NFTs: Present Legal Challenges and the Future Ahead

Introduction

From Bollywood Superstars like Amitabh Bachchan and Salman Khan to Auto Brands like MG Motors, many have entered the Non-Fungible Token (“NFT”) marketplace. These tokens can be used to represent ownership of unique items such as photos, videos, audio and other types of digital files. These tokens are not interchangeable because of their singular properties and cannot be replicated courtesy of blockchain technology. They are crypto assets with a unique proof of authenticity that makes them rare and high-value digital assets. For instance, Amitabh Bachchan’s NFTs of Madhushala, a book of poetry by his father, recorded in his own voice along with autographed posters and collectibles received aggregate bids close to $1 million. Similarly, Gary Vee, an internet personality and an entrepreneur launched his Utility NFT known as VeeFriends which has value added benefits, such as pass to attend VeeCon, an informational conference for NFT holders. Web3 popularly known as “future of internet’’ incorporates block chain technology including NFTs. NFTs are also playing a major role in the boom of Metaverse, a network of 3-Dimensional virtual worlds. NFTs have transformed the gaming world by letting gamers earn through collection of unique characters, avatars, weapons, etc. The NFT marketplace is booming, and every artist wants a piece of it. Every NFT is different, setting it apart from fungible tokens, such as cryptocurrency, that can be exchanged for one another.

Laws in India

Since NFTs can only be traded in cryptocurrencies, all platforms launched for trading of NFTs have been cryptocurrency exchanges. It is pertinent to note that even though cryptocurrencies are not yet regulated in India, there is no legal framework which bans the trading of NFTs. Unfortunately, due to lack of regulations concerning NFTs, there has been some chaos about the governing laws. Some believe NFTs to be a contract while others believe it to be a derivative, a risk instrument or contract for differences. As opined earlier, cryptocurrency and their exchanges are not regulated in India, in arguendo, if NFTs are believed to be derivatives then there would be a complete ban on trading of NFTs due to Section 18 of the Securities Contract (Regulations) Act, 1956, as none of the cryptocurrency exchanges are recognized or licensed by the Central Government.

Moreover, fractional investment of NFTs has been catching pace due to the exorbitant prices of the NFTs. The lack of a well-defined framework for NFTs has left the common man in dubiety, and hopefully, the legislation can provide transparency on the same.

Regarding the taxation of NFTs, it is still ambiguous if the capital gains from NFTs would fit under the headings of ‘capital assets’ as defined in Section 2(14) of the Income Tax Act, 1961. With respect to the Central Goods and Services Tax Act, 2017 (“CGST Act”), Section 9 imposes GST on the supply of goods or services or both. The definition of ‘goods’ includes any movable property and ‘services’ includes everything other than goods. Thus, there may be a possibility of GST on NFTs under the ambit of ‘services.’ However, due to lack of clarity, there is vagueness of how NFTs can be taxed.

It would be interesting to see how the Cryptocurrency Bill, 2019 will lay the path for regulations and trading of this nascent technology considering the number of rumors, misinformation, genuine sources, and credibility in the market. This Bill was to be introduced in the winter session; however it has been deferred due to paucity of time and clarifications.

Rising Concerns

Despite the ongoing craze of NFTs around the world, there are plausible troubles which need to be addressed.

Contract Drafting and Interpretations

Recently, Miramax, an American entertainment company has filed a lawsuit against Hollywood director Quentin Tarantino, who had planned to auction 7 NFTs based on his award-winning film ‘Pulp Fiction’. Miramax argued that the planned offerings violated the copyright it held over the director’s film. According to Tarantino he had ‘ Reserved Rights’ which includes the print publication of the film. However, Miramax claimed that the sale of original scenes from the movie as NFT was a one-time transaction which is off-limits from the word “publication” and could mislead others into believing that Miramax was involved in that venture and that they also had developed rights to pursue similar offerings. The key argument revolved around copyright infringement and breach of contract. Going forward, it would be fascinating to see how the intellectual property (“IP”) rights are negotiated and offered to the purchasers. This lawsuit will lead other businesses to determine old contracts and contractual interpretations of the rights assigned to each party.

