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Nonfungible Tokens and Copyright: Diligence Issues to Consider

April 12, 2021

Nonfungible tokens (NFTs) are the latest cryptocurrency craze. These one-of-a-kind-collectibles have dramatically risen in popularity and have penetrated mainstream marketplaces. Since NFTs are often associated with images, videos, music, and other content, the relevance of copyright law is critical to this evolving marketplace, and it likely will take time to learn exactly how copyright law will apply to this new technology under different circumstances.

Recently, an NFT of artwork by the digital artist Beeple sold at Christie’s Auction House for $69,346,250. Many other interesting examples are in the news, spanning from tweets to sports cards to memes. The financial backing to support this fledgling form of cryptocurrency has the attention of investors as well. Forbes reported on March 23, 2021, that sports card marketplace Dibbs raised $2.8 million in seed funding to be used to support its collectables marketplace platform.

What Is an NFT?

An NFT is a digitized, authenticated token linked to a digital asset, and the NFT is recorded on a blockchain, most commonly the Ethereum blockchain. Typically, the blockchain does not store the actual work that is tokenized because it is too large. Ethereum is often used because it is both a cryptocurrency that can be used for payments and a programming language that can support “smart contracts” that facilitate blockchain transactions. (“Smart contracts” is a bit of a misnomer; a more accurate description in our view would be “blockchain applications.”)

NFTs are traceable and, its supporters emphasize, incapable of duplication because each NFT contains a unique serial number or “fingerprint” (also known as a hash) that cannot be reproduced. A hash will match only one specific copy of content because the hash is a cryptographic key literally generated from a specific digital file. Owners of NFTs can use hashes to establish that they own a copy of the linked content from which the NFT was generated. In other words, the NFT is an ownership record of this match that is stored on the blockchain, which can be transferred to someone else whose ownership will also be stored on the blockchain. The complete record of title, payment history, and information about the underlying asset is maintained, likely securely, on this new form of decentralized database known as the blockchain.

The value of the NFT turns on the “nonfungible” aspect because the purchaser is buying an authenticated digital asset, similar to a certified nondigital asset, such as an autographed painting or a signed baseball card. Rarely when one acquires a painting or a baseball card do any copyright rights convey, and it is generally the same with an NFT. The first-ever published tweet was recently sold as an NFT for $2.9 million. Jack Dorsey, who wrote the tweet, was able to both verify its authenticity and avoid any claim of copyright infringement because he was the author. It is not always that straightforward.

We highlight below a few copyright issues that purchasers and sellers of NFTs should consider when contemplating NFT transactions.

Transfer of an NFT Alone Does Not Transfer Copyright of the Linked Work

Generally, the creator of a copyrightable work owns the copyright to that work upon fixation. If it is a work for hire, the employer or commissioning party owns the copyright on creation. Outside of a work-for-hire situation, if you are not the creator of a work and you wish to own the copyright for that work, you must have the rights transferred to you by the copyright owner. The transfer must be express and in writing.[1]

It appears that in many NFT transactions, currently, copyright is not mentioned at all, so in those cases there is no possibility that copyright rights transfer upon the acquisition of an NFT. If the seller of an NFT does say expressly in the written description of the NFT for sale that all, or certain, copyright rights will transfer with the NFT, then the question may be whether such a transfer is express and “in writing.”

Courts have upheld copyright transfers set out entirely in an electronic writing with an esignature, so long as they meet the other requirements of a valid bargain. Recently, even the US Copyright Office, traditionally a major proponent of original signed documents, has held that the recordation of transfers can be accomplished by submitting a transfer with any legally binding signature, including electronic signatures, as defined by the E-Sign Act. We still expect disputes over whether any copyright rights convey in an NFT transaction even when the word “copyright” is mentioned. If a purchaser is paying, in part, for a copyright right, this issue should be carefully considered.

Copyrights in NFTs Are Separate from the Linked Content

Is there any copyright in the NFT itself? The software that creates the NFT is likely copyrightable. To the extent a content owner engages someone to create an NFT, the copyright owner in the content would not own any rights in the NFT software unless it were a work made for hire or acquired by assignment. We suspect most content owners creating NFTs at this time are using third-party services that claim to own the copyrights associated with their services, which are then licensed to the content owner through the terms of service. Interestingly, to the extent the NFT is just a link to content, and is primarily a hash, the NFT may have no copyrightable content itself.

