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What an NFT smart contract is, the specifics of its legal regulation, and the significance of NFT in the future.
What an NFT smart contract is, the specifics of its legal regulation, and the significance of NFT in the future.
Interview with Kira Maevska - Legal Advisor at Kira Maevska Legal and the crypto-consultant of HF-Solution.
Over the past few years, there has been a rapid growth in the popularity of cryptocurrencies, and the word "blockchain" has begun to be heard often not only among fans of high technologies but also in everyday news. Smart contracts are replacing the usual contractual relationship, and the main trend of 2021 is buying and selling NFTs.
How legitimate are blockchain smart contracts, what rules regulate NFT trading, is there a future for decentralized systems and is it possible to resolve legal disputes online without the participation of people - we talked about all this with Kira Maevska - Legal Advisor at Kira Maevska Legal and the crypto-consultant of HF-Solution.
How legitimate are blockchain smart contracts, what rules regulate NFT trading, is there a future for decentralized systems and is it possible to resolve legal disputes online without the participation of people - we talked about all this with Kira Maevska - Legal Advisor at Kira Maevska Legal and the crypto-consultant of HF-Solution.
Information note
Blockchain is a database that is stored on a huge number of computers at the same time. The blockchain consists of a chain of sequential blocks, in which each subsequent block contains information (hash) about the previous one. Once recorded in the blockchain, information cannot be changed or deleted.
Smart contracts are simple programs that are stored in the blockchain and can be used to exchange tokens based on a single set of conditions. These are contracts that do not require a person to control their execution. It is an executable machine code that will work as it is programmed.
A token is every entry in the blockchain. In an open blockchain, all tokens are equal and fungible. One token can be replaced with another one and nothing will change (e.g. Bitcoins).
The Non-Fungible Token (NFT) technology works differently. Each non-fungible token is unique and cannot be counterfeited, split, or subtly replaced. All information about its author, buyer, and all transactions with it is securely stored in the blockchain.
In other words, NFT is a digital certificate attached to a unique object. Moreover, the object itself can be both digital and real. NFT = Blockchain Entry + Metadata + Media.
In other words, NFT is a digital certificate attached to a unique object. Moreover, the object itself can be both digital and real. NFT = Blockchain Entry + Metadata + Media.
Hi Kira. Let's start with the very basic concept of NFT. What can be sold in NFT form and how?
From a technical point of view, with the help of NFT, you can tokenize anything - music, images, text, video, 3D models - any digital or even real object. NFT has gained particular importance for collectors, gamers, and artists. We are now at the very early stage of NFT development. There are not many use cases on the application of NFT yet. Where an NFT does not have any underlying asset, for example, if it is a collectible or a ticket, like NBA Top Shots or Crypto Punks collectibles. The second case is where the NFT has an underlying asset such as digital artwork or music. To simplify, NFT is like a certificate confirming some kind of intellectual property rights to the underlying asset, it is not ownership of the object. Usually, this is a license for the right to store, use, watch, and so on, but in 90% of cases, you do not acquire any significant rights to the object that underlies this NFT. The only thing you get for sure is the NFT itself.
The whole DeFi system is a concept of decentralized finance that is fundamentally designed to be user-friendly. NFTs are sold on special platforms - marketplaces. Well-known services include OpenSea, Rarible, Niftygateway and SuperRare. The platforms take a commission in Ethereum (the exchange unit of the Ethereum cryptocurrency, non-fungible tokens were created based on its infrastructure) for all operations - both for the creation (minting) of NFT and for its transfer to the new owner. The size of the commission varies but usually amounts to tens of dollars. For example, just making a transaction in Ethereum - transferring cryptocurrency from one wallet to another - may cost $10, $15, or maybe $20. The price depends on the workload of the system. It can be even $30-40 at its peak. On average, 40-50 dollars goes to the creation of NFT. However, it can be $100-150 because their prices vary even depending on the time of day.
The whole DeFi system is a concept of decentralized finance that is fundamentally designed to be user-friendly. NFTs are sold on special platforms - marketplaces. Well-known services include OpenSea, Rarible, Niftygateway and SuperRare. The platforms take a commission in Ethereum (the exchange unit of the Ethereum cryptocurrency, non-fungible tokens were created based on its infrastructure) for all operations - both for the creation (minting) of NFT and for its transfer to the new owner. The size of the commission varies but usually amounts to tens of dollars. For example, just making a transaction in Ethereum - transferring cryptocurrency from one wallet to another - may cost $10, $15, or maybe $20. The price depends on the workload of the system. It can be even $30-40 at its peak. On average, 40-50 dollars goes to the creation of NFT. However, it can be $100-150 because their prices vary even depending on the time of day.
