs through cryptocurrencies.
Who regulators will ultimately hold responsible for NFT-related issues is a difficult question. A violation could implicate all involved, but the risks can be mitigated through thorough contracting and best practices. With NFTs, contracting parties may consider adding securities, anti-money laundering and other compliance matters to the mandatory contractual terms, along with the typical IP infringement indemnities and liabilities provisions you would see in a content agreement.
NFTs make possible new and exciting ways for consumers to engage with content, and as with most technological innovation, they present new and challenging considerations. Whether NFTs become a lasting revenue source for the content industry may depend less on consumer preferences and more on whether market participants invest in solving the challenges posed by them.
Adrian Perry is a partner in the New York office of global law firm Covington & Burling LLP and co-chair of its Music Industry practice, representing entertainment and sports clients in tech, data and IP-focused transactions. Jenny Konko is a senior associate in the Washington, D.C., office of Covington & Burling in its Financial Services Regulation practice, specializing in digital assets and cryptocurrency, blockchain technology and electronic payment systems.