Ever since the renowned auction house Christie's auctioned the digital artwork "Everydays: The first 5000 days" off to an anonymous buyer for 69 million dollars on March 11, 2021, a wider audience has also become aware of the future implications of using non-fungible tokens (NFTs). This is because the auctioned work of art was not an actual physical object, but merely a digital signature.
Until now, creators of virtual art have always faced the difficulty that their efforts could easily be reproduced by third parties without the creator being able to prove the originality of the original signature. The use of NFTs now seems to have resolved this problem. This is not the only reason why this technology has been attracting growing interest since the beginning of 2021. The limits of the possible uses here are far from being exhausted. However, this brings forth a number of legal questions to which the answers have also not yet been conclusively clarified.
Similar to cryptocurrencies, NFTs are also based on blockchain technology. This is a continuously expandable chain of datasets (blocks). Unlike datasets in a cloud, these are stored decentrally on many different computers and each contains its own value (hash), the value of the previous block. If the hash of a block in the chain were to be changed, the chain would thus break. Since the chain is stored on many different computers, an altered chain would be noticed as manipulation. This approach makes the blockchain tamper-resistant. It is therefore particularly suitable for storing data in a tamper-proof manner.
A distinction is made between fungible tokens and non-fungible tokens (NFTs). Fungible tokens all have the same asset value, so it is then irrelevant to the holder which token is actually assigned to them. The best known application for this is cryptocurrencies. As with banknotes, it does not matter to the cryptocurrency user which token they own, as all other tokens of this type also have the same value. In that respect, from the user's point of view, they are interchangeable.
NFTs, on the other hand, are tokens that are marked with unique information. These are then not found on any other token in the blockchain. This allows the ownership of a particular asset - whether physical or digital - to be linked to an NFT and assigned to a certain individual. These tokens are not arbitrarily interchangeable with other tokens. Rather, it is precisely the individual token that matters, as it is unique. NFTs exist only once within the blockchain and cannot be split into smaller individual parts.
Currently, NFTs are mainly used in digital trading cards, game characters, virtual lands in virtual worlds or in crypto art. By storing the information about the original file in an NFT, a digitally unique unit is created. If the purchaser receives the NFT as well as the original file, they can prove that they are the owner of the original. This resolves a problem that has long hampered lucrative trading in digital assets. Whereas, for example, physically existing original works of art can usually be proven beyond doubt to be such, virtual assets could previously be copied and distributed without any problems. It was difficult for the owner of the original file to prove its originality.
Although the use of NFTs does not prevent the original files from still being copied at will, "tokenization" now makes it possible to prove their originality beyond doubt and, as a result, they become a significant factor in increasing the value of a file. Because of its provability, the value of a file is no longer undermined by identical copies. This guarantee of uniqueness ultimately grants virtual assets a quality that they previously lacked in comparison to analog works of art. Consequently, they become serious digital commodities and investments, which their creators, in turn, benefit from as it generates a secure source of revenue. Many of these transactions are processed using Smart Contracts which are also based on blockchain technology. Although, to date, NFTs have primarily been used for digital art and collectibles, their potential range of application goes far beyond that. For example, NFTs could also serve as the basis for digital identification documents.
As with blockchain technology in general, NFTs raise numerous legal issues that may have a significant impact on their users. However, these concerns have not yet been conclusively resolved. This is reason enough to obtain a brief overview.
The question arises, particularly regarding service providers offering services in connection with NFTs in Germany, whether their activities are subject to licensing under the German Banking Act (Kreditwesengesetz, KWG). This would be the case if NFTs were a financial instrument pursuant to § 1 (11) of the Banking Act. In this context, the catalogue of financial instruments in § 1 (11) No. 10 of the Banking Act also covers crypto assets, whose legal definition in § 1 (11) Clause 4 of the Banking Act covers not only the "means of exchange and payment" but also digital representations that serve investment purposes. Virtual assets can be traded as investment objects through the use of NFTs and could therefore be a financial instrument under the German Banking Act.
The consequence of this classification is that the corresponding economic dealings with NFTs are subject to the licensing requirements of § 32 (1) of the German Banking Act. Particularly important in this context is the permission to act as an investment broker (§ 1 (1a) Clause 2 No. 1 of the Banking Act), but proprietary trading or the custody of NFTs are then also subject to permission.
