Non-Fungible Tokens (NFTs) are all the rage in today’s fast-evolving world. From pictures of a cat being sold for a couple of hundred thousand dollars, to Jack Dorsey entertaining a bid of $2.5 million for the first-ever tweet – the intricacies around NFTs are worth diving into. A recent episode on Fintech Beat Podcast brought together Dr. Chris Brummer with Nic Carter and Amy Luo, to help explain how NFTs work, and what their meteoric rise means for blockchain technology and securities law.
The Fintech Beat podcast is a weekly series, hosted by Dr. Chris Brummer. A professor and faculty director of Georgetown’s Institute of International Economic Law, as well as Scholar in Residence at Paradigm, Brummer has taught at several prestigious universities. In addition to his service to academia, Brummer is a member of the Commodity Futures Trading Commission’s Subcommittee on Virtual Currencies and a member of the Consultative Working Group for the European Securities and Markets Authority’s Financial Innovation Standing Committee. Rachel Loko, the noted securities lawyer and former microfinance expert, is his wife.
What are NFTs?
In a nutshell, an NFT is a serialized piece of information that exists on a public blockchain. Most people define it by providing a simple explanation using the concept of fungibility. Fungibility is the ability of a good or asset to be interchangeable with goods or assets of the same type. Commodities, common shares, options, and dollar bills are all examples of fungible goods. A non-fungible good on the other hand is not interchangeable, like a diamond or a car.
There is no single-use to NFT’s but the popular ones are art, collectibles, and in-game assets. According to Amy Luo, who is the general counsel at Centre, a consortium of industry players, designed to help support the US dollar coin (USDC); NFT’s are packets of information that can embody anything and everything. “In the future, almost all data on Web3 will be in the form of NFTs. You can think of that not only in terms of music, art, and digital goods but your shopping preferences, medical history, and your DNA, to even social media generated content.”
According to Nic Carter, a partner at Castle Island Ventures, it’s a common misconception that inserting a serial number or a piece of data on the blockchain renders it scarce and amenable to being financialised. You need two things.
1. You first need to associate assets with a token on the blockchain. This allows you to track their proof of provenance and keep track of it as ownership changes over time.
2. You then need external assurances from the issuer. The issuer needs to assure buyers that they will only create a limited number of these references and will not arbitrarily inflate them.
An example of an issuer meeting both these requirements is NBA top shots, where the NBA has given assurances that they’re not going to deviate from the supply schedule and hyper-inflate the quantities of collectibles.
Amy Luo also outlined three characteristics which she believed rendered NFTs as unique:
1. The accessibility due to a borderless market.
2. NFTs as a new form of entertainment in a post-pandemic world. Where there are no live basketball games people are trading top-shots online and being able to participate in the sports arena.
3. The programmability aspect of NFTs: It’s not just 2d or 3d art forms. You can program and plugin oracles that make art that can change in time with the weather or each time it trades hands or based on the price of BTC. There are many ways in which artists will be able to unleash different ways of creativity with this concept.
Dr. Brummer, who recently joined the board of K2 Integrity, was also curious to know why the first application of NFTs was found in the art world. Is there a particular characteristic of NFTs that lends them to this industry? On this point, Nic explained how blockchains help render things innately transferable and open to being financialised. Artwork and collectibles are generally assets that gain value and are tradeable. However, exchanging artwork can be cumbersome, due to a requirement for physical settlement. Therefore, it made sense that the first broad-based application for a dematerialized collectible would be in the art and collectible game space. Because you risk art or collectibles being lost or destroyed, dematerializing art makes sense the same way it does for money.
Apart from the unique characteristics of NFTs and what makes them so popular, there are some interesting legal questions. For Dr. Brummer, it’s not just an issue of how you experience art but how and whether other people can experience that art as well. On a basic level, people in this space are unaware of what they are buying. We need to think about what the creator is selling and what the purchaser is buying. At times, knowing who the creator is, can also be cumbersome. This is because, in generative art, it is usually a smart contract or an algorithm that is creating the art. Subsequently, what are the rights as the original minter of a work vs the purchaser of a print of the work? For this reason, it is quite important to read the fine print on the platforms where these NFTs are being sold.
There are also issues of copyright. Copyright refers to not one right, but a group of rights granted as soon as a work of art is made. This group of rights is extensive and includes the right to publish, copy, monetize and create derivative works. When you sell a piece of art NFT, you’re only granting the right to use it for personal and non-commercial consumption other than resale. This is an area that buyers should pay attention to before making purchases. “There is a huge amount of confusion within people as to what they’re buying. That’s partly because of the issuer. They have done a poor job of codifying the rights that accompany the purchase of an NFT and that’s not due to malice but due to it being poorly understood, from the buyer and issuer perspective,” says Nic.
The episode concluded with a discussion about the future of NFTs and whether or not they would trigger some of the same concerns seen in the ICO market. Both speakers believed that concerns on securities law will arise, especially as artists and creators start looking at ways to share ownership in their creations with fans in ways that share revenue streams. This led to a discussion on whether the Howey Test would apply to NFTs. The Test refers to the U.S. Supreme Court case for determining whether a transaction qualifies as an “investment contract,” and therefore would be considered a security and subject to disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934.
To be a part of more interesting conversations like this you can join in on ‘Fintech Beat Podcast’ – where Dr. Chris Brummer brings together brilliant minds every Tuesday to tackle the challenges erupting at the intersection of finance, tech, and policy.
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