An Intro to NFTs and Blockchain (It's Not What You Think 😨 )

Over the past two years, there has been a significant uptick in e-commerce.  One growth area in particular has been the use of non-fungible tokens, or NFTs, to verify online purchases.

If you’ve been following popular culture, you’ve probably seen a reference or two to NFTs.  In early March 2021, for example, a digital collage sold at a Christie’s auction for nearly $70 million.  Similarly, Twitter Founder and CEO Jack Dorsey sold a digitally-autographed version of the first tweet for $2.9 million.  SNL even made a rap parody all about NFTs.

But, like most people, even if you’ve seen the online chatter, you’re probably still wondering a few things, namely: what are NFTs, and how do they work?

What are NFTs?

A non-fungible token, also known as an NFT, is a certificate used to digitally represent an asset; however, the asset does not have to be digital.  It could be a physical item, like a house or car, a digital item, like a computer file, or even an intangible experience, like an exclusive tour of a winery.

An NFT can be created for nearly any type of asset.  There are three main appeals to using NFTs:  (1) only one NFT can exist per asset, which decreases fraud; (2) NFTs can be quickly and easily exchanged, since everything is stored online; and (3) NFTs are stored on blockchain, which provides a secure and trusted record of ownership.

NFTs exist on a blockchain record that is linked to the asset.  The blockchain records the buying and selling of an asset, by using the digital token to represent the asset.  That is, whoever has the NFT in their digital wallet also owns the asset which the NFT represents.

The concept for NFTs is based on “fungibility,” or whether or not an item can be easily replaced and still maintain its value.  A common example is money.  If someone has a $100 bill, this could be replaced with either five $20 bills, ten $10 bills, or two $50 bills.  Each of these substitutions still achieves the original value - $100.

However, if we replace the example with Picasso’s Guernica painting, this would be a non-fungible item, since only one exists.  You could theoretically sell this and exchange it for money, but this would still not have the same value.  The only thing that is equal in value to the painting would be an identical painting.

When an NFT is created to represent an asset, it is “minted” and verified.  Since only one person can own the NFT for a particular asset, this creates exclusivity and in turn makes NFTs a valuable trading commodity.

Keep in mind, the NFT acts more as a secure, digital receipt to show ownership of a unique asset.  When you “purchase” an NFT, you’re really purchasing the underlying asset and receiving a unique token to prove that.  However, as mentioned later in the article, while an NFT proves you own an asset, it does not prove you own the underlying intellectual property rights.

What is Blockchain Technology?

Blockchain originated as a safe way to transfer money electronically.  Two primary appeals of blockchain technology are its immutable and decentralized nature.   This means it is difficult to alter and generally available to the public.

Also known as “distributive ledger” technology, blockchain works like a traditional ledger.  The digital ledger tracks ownership of a particular asset.  However, unlike a physical ledger which can be easily altered, blockchain is highly secure due to the entries all being interlinked.

A blockchain record consists of various “blocks” of information that are “chained” together by unique codes, called a transactional “hash.”  Each time the asset attached to an NFT is transferred or sold, a new entry is added to the blockchain to represent that transaction.  

A new entry would include both the hash from Seller’s original purchase and the new hash representing Buyer’s purchase from the Seller.  Including both unique codes adds a layer of security to the record and makes it more difficult to change later.  Typically, no one user will have access to the entire blockchain record, which is why the system is considered “immutable.”

Money for these transactions is usually exchanged using a cryptocurrency platform, such as Bitcoin or Ethereum.  This can also speed the transaction since third-party intermediaries, like banks, are no longer needed to transfer funds.

Remember:  The blockchain records the transfer of an NFT.  The NFT represents an asset.  If someone says they own an NFT, really, they own an asset and have a secure, digital receipt to prove it.

What is a Smart Contract?

A “smart contract” can be incorporated into the blockchain code for a particular transaction.  With smart contracts, contract terms are self-executing, very similar to an “IF/THEN” formula.  If a contract clause depends on an event happening, that clause will automatically execute once the triggering event is met.

For example, in a purchase of real estate, the seller may be hesitant to sign over ownership before receiving funds.  Likewise, the buyer may be hesitant to send the funds before receiving the ownership.  Traditionally, this could include placing funds in escrow, which not only included a third-party but added extra time to the transaction.

By using smart contracts, both parties could upload the required materials.  Seller would upload a completed ownership transfer document, and buyer would upload the funds.  A smart contract can detect when both conditions have been met and automatically carry out the exchange.  Not only does this speed up the transaction, but it can help cut down on fraud.

Keep in mind, however, that smart contracts still must meet certain legal requirements to be considered an enforceable legal contract.  If you are considering using a smart contract in a transaction, it is best to consult an attorney for help drafting the terms to be included.

NFTs and Traditional IP Protection

One important distinction about NFTs is they do not, alone, establish ownership of intellectual property rights.

While intellectual property and NFTs both involve “exclusive” ownership, the ownership associated with NFTs only extends to the underlying asset.

Intellectual property rights are established by filing for registration with the relevant government office.  For trademarks and patents, this is filing with the U.S. Patent and Trademark Office.  The U.S. Copyright Office handles registration of copyrights.

This is very important, especially if you are an artist considering selling artwork via an NFT Marketplace.  Even if an NFT lists you as the “creator” of the work, this is not a replacement for registering the work with the Copyright Office.  A copyright registration is required for certain legal actions, such as prosecuting someone for misappropriating your art.

For trademark owners, NFTs could offer an outlet to expand a brand’s registration to include digital goods.  This is particularly of interest for trademark owners who primarily offer physical goods, such as clothing companies.  Expanding into NFTs could be a gateway to expand your brand’s trademark protection, especially as more commerce expands into the digital world.

Copyright and trademark owners alike should also be vigilant in monitoring NFT marketplaces for potential infringement.  While this is a new area and difficult to predict how courts may handle these lawsuits, many challenges have emerged over the past year.  Most notably, Birkin bag creator, Hermés, sued NFT creator Mason Rothschild, creator of the NFT “MetaBirkins,” claiming trademark infringement and dilution of their famous mark.

The future:  Are NFTs Here to Stay?

Technology is ever-changing, which makes it difficult to say how long people will be using blockchain and NFTs to record transactions. 

This method is probably not going to be common-place for small purchases, like notepads or coffee.  For that, we’ll probably just stick to a dollar bill or debit card.

However, for large-scale buys like real estate, homes, luxury items, and rare collectibles, blockchain does offer a secure method for carrying out the transaction.  Not only can it establish trust by ensuring both parties carry out the contract terms as agreed, but it can speed up transactions by eliminating the need for escrow and third-party intermediaries, like a bank or real estate agent.

One thing we do know is regardless of whether you use blockchain and NFTs to record the transaction, be sure to work with a lawyer to clearly draft contract terms to ensure you stay protected legally.

The Last Word

The above resources are just a few of the resources available to help you understand the nuances of NFT and Blockchain. More to come!

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Mary Kathryn Whitaker (“MK”) is a trademark and copyright attorney at PRECIPICE.

👉🏿 Sign up to join our community and to learn more about our legal services visit www.precipiceip.com/purchase. Precipice provides intellectual property legal services to science and technology startups.