NFTs, and the tokenisation of real world to digital assets, is a hot topic across multiple industries including sports, gaming, art, fashion, and real estate. Although it is early days in the adoption of this new technology, new applications and use-cases
are emerging. While the market in the first wave of NFTs might have crashed, there are many who are excited about the emergence of the “NFT 2.0”– with far greater utility than overpriced digital art.
The opportunity for corporate-to-consumer businesses to use NFTs to strengthen their brand and customer relationships is attracting a lot of interest. As with most ventures into frontier technology, businesses will need to navigate the legal and risk issues
to leverage the opportunities NFTs offer.
Value creation
Creating an NFT (non-fungible token) means linking an asset, often in a digital format (jpegs, music, or video files) to a unique digital token which can be transferred and traded on NFT marketplaces. Distributed ledger technology (DLT) is key: the token
is “minted” on a public blockchain (usually Ethereum) and represents a digital certificate of ownership for that asset which can be publicly inspected.
There are different structuring techniques used in “stapling” an NFT to an underlying asset; in some cases, this is by associating a unique token ID and a URL link to an asset that exists in digital form. The blockchain enables, and allows verification through
public inspection, of transfers of ownership or control of the NFT without a central authority (a custodian or land registry)
NFTs can be linked to legal rights, such as IP rights, with respect to an underlying asset. NFTs can also be powered by smart contracts, deployed on the same blockchain, to execute those rights automatically, for example, automatic payment of artist royalties
in connection with the sale of the NFT. It is these rights to the underlying assets that NFTs offer which create a scarce digital market of value – and an opportunity be unlocked.
Opportunities in consumer
When it comes to e-commerce, one of the main drivers of interest in NFTs is the opportunities they present for brands to connect with customers and build new interactive experiences. The appeal in digital luxury goods has been recognised for some time now
but there are many businesses that are the start of this journey.
Collaborations are good way to get off the ground: brands can partner with a pure tech provider to create the NFT and then with an NFT exchange for their distribution (although third party risk, including the risk of platform insolvency highlighted by the
collapse of crypto exchange FTX will need to be actively managed).
The luxury goods, sports, and gaming industries are leading the way in the early adoption of NFTs. For example, Dolce & Gabbana sold a nine-piece collection of NFTs for $5.6m which included physical items and their digital versions as NFTs. While it is early
days in the development of digital spaces where NFTs might really come into their own, the good thing is that NFTs are already available and can be “minted” by anyone right now.
NFT 2.0
According to Reuters, NFT sales for 2021 hit $25 billion. However the Crypto Winter of 2022 has hit NFT markets hard. According to data from Dune Analytics, NFT trading volumes have been on
a downward spiral in 2022: from an apex of $17 billion in January falling to around $470 million in September. Whilst this is a huge 97% drop in just 9 months, some argue that this has resulted in a positive outcome. It has cleaned out the “get rich quick”
projects and paved the way for developers and creators committed to the NFTs space to develop NFTs with greater utility.
Certainly, if the NFT space is to stage a comeback, the use case has to move on from ape themed jpegs those with some actual utility to business and consumers alike. Luckily technological development never stands still. The development of “NFT 2.0” is already
progressing from the NFT1.0 of simple pixilated images of digital art (such as CryptoPunks and Bored Ape Yacht Club) to high-fidelity 3D animations (for life-like digital representation) and complex play-to-earn, or P2E, game mechanics (which reward gamers
with monetary incentives).
NFT 2.0 is about making “smart” and realistic NFTs for in-game items, music, digital collectibles, tickets, and coupons. For example, event companies can use NFTs “tickets” to enable holders to enjoy the exclusivity of attending virtual and or real world
events.
NFTs in the metaverse
Whilst the metaverse is still some way off full realisation, it is easy to see how it promise of a fully immersive digital world of “VR”-commerce could be a game-changer for NFTs. The metaverse provides the more immersive digital space for both storing and
appreciating your NFT art, the catwalk for your NFT digital wearables, and opportunity to extend real-to-digital commerce to digital-to-digital (purchasing digital assets with digital currency) and digital-to-real commerce (receiving physical goods in connect
with a digital purchase). As more interesting and immersive digital spaces emerge there will be more opportunity for consumers to engage more fully with their NFTs and related rights.
NFTs could also be key to providing digital identity in the metaverse. An NFT can link to a customer’s identity, providing a secure login into virtual or real world experiences which can then be securely tracked with permissions controlled directly by the
customer (instead of by Big Tech third parties). NFTs therefore present opportunities for brands, particularly those in retail and entertainment, to leverage the evolving capabilities of these digital assets as “next generation” loyalty and rewards cards.
Together with digital wallets – which can store both NFTs and the crypto used to pay for them, NFTs could help meet the challenge of how to ensure the portability of digital assets across metaverse platforms.
Legal risk
As with all DLT based digital assets, NFTs do not fit neatly into traditional legal frameworks. The anonymous, decentralised, automated and borderless nature of products, transactions and infrastructure based on blockchain, creates a host of unique legal
uncertainties:
> Applicable regulation: When issuing an NFT how do you ensure that you are not caught by securities regulation requirements (which could impose for example anti-money laundering requirements or rules on promoting, advertising or issuing such NFTs)?
> Applicable law: What laws will apply to an NFT and where would you claim if things went wrong?
> Ownership rights: When purchasing an NFT how do you ensure that you have bought it? How do you ensure it is attached to a measurable IP?
> Security: How do you keep your NFT safe when it is held by a third party market place?
> Liability and rights of action: Who can you sue if your NFT is stolen from a marketplace? Who is liable when a smart contract goes wrong?
> Legal process: Can NFTs be seized or frozen by order or injunction?
These risks are exacerbated by the reality that many operators in the digital asset ecosystem are younger enterprises, with less developed compliance frameworks and a culture that prioritises growth and swift action. Paying attention to legal risk in NFT
ventures should be a key priority.