What are NFTs? How are they regulated?
Our Associate, Nayel AlBorshaid explains NFTs.
Nayel AlBorshaid – Associate ([email protected])
A Non-Fungible Token (“NFT”) is a type of cryptocurrency asset that exists on the blockchain, which is a network that supports different types of cryptocurrencies (for more information on the blockchain, click here). NFTs are programmed in a way that limits their tradability, and usability to the confinements of the blockchain itself. In the context of NFTs, the blockchain serves as a distributed database that has the ability to store data, with a consensus mechanism which ensures that each new entry complies and is compatible with previous records of the same data, in the same database.
Tokens, which are digital assets that are built on another cryptocurrency’s blockchain, are components of value linked to digital properties. Likewise, tokenisation can exist in many different of domains, from the well-known crypto-coin to equities, securities, real estate, and contracts. The commonality, on the other hand, was registered on a public blockchain, which means that the digital infrastructure and standard of a blockchain determines the token’s compatibility with such. Many NFTs already use the Ethereum blockchain as a transactional platform. Furthermore, NFTs differ from fungible tokens, that can be substituted with an identical token and whose value may be traded. Fungible coins are well-known in the form of cryptocurrencies, whereas NFTs are non-divisible and separate from other depictions of a physical or electronic commodity.
As already indicated, non-fungible token transactions involve a blockchain-based infrastructure to function correctly, that facilitates the underlying model that enables non-fungible token transactions. Conversely, in order for NFTs to function as intended on the blockchain, they must first be minted, which implies they must be manufactured or generated before being recognized on the Ethereum compatible blockchain. The produced NFTs are then deposited on the same distributed network or blockchain, demonstrating possession of the commodity in question.
What is the value of Artistic NFTs?
NFTs have swept the artistic sector, with electronically preserved artworks being offered on the blockchain to clients. Even though NFTs are non-fungible, they can also be sold online.
More significantly, NFTs validate art forms in its virtual form, in which it uses a specific non-fungible encryption to identify works of art, that renders them as distinct one-off works, creating a demand comparable to tangible works of art.
Thus, when questions arise surrounding the originality and/or legitimacy of an art piece, it is important to note that an NFT is more inclined to be profitable; because it is difficult to recreate and no two NFTs are identical, hence their popularity and exclusivity are likely to expand.
However, irrespective of the market value, in addition to the scarcity of an NFT as a piece of art, the question can be raised as to whether NFTs hold any value at all. This question is particularly valid when considering the legal enforcement of rights that are associated with the ownership of an NFT. Although, cryptocurrencies are slowly becoming regulated by financial/governmental institutions around the world, the current regulations in place do not define any legal enforcement over the ownership of, or violation thereof, an NFT; ownership without the means of enforcement is without value.
Legal Implications & NFTs
NFTs have the potential to be used to serialise property, but not to symbolise financial instruments. Moreover, when minting (‘Minting’ is the process of taking a digital asset and converting the digital file into a digital asset, and storing it on the blockchain) an asset, it is essential to consider the quantity of rights granted to token holders.
Token holders, for instance, can have revenue privileges or something equivalent. These assets will be classified as security tokens and subject to applicable financial reporting framework. As previously stated, NFTs hardly offer such privileges and typically just provide access to potential resource or retaining future compensation entitlements.
Therefore, generally NFTs will not confer any protections on the purchaser against the issuer. Significantly, the issuer has no choice control over the project, and the commodity flow is rarely decipherable. Regardless of the fact that NFTs are fungible and movable, NFTs are not tradable on organized market systems. As a result, there are no legal channels for the circulation and surveillance of the same.
Intellectual Property over NFTs
While possession of an NFT doesn’t quite imply possession of an artistic creation, the applicability of IP rights over NFTs is relatively minimal under the Central Bank of Bahrain’s current regulatory framework. Furthermore, acquiring an NFT does not always guarantee that you will receive the IP rights that are typically associated with the purchase of unique commodities.
An NFT essentially functions as a virtual certificate in terms of authorship over the goods, implying that the owner possesses a rendition of a work in the form in which it was acquired.
Obtaining intellectual property rights within the context of NFTs might also be problematic due to the prospect of extended legal analysis/debate. Despite the benefits of digital property, NFTs are not flexible enough to eliminate misconceptions of tokenization and the rights that are commonly associated with it.
NFT as a Legal Instrument
The potential utility of using NFTs for filing/maintaining public papers is easy to see, but it is difficult to foresee how a blockchain solution adds much value to those initiatives already in place. The current system in place for the storage and regulation of such is centralised, and to revert the whole system to a decentralised one would be a difficult task to plan, let alone to achieve and implement efficiently. In any event, it would be a large-scale task for any one network to take on these large-scale initiatives, but that isn’t to say it isn’t feasible. Within the present institutional framework it would be very unlikely to be able to deploy a ready-made system that would operate across the GCC, and even more so across the various legal jurisdictions around the world.
In addition, in various jurisdictions, the monitoring system may vary, with officials legally approved to do distinct tasks. It’s a significant challenge to address, and with institutional inertia as it is, it is unlikely that we will see much NFT/blockchain adoption in the legal sector. However, if a protocol can effectively sell and implement the notion, it will be granted the authority to issue money within this framework.
Final Remarks
Control over such digital commodities within the blockchain is still in its early stages. As a result, it is vital to consider whether a specific NFT conforms with the CBB’s relevant Anti-money laundering and financial legislation. Regardless of this preceding condition, as illustrated above, the legal rights associated with NFTs are ambiguous, and no present framework exists to defend the privileges of digital ownership as compared to physical ownership of a tangible asset. NFTs are just an expansion of crypto, with the exception that they do not even claim to be a financial instrument. It employs the same technique to provide false exclusivity and collectability to a limitless supply of otherwise free downloadable commodities. Furthermore, NFTs do not ensure licensing rights. There are currently legal avenues for getting comprehensive distribution privileges (copyright laws, permissions, and royalty revenues) at reduced rates when compared to those offered by NFTs, hence it is a fundamentally flawed concept when considering them from a legal perspective.
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