If the NFT is authorized, is it a derivative work? A derivative work is a work of authorship based on modifications or adaptations of a copyrightable work. Creation of derivative works is an exclusive right of the copyright owner. But an automated cryptographic key arguably does not have sufficient authorship (i.e., creative spark) to constitute a derivative work.

Accordingly, the NFT itself, separate and apart from the linked asset, may not be copyrightable subject matter.

First Sale Doctrine and the NFT Marketplace

A well-established principle of copyright law is the first sale doctrine which, pursuant to 17 USC § 109, permits the owner of a lawful copy to sell or otherwise dispose of its copy notwithstanding the exclusive rights of the copyright owner. The first sale doctrine makes secondary markets like used bookstores possible.

Interestingly, ownership of a lawful copy is not necessarily what one might expect for digital assets. You might think you own a copy of a digital book or an MP3, but in most cases you have a license to access those digital products and no ownership interest.[2] In such cases, you cannot rely on the first sale doctrine to sell your ebook or MP3.

Arguably, the primary value of an NFT is the ability to resell it. So a key difference between an NFT that is linked to copyrightable subject matter and the lawful possession of an ebook would need to be that the NFT represents ownership of a specific lawful copy of something as opposed to a nonexclusive right access it. This is an example of where the nonfungible aspect of NFTs becomes relevant. Ebooks and MP3s should be considered fungible—everyone gets the same download. NFTs are closer to the actual book or CD that you buy (of which there is only one) because the NFT represents ownership of a specific copy that is cryptographically linked to the NFT. If NFTs are construed this way, that one copy can be resold over and over like a physical book.

One may also argue that an NFT is nothing more than a digital code and, therefore, the first sale doctrine is completely inapplicable.[3]

In either case, as a practical matter, as long as the NFT creation and first sale have been authorized by a copyright owner of the linked asset, resale of the NFT is not likely to be challenged by the copyright owner. Indeed, the copyright owner may benefit from the resale of the NFTs, as discussed below.

Unauthorized Creation and Distribution of NFTs

An NFT is created by generating a hash that corresponds to a specific content file. That file will contain whatever work is being tokenized, such as art or a tweet, and that file can exist anywhere in cyberspace. The software that generates the hash for the NFT arguably makes a copy of the content file in the process. Currently, some services that create NFTs have the user upload the content file to create the NFT. Further, display of the linked content is generally included in marketing the NFT. For these and other reasons, creation of an NFT should generally require consent of the copyright owner.

But when NFTs are made without authorization of the copyright owner, does the resale of such an NFT constitute copyright infringement? Such a sale may be considered analogous to reselling a counterfeit book or song. If the NFT represents ownership of a specific copy of a work, the ownership of the copy must be lawful; otherwise, further distribution of that work could constitute copyright infringement. Further, linking to infringing content has been the subject of infringement claims.[4] Copyright owners of works linked to NFTs without authorization likely will send Digital Millennium Copyright Act (DMCA) takedown notices to sites that host that content and to marketplaces that promote the sale of such NFTs. If the underlying work is taken down for this reason, or if the relevant copy is deleted for any reason, the link to the NFT can be broken, and the NFT may represent proof of ownership of a copy that no longer exists.

For all of these reasons, understanding the connection, if any, between the seller of an NFT and the copyright owner of the linked content should be part of an NFT buyer’s diligence.

The creation and marketing of NFTs of memes has risen in popularity. Some have suggested that NFTs provide meme creators with more protection. If the meme is lawfully made and initially distributed that way, perhaps that is true, as the source of the meme should be clear and there will be an authorized copy of it that may rise in value. But the overarching issue of whether creating a meme based on a third party’s photograph without consent is lawful does not change. There is certainly an argument that an unauthorized meme infringes the copyright in the photo, and in some cases there will be a possible defense that the meme is a fair use. So far, the enthusiasm for NFTs and memes seems to have sidestepped this important issue, but like any NFT of copyrightable work without consent, we expect challenges to some NFT memes to arise.

In connection with copyright challenges to the marketing of NFTs, accused infringers will likely argue that an NFT is just a record of ownership, and not a copy of anything itself, and therefore, its subsequent resale cannot constitute copyright infringement, comparable to reselling a receipt or deed. This is a key issue that courts will almost certainly need to decide.

