Friday 3 September 2021 9:45 pm

NFTs – what am I buying?

by Nick Breen and Sophie Goossens of Reed Smith

Unless you have been living under a rock for the past few months, you will by now likely have heard of NFTs. In fact, you may have even heard of the JPEG of a rock that was sold as an NFT for over $1 million last month.

Reminiscent of the Bitcoin surge back in December 2017, it is now NFTs that are overtaking dinner party conversations. Nevertheless, one question that continues to be at the focus in these discussions is “okay, but what is an NFT?”.

The answer

Sophie Goossens, Partner at Reed Smith

The reason this question continues to be asked is that the use cases for NFTs are extensive and, despite the overwhelming media coverage that may suggest otherwise, NFTs are not all digital art collectibles.

At its simplest level, an NFT is a representation of a transaction that is recorded on a blockchain, similar to a receipt. Because it leverages blockchain technology, details of each initial minting (i.e. creation) and subsequent sale/transfer of an NFT is forever documented and cannot be changed or overridden.

NFTs contain unique data, including code and metadata (sometimes relating to an identifiable off-chain asset) that distinguishes it from other NFTs. The combination of the uniqueness, high liquidity and immutability of each NFT has given rise to numerous applications across a variety of industries.

We often see NFTs being described in generalist or reductive ways that do not take account of the multitude of use cases they can offer. The easiest way to understand the various forms of NFT is to consider a few examples. Here is a summary of the most common applications we have seen for NFTs so far, and what you are ‘buying’ with each.

  • Transfer of ownership is the least common form of NFT that we have come across. This is where an NFT records the transfer of ownership of property, which could be a ‘physical property’ like a house or a piece of fine art, or it could be referring to a legally-recognised form of intangible property (namely intellectual property, such as copyright). For example, I could use an NFT to assign to you the copyright to a sketch I drew of my cat.
  • Contractual rights or licences: When you purchase an NFT, you may be provided with certain rights or licences, such as a licence to display a short highlight clip from an NBA game, or a limited-edition piece of digital artwork from Twitter, for your own personal, non-commercial use. Or you could buy an NFT that gives you the contractual right to redeem front-row concert tickets to every Kings of Leon gig for life.
  • Bragging rights (or ‘authentication’): Some NFT do not purport to give the purchaser ownership of property or any explicit usage rights or licences at all. This can be common with digital art collectibles; although there is no explicit set of rights granted to the NFT holder, they can nevertheless show (or brag) that they have a unique connection with the underlying artwork or artist that nobody else has. This is like having a baseball card autographed by the player, except that the autograph lives on a blockchain, for all to see. 

The examples given here are by no means exhaustive and hopefully demonstrate that each NFT is different and needs to be considered individually.

Nick Breen, Partner at Reed Smith

Ownership of the asset

There is unfortunately a common misconception that by buying an NFT, you then ‘own’ the underlying asset as you would when buying a piece of art in a gallery.

Although, as explained in the first example given above, it is possible to transfer ownership of property using an NFT, in practice this is quite rare and is likely not the case for the majority of NFTs currently circulating the various marketplaces.

The reason why this real-world comparison does not hold is simple: with physical artwork, there are two separate forms of property that exist; the property of the physical object itself, in the form of the canvas, the paint etc. and, separately, the intellectual property (i.e. copyright) in the artwork.

You can buy the first one in the same way as you would a piece of furniture, but you would never expect to receive intellectual property rights from an art gallery as these generally remain at all times with the artist. By contrast, in a virtual world, there is no equivalent digital canvas or paint that can be acquired in a digital image that is separate from the copyright.

A digital artwork ultimately only comprises data in the form of 0s and 1s and cannot be ‘owned’ in the same way a physical object can be.

This distinction does not mean that these art collectible NFTs are without value. On the contrary, the last few months has proven that they have the potential to be extremely valuable. The key takeaway is to understand what it is you are ‘buying’.

Equally important is for those creating NFTs to be careful in how they market and advertise them. Advertising the ‘sale’ of an artwork NFT could be potentially misleading if all the NFT creator is offering are bragging rights, rather than exclusive usage rights or transfer of copyright.

Considerations before purchasing an NFT

We have only started to scratch the surface of the opportunities there are for NFTs, which are a fantastic tool for conceptualizing and encapsulating transactions. There are some great NFT projects out there and far more to come. Nevertheless, if you are considering purchasing an NFT, we would recommend that you do your research.

It is important to check that the marketplace you are using to buy the NFT is legitimate and established and you have read the terms and conditions of the marketplace you are buying through. Some marketplaces provide standard terms that govern the usage rights and sale terms for all NFTs sold on their platform.

It is also crucial to check all the descriptions given in the NFT listing and all related metadata. Sometimes these descriptions can embed terms of use, or link out to separate terms or agreements on other websites that seek to govern the token. If there are no terms of use that you can find to govern the sale of the NFT, you are likely acquiring the ‘bragging rights’ we described above or, at best, an implied licence to use the tokenized asset for your own personal use.

The prominence of NFTs is continuing to rise, so you shouldn’t shy away from entering the market due to a lack of knowledge about the intricacies of this digital landscape. With this information at hand and research into your purchase, you will be confidently navigating those dinner party conversations in no time at all.