This will be a two-part posting. In this first part, we will focus on the NFT technology, and in the second part the legal underpinnings. NFT technology presents an extraordinary opportunity for arbitration to be used as the most viable approach to disputes. All disputes regarding foundational issues and smart contracts, including privacy/security; intellectual property; securities; and contract law may be resolved in an arbitral forum. Initially, nonfungible tokens (NFT) serve as products or services in the metaverse and may be bought and sold with cryptocurrency through the blockchain technology, Web3’s infrastructure. Web3 is a new set of standards for how the internet should be used and governed, and it is used to access the metaverse. The metaverse supports gaming, social media, retail and other experiences such as virtual reality. Using virtual reality (VR) access (headset), people have a “body” (avatar) that may be customized, with a home to “furnish” and other spaces to visit. Interaction with others to work, play, and perform basically everything you would do in the “real” world. Such uses reduce travel and need for physical resources, allowing people to visualize and interact with any object without great effort or time. Connects all activities, chats, locations and data, among other things, without the need to switch between apps and a web browser.
NFT Foundational Technology
Web3 represents an open 3D-immersive internet. Built upon blockchain technology with the data decentralized, open, and easily distributed. Web3 applications, augmented by decentralized products and NFTs, are the foundation for a new era of connection, interaction, work and play. Web 3.0 benefits users since they own their data and are free to trade them without losing ownership, privacy, or depending on intermediaries, and enables security without tracking.
Metaverse and NFTs have users work, learn, play, entertain, and play games with other people using VR and Augmented Reality (AR). Both have own independent virtual economy, enabled by digital currencies and NFTs.
NFTs use the metaverse, can be used to facilitate transactions, serve as products or services, and be bought and sold with cryptocurrency. For example, NFTs are used in the Marketplace, like Nikeland, Art, Real Estate, Gaming, Sports, Media and entertainment. NFTs are a token that conveys ownership of any type of asset attached to an underlying intangible asset. Buyers get a clear chain of custody and ownership transparency once the transfer of ownership is recorded on the blockchain. The transaction history is public and cannot be altered or erased. NFT purchasers can do due diligence by looking at the ledger. NFT sellers do not need traditional intermediaries. NFT creators utilize code in a smart contract to embed certain sales conditions, such as the provision of automatic resale royalties.
NFTs employ blockchain technology. Blockchain Distributed Ledgers are immutable since they provide providing unassailable trust across a broad and growing spectrum of transactions. NFTs are transparent where all transactions are stored in corresponding blocks on a blockchain, secure from being corrupted, and tamper-evident. NFTs evolved from the ERC-721 standard, and were created by the same people who developed the ERC-20 smart contract
ERC-721 defines the minimum interface—ownership details, security, and metadata—required for the exchange and distribution of gaming tokens. The ERC-1155 standard reduces the transaction and storage costs required for NFTs and batching multiple types of non-fungible tokens into a single contract.
NFTs are an outgrowth of Distributed Ledger technology, utilizing a blockchain, a form of a distributed ledger. A distributed ledger is a database that exists across several locations or among multiple participants. Most companies use a centralized database existing in a fixed location. A distributed ledger removes third parties from the process, making them quite attractive.
The Use of Smart Contracts
The creation, or “minting,” of NFTs provides the opportunity for creators, who own IP rights in the underlying asset to set the terms for a license to be transferred to the NFT buyer. The parties owning these IP rights and wishing to transfer them use “smart contracts” to memorialize the express written terms of the assignment or licensing of IP rights. Smart contracts are simply programs stored on a blockchain that run when predetermined conditions are met. Essentially, it is the software code that generates a self-executing transaction triggered by an encoded condition.
NFTs: The New Privacy and Security Nightmare?
Generally, the use of a distributed ledger/blockchain technology provides anonymity. No requirement to attach a name or identifying information to anyone’s “wallet” like a bank or brokerage account. NFTs undermine this anonymity.
For example, in the matter involving Jimmy Fallon and the Bored Ape NFT, we saw that public blockchains have low-privacy environments. One can learn another’s wallet address, thereby, having access to a whole range of individual information. Wallet addresses may need to be shared to complete a NFT transaction, that is, if a user ties an NFT to any part of their online or identity, using an NFT as a profile picture or maintaining NFT marketplace profile, it becomes easy to view the person’s wallet.
Privacy Legislation is not built for blockchain. With CCPA and GDPR, Individuals can exercise their right to delete personal information. Blockchain entries are immutable, and se of location based NFTs and wallet trackers could violate new privacy laws
NFTs’ Security
Current NFT platforms may not be secure frameworks. Platforms may permit the transmission of unwanted NFTs into a wallet causing a cost to remove them. For example, the Rapper Wacka Flocka Flame clicked on the dubious NFTs leading to $19K being taken straight out of his account.
Since NFTs are governed by “smart contracts,” software code (in smart contracts) may be susceptible to manipulation and/or human error. There is also hacking into NFT user accounts. For example, Sandbox (seller of virtual land NFTs) demonstrates software vulnerability. Similarly, Poly Network’s software error allowed them to transfer $600 million worth of tokens to their own crypto wallets.
The use of NFTs is highly specialized, and requires thorough understanding of the technology. In our next blog we will focus on the legal ramifications in their use.