If there is a prospectus requirement, an appropriate prospectus must be published the first time a security is offered to the public that provides investors with transparent information on the content and risks. Whether the creator of an NFT must also publish such a prospectus again depends on the legal classification of the NFTs. In addition to being an investment object, these would also have to be securities in order to prompt a prospectus requirement under the Prospectus Regulation (VO 2017/1129). According to Art. 2 lit. a of the Prospectus Regulation in conjunction with Art. 4 (1) No. 44 of the Directive 2014/65/EU (MiFID II), securities within the meaning of the Prospectus Regulation can be traded on the capital market. According to the German Federal Financial Supervisory Authority (BaFin), tradability requires a minimum degree of standardization that makes the securities comparable in the sense of a class.
Even if the assessment from the BaFin does not seem to apply to the individualized NFTs, it must be taken into account that the individual NFTs can certainly be transferred, are thus tradable and could be covered by the wording of the Prospectus Regulation. However, NFTs do not fit the securities examples cited in Art. 4 (1) No. 44 of the Directive 2014/65/EU (MiFID II), so their classification as securities has not been conclusively clarified. Nevertheless, there are good arguments against this. Moreover, a prospectus requirement is cancelled in each instance when an NFT is offered for not less than 100,000 euros (Art. 1 Para. 4 lit. c, d of the German Prospectus Regulation).
German copyright law also raises some questions about the use and, in particular, the purchase of NFTs. This starts with the question of who is entitled to create and commercially distribute an NFT of a copyrighted digital work. If the creation of an NFT were to require a right of public reproduction pursuant to § 15 (2) of the Copyright Law, it would initially belong exclusively to the author. If the author has already assigned the rights to a publisher or label, it is important to check whether the right to emboss an NFT has also been assigned. The wording of the contract in the individual case is decisive in this respect. The written form requirement of § 31a (1) Clause 1 of the Copyright Law must also be taken into account.
If, on the other hand, one concludes that the authorship of a digital work and the right to a corresponding NFT are separate, NFTs do not enjoy copyright protection. However, the subsequent question then arises as to how an author can take action against the creation and sale of an NFT of his copyrighted work. NFTs could then at least be an "other right" within the meaning of § 823 (1) of the German Civil Code (BGB) and give the owner an opportunity to defend himself against the unauthorized creation of additional, identical NFTs. To date, however, computer data have never been recognized as "other rights." For this, they would have to be able to clearly assign a person who could, at the same time, exclude all other persons from using them and thus hold a position similar to that of an owner. Due to the limitless reproducibility, this option has not been available to data thus far.
However, NFTs now make it possible to identify the original and prevent third parties from using these same originals. This could lead to a change in thinking regarding the classification of data stored on NFTs as "other rights" in the future.
When transferring NFTs, the creator and the purchaser must clarify which rights the purchaser can acquire in the first place and which rights the purchaser should acquire. It should be taken into account here that the parties must agree on the transfer of rights to both the asset and the NFT. Indeed, the rights to the asset do not result from the transfer of the NFT. Although it can be expected that the market will soon define uniform standards here as the business field becomes more popular, the contracting parties will have to agree on them individually until then.
For the purchaser, the most important concern will be what rights they acquire to the digital original. If the object of purchase is not a tangible object, they cannot acquire ownership of it. The purchaser can only acquire rights of use, which must be granted individually. In order to obtain a position similar to ownership, the purchaser must obtain exclusive rights of use, unrestricted in time, region and content, which allows them, in turn, to transfer, create sublicenses and rent. In the specific case of NFTs, these rights of use can be extended to include the right to various types of use, such as a right to edit. If the purchaser wants to have the uniqueness of the asset guaranteed, it may also be decisive to exclude the sale of another original together with the corresponding NFT by the originator.
Furthermore, it must be taken into account in the sale that the author can participate in any subsequent increase in value in accordance with § 32a of the Copyright Law. In this case, it would also be conceivable to allow the author to participate automatically and directly in the proceeds of sale with every additional transaction by means of Smart Contracts.
Most blockchains are publicly viewable, and the participants or owners of each block are only pseudonymized and not anonymized. Therefore, the scope of application of the GDPR is fundamentally open to NFTs as well. Users should not overlook this when creating NFTs.
NFTs are currently revolutionizing the market for virtual valuables. Selling these valuable assets creates a lucrative business model that transforms digital assets into new investment properties. However, many accompanying legal concerns are still unclarified, which can decisively influence design and profitability. The conceivable limits of NFT use and the resulting legal concerns also remain far from being achieved. Users, traders and purchasers of NFTs should consider these legal concerns at an early stage in order to ensure the legal security of a transaction or an NFT business model and to eliminate risks. We are happy to advise you as you pursue a successful NFT business model.
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