The evolving legal landscape of NFTs

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The history of the NFTs

NFTs, also known as non-fungible tokens, have been around for almost a decade. The term “non-fungible” refers to something that is unique and cannot be replaced by another – that is, an indication of the authenticity of the item and an obstacle to the counterfeit market. The earliest issue of NFTs was on the Bitcoin blockchain platform in 2012 to authenticate ownership of assets, including real estate, tickets, and company shares.

While NFTs are now known as valuable works of art, NFTs were originally used by the game industry for game developers to dispense virtual assets. Peer-to-peer financial platform and digital asset trading company Counterparty paved the way for NFTs in the game and entertainment industry through their collaboration with game companies Spells of Genesis and Force of Will.

It wasn’t until 2016 that the art world made its first foray into the NFT space and triggered a shopping spree in the first quarters of 2021.

The cartoon character Pepe Frog was added to the Counterparty platform as a meme. Dubbed the “Rare Pepes,” the meme not only gained a large and avid fan base, but also inherited an intrinsic value as Ethereum grew in popularity. Ethereum as a decentralized open source platform issues its own cryptocurrency Ether, which can be stored on digital wallets for trading purposes.

As of 2017, other newly created NFTs like Cryptopunks and CryptoKitties have seen a rapid surge in popularity and are being adopted in the mainstream. In recent years, music and art professionals have begun to take advantage of the use of NFTs, peaking in trading volume in September 2021 with nearly 29,000 sales with a sales value of more than $ 1 billion.

On October 28, 2021, CryptoPunk was awarded a record $ 530 million.

Basil Hwang von Hauzen LLP gives preference to NFTs from a contractual and regulatory perspective.

Lawyers and NFTs

On October 25, 2021, Stephenson Law hit the headlines as the first law firm to launch its own NFT in a series of three that serve as “crypto art tokens that represent legal advice” that allow the right to buy theirs NFT for “an hour of legal advice on financial services regulation, blockchain and NFTs, as well as strategy, compliance, governance and documentation required for such a newfangled technology. One of the NFTs entitles the buyer to personal access to Alice Stephenson, the founder of Stephenson Law.

This innovation has aroused a lot of skepticism and criticism from legal traditionalists, who quickly accuse the firm of marketing gimmicks. Other critics claimed that NFTs are a potential money laundering channel that undermines the integrity of the legal profession.

While NFTs are still in their infancy for use in the legal industry, the recent trade frenzy has caught the attention of many legal professionals.

NFTs, like any other asset, are subject to legal ramifications of ownership, copyright, fraudulent trading, cybersecurity, and contractual obligations. As it is an emerging technology, there are currently only a few lawyers who are knowledgeable about the technical details of NFT technology.

Basil Hwang von Hauzen LLP gives preference to NFTs from a contractual and regulatory perspective. Since 2014, Hwang has handled more than 50 cases related to cryptocurrency regulatory tokens, disputes and blockchain contract agreements. In a typical NFT transaction, Hwang reviews NFT-related contracts and ensures that the contract and service terms are specific and can be upheld by existing laws and courts. Hauzen LLP performs due diligence for clients so that its clients are legally protected in the event of a transaction failure or in the event of a fraudulent transaction.

The Increase in NFT Crime and Legal Risks

Blockchain as a shared (or decentralized) digital ledger platform has been praised for increasing visibility and transparency, helping to detect fraud by exchanging real-time information and providing transparency about transactions for all participants in a blockchain. This bypasses the levels created by traditional databases that are managed from a single centralized entity.

With the recent increase in the value of NFTs held on NFT platforms, theft and identity theft have also become widespread. News reports have covered impersonators running online auctions on Banksy’s behalf and syndicates running sophisticated NFT scams, as in the case of Evolved Apes.

Ironically, the lack of centralized authority has proven to be a double-edged sword. It can be difficult, if not impossible, to hold an individual or legal entity accountable. In NFT business, NFT platforms like OpenSea and Rarible have compared to traditional transaction sites where there are many verification hurdles (proof of national ID number, proof of bank account and statement of income, etc.) user must delete before being allowed on the platform.

Recent legal cases related to NFTs

On May 12, 2021, the first NFT lawsuit was filed between plaintiff Jeeun Friel and Dapper Labs Inc and the CEO of Dapper Labs in the Jeeun Friel vs. Dapper Labs and Roham Gharegozlou case. Plaintiff Fiel alleged that Dapper Labs’ platform, NBA Top Shot, sold securities when it sold NFTs on its platform in violation of securities laws. The plaintiff alleged that the NFTs should have been registered with the Securities and Exchange Commission because the NFTs are digital assets that “derive their value from the success or failure of a particular project, promoter or start-up”.

The verdict in the Dapper Labs case has not yet been issued. This could be a landmark case that would provide guidance to legal professionals on NFT transactions. The verdict will be interesting as it could shed some light on whether NFTs should be considered “securities”, including under the Hong Kong Securities and Futures Regulation (the “SFO”).

In the high-profile litigation between the record company Roc-A-Fella Records (co-founded by star singer Shawn “Jay-Z” Carter, better known as Jay-Z) and the former business partner who became the defendant Damon Dash, the decision was made in favor of the Plaintiff by stopping Dash’s attempt to sell Jay-Z’s ‘Reasonable Doubt’ as an NFT. The court ruled that Dash’s attempt to sell the virtual ownership of the album’s copyrights was a breach of duty of loyalty, conversion and unjust enrichment. “Securities” are defined in the SFO as “shares; Debt securities (e.g. bonds and notes); Rights and options in stocks and bonds; Participations in collective investment schemes; Interest that is generally considered to be securities but does not include a range of things such as deposits or transferable certificates or documents evidencing a deposit; or a structured product that does not fall under the current definition of securities and for which the offer documents require SFC approval under SFO in accordance with Appendix 1. The position in Hong Kong is that some cryptocurrencies are considered securities, but others are not, depending on their value.

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2021 appears to be a milestone in the popularity and trading activity of NFTs. The NFT market will continue to grow, with talks about using NFT to preserve delicate works of art leading the way in the fight against counterfeit luxury goods.

To gain some of the legal market in relation to NFT, the lowest hanging fruit for law firms and attorneys would be to protect clients from fraudulent NFT activity. It would be advisable for regulators to work with NFT platforms to improve consumer protection in NFT transactions. While regulators work to create a broader framework for regulating NFTs, it is left to law firms to apply existing common law and legislation to the ever-changing world of NFTs, with all of its technical variations.

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