Intellectual Property Rights

NFTs represent ownership of digital art and collectibles yet interpreting the word “ownership” can be perplexing. Owning an NFT does not guarantee ownership of the underlying IP. The ownership of the underlying IP will only be transferred if the creator of the original work agrees to it specifically. If it is transferred through licensing, it can be based on certain conditions which restrict the NFT owner to reproduce, distribute, or adapt the NFT. Whereas IP such as patents allow an NFT block chain owner to license the technology they use for their NFT and let the consumers possess genuine collectibles of the brand. For instance, Nike, an American multinational corporation involved in the shoe business owns a patent known as “Cryptokicks” to create digital asset (token) of shoes. The owner of Crytokicks will be able to breed with another digital shoe to create an offspring.

Money Laundering

Users of NFT should carefully review ‘Terms of Use’ to assess the impact of theft or hacking of their account or digital wallet. Few months back, users of the platform Nifty Gateway wrote on Twitter that their NFTs of Beeple’s artwork had been stolen and their accounts had been hacked. Later, in a statement, Nifty Gateway stated that they observed ‘no indication of compromise of the Nifty Gateway platform,’ and elaborated that the accounts that had been affected didn’t have two-factor authentication enabled. It is abstruse to determine the value of a piece of art or antiquities which lead to inflated prices. Many money-launderers resort to art to steer clear of regulatory concerns and with the growth of NFTs, the money-launderers will have an added advantage. To address these concerns, the Government of the United States of America recently enacted several anti-money laundering provisions in the omnibus National Defense Authorization Act (“NDAA”), which came into effect from January 2021. The NDAA includes updates and reforms of several anti-money laundering laws, including the Bank Secrecy Act (“BSA”), the Anti-Money Laundering Act (“AMLA”), and the newly enacted Corporate Transparency Act (“CTA”). Through the medium of measures like ‘Know your customer’ (“KYC”), cyber security measures, and a stolen art registry, the risk of money-laundering can be supervised.

Meta-challenges

The main concern in this digital era is protecting the privacy of the users. Recently, the Joint Committee on the Personal Data Protection Bill 2019 (“JCP”) has showcased its report in the Parliament providing recommendations related to privacy and protection of data. The Committee has recommended a 24-month plan to implement the Bill.

Metaverse is a combination of virtual reality (“VR”) and augmented reality (“AR”). As it progresses, NFT has also become a medium for Metaverse that allows for a fair economy and empowers players of the blockchain game. NFTs are the bridge to the metaverse, as they facilitate identity, community, and social experiences in the metaverse. Therefore, whoever controls Metaverse, they could also control the reality. Facebook, now known as Meta, has a significant portion of database available at its hands. It has always been in disputes over breach of data, and now with its focus on Metaverse, it could further exploit the privacy of its users. However, it is up and running to introduce privacy-enhancing technology (“PET”) to regulate the use of personal data for targeted advertisements.

Environmental issues

Moreover, there are various environmental concerns surrounding NFTs. During the process of mining, an exorbitant amount of electricity is used which leads to emission of greenhouse gases . With the growing importance of Environmental, Social and Corporate Governance (“ESG”) framework, businesses need to reevaluate the risks associated with NFTs.

Conclusion

The volume of sale of NFTs seems to be aiming for the moon & this has left the regulatory authorities in a time crunch to formulate any substantial regulations for their governance. However, since NFTs provide complete anonymity, it serves as a perfect platform for money-laundering and privacy for criminals. The European Union has extended its anti-money laundering regulations to include virtual currency exchanges and custodian wallet providers. The European Commission proposed for the regulation of crypto-assets under the legislative framework of Markets in Crypto-assets Regulation that would also apply to NFTs in certain cases. Indian regulatory authorities can definitely take inspiration from these initiatives. Currently, several investors have defined the cryptocurrency market as a bubble. Yet, it would be interesting to see whether NFTs are the future of the art market or a much-hyped bubble. Notably, NFTs have revolutionized new methods, identity, and means of monetization of assets that people were unaware of. Still in its nascent stage, this market continues to grow while the legal and environmental issues around it remain a key concern.

(This post has been authored by Nidhi Agarwal and Devansh Parekh, final year law students at Rizvi Law College, Mumbai and Government Law College, Mumbai, respectively.)

Cite As: Nidhi Agarwal and Devansh Parekh, ‘NFTs: Present Legal Challenges and the Future Ahead’ (The Contemporary Law Forum, 16 January 2022) <https://tclf.in/2022/01/16/nfts-present-legal-challenges-and-the-future-ahead/> date of access. 

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