Divisibility of Copyrights

Copyrights are divisible by contract in an almost an unlimited manner. The various exclusive rights of a copyright owner can be transferred and divided by geographic location, among multiple parties, in various media, etc., and each divisible right can have its own duration, pricing, and payment terms. Artists could sell a fractional ownership of any one of their exclusive rights. Keeping track of these divided rights once granted, each of which may then be subsequently conveyed, can be very complex and challenging.

NFTs may provide an opportunity to automate this process, allowing the copyright owner of the original work, or of a divided right, to keep track of what they have sold and collect payments. But again, this assumes that an NFT is used to convey any copyright right at all, and currently, for the most part, they do not. If and when NFTs are used to transfer copyrights, blockchain accounting will likely be very helpful in keeping track of all of these divided interests.

Currently, NFTs are considered indivisible in that they cannot be split into smaller values, as cryptocurrencies can. But our guess is that will change. An NFT could represent not just ownership of a complete specific copy of a work but someday a divided ownership of a copy. In this way the purchaser of an expensive NFT of digital art could sell fractional shares of his NFT via the blockchain. In addition, the creator of an NFT could receive a percentage of the resale not only of the NFT he sold, but of each subsequent individual interest in that NFT.[5]

This is an example of how NFTs may indeed follow and improve on traditional complex, multiparty ownership of divisible copyright rights.

Conclusion

How long the current fascination and valuations of NFTs will last is unknown, and how copyright law will apply to them in various instances is yet to be clarified. But the ability to maintain accurate (decentralized) records and to trace every authorized copy of a digital work should enhance efforts to protect, distribute, and share revenue from copyrightable works. We expect to see both enforcement efforts and greater diligence after this initial rush of excitement in the NFT marketplace.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the authors, Ron N. Dreben (Boston and Washington, DC) or Amelia Pennington (Boston), or any of the following lawyers:

Chicago
Scott D. Sherwin

San Francisco
John A. Polito

Silicon Valley
Dion M. Bregman
Andrew J. Gray IV
Jacob J.O. Minne

Washington, DC
Rachel E. Fertig



[1] See 17 USC § 204 (“A transfer of copyright ownership, other than by operation of law, is not valid unless an instrument of conveyance, or a note or memorandum of the transfer, is in writing and signed by the owner of the rights conveyed or such owner’s duly authorized agent.”).

[2] See Capitol Records, LLC v. ReDigi Inc., 910 F.3d 649, 657 (2d Cir. 2018) (holding that a service that allowed for the “owner” of an MP3 to sell it to another was infringement because “each transfer of a digital music file to ReDigi’s server and each new purchaser’s download of a digital music file to his device creates new phonorecords”).

[3] See Redbox Automated Retail, LLC v. Buena Vista Home Entm’t, Inc., 399 F. Supp. 3d 1018, 1032-33 (C.D. Cal. 2019) (“[T]he first sale doctrine is inapplicable to digital codes. The first sale doctrine applies to ‘particular’ copies that exist in the material world. See 17 U.S.C. § 101; Redbox I, Dkt. 74 at 19-24. Here, no such physical object exists when a standalone code is transferred, or prior to the time that that code is redeemed and the copyrighted work is fixed onto the downloader's physical hard drive.”).

[4] See Intellectual Reserve, Inc. v. Utah Lighthouse Ministry, Inc., 75 F. Supp. 2d 1290, 1293, 53 U.S.P.Q.2d 1425 (D. Utah 1999) (defendant ordered to remove from website addresses to websites that defendants knew, or had reason to know, contained material alleged to infringe copyright), and Universal City Studios Prods. LLP v. TickBox TV LLC, Case No. 2:17-cv-07496-MWF(AS) (C.D. Cal. Sept. 12, 2018) (issuing a preliminary injunction “compelling TickBox to maintain the current iteration of the Device's user interface, which seemingly no longer contains links to the themes and addons . . . that provided access to unauthorized streaming versions of Plaintiffs copyrighted works”).

[5] We must point out that if NFTs become divisible, and if divisible copyright rights do transfer with some NFTs, then the blockchain will need to keep track of a mind-boggling number of possible rights, payments, and ownership interests. But technology has surprised us before. Also, when multiple rights holders hold interests in the same copyright rights for the same work, courts sometimes impose limits on the transfer and exercise of those rights, especially when only a subset of rights holders take action—another reason that accurate tracking of ownership will be essential.