What rights do I get when buying NFT? Can I manage my NFT outside the platform?
If you go to the platform you agree with what they have. The platform (marketplace) has a service containing a specific registered license rights scope of who gets what. It regulates what license gets the new owner of NFT, what license gets the platform itself. There is, as a rule, a licensing scope containing 95% of cases when ownership of the object is not transferred to the new owner in any way.
From a legal point of view, NFT is subject to the same categories. For example, now there is no need to regulate copyright matters related to NFTs, that is, there is no need to reinvent the wheel since there are classical norms that also apply to NFTs. However, the classical rules are not always applicable to NFTs. But the essence is the same. Something revolutionary new in copyright will not appear, the exclusive rights and license will remain.
NFT serves different purposes. When you buy NFT, which is based on some other object, you get the right to use this object for non-commercial purposes - you can use it for personal purposes. There are platforms where it is possible. There is an additional checkmark granting the right for commercial use (for example, purchase of stock photos). You can buy a regular license or an extended license. Typically, a regular one is for personal use, an extended one is for commercial use. Therefore, when you purchase a token, you get the right to use it in a limited scope of cases. However, at the same time, the one who mints this token undertakes to no longer mine tokens or any other objects attached to this artwork object, and so on. This is a scenario when we have exactly an object that is somehow tied to NFT. From the technical point of view, they are not related: the object itself is stored either on Amazon or IPFS or in another storage, and its link is wired into NFT.
From a legal point of view, NFT is subject to the same categories. For example, now there is no need to regulate copyright matters related to NFTs, that is, there is no need to reinvent the wheel since there are classical norms that also apply to NFTs. However, the classical rules are not always applicable to NFTs. But the essence is the same. Something revolutionary new in copyright will not appear, the exclusive rights and license will remain.
NFT serves different purposes. When you buy NFT, which is based on some other object, you get the right to use this object for non-commercial purposes - you can use it for personal purposes. There are platforms where it is possible. There is an additional checkmark granting the right for commercial use (for example, purchase of stock photos). You can buy a regular license or an extended license. Typically, a regular one is for personal use, an extended one is for commercial use. Therefore, when you purchase a token, you get the right to use it in a limited scope of cases. However, at the same time, the one who mints this token undertakes to no longer mine tokens or any other objects attached to this artwork object, and so on. This is a scenario when we have exactly an object that is somehow tied to NFT. From the technical point of view, they are not related: the object itself is stored either on Amazon or IPFS or in another storage, and its link is wired into NFT.
What should the owner of the NFT do if they discover that the media to which they issued the token is no longer available on this third-party source?
It can be different. If the guarantee goes through the platform, then the platform is obliged to store this media file. The user can contact either the issuer of the token, or the last seller from whom he bought the token, or the platform. There is no universal mechanism here, there are many different scenarios and options.
There is another case - NFT as a collectible card - for example, Crypto Punks, Crypto kitties. They are already independent objects since they have an object integrated into the blockchain inside them. It is not like, for example, having an empty card with the address where you can go to look at the picture written on it, and this card is the pass. Here, the picture will already be on this card itself.
It can be different. If the guarantee goes through the platform, then the platform is obliged to store this media file. The user can contact either the issuer of the token, or the last seller from whom he bought the token, or the platform. There is no universal mechanism here, there are many different scenarios and options.
There is another case - NFT as a collectible card - for example, Crypto Punks, Crypto kitties. They are already independent objects since they have an object integrated into the blockchain inside them. It is not like, for example, having an empty card with the address where you can go to look at the picture written on it, and this card is the pass. Here, the picture will already be on this card itself.
Is that why they have such strange pixel quality? Is it because the space is expensive?
This is because the place is very expensive, but also because such pixelated images are a special direction of crypto art.
Let's imagine that someone created a picture, attached a media file to the NFT on the marketplace, and suddenly comes a person saying that they are the author and they have evidence. What will the platform do in this case?
There is a standard procedure - takedown of infringing content. There are specific mechanisms for protecting copyright infringement. According to most of the applicable legislation, the owner, whose copyright is violated, sends a certain document in electronic form, where they specifically confirm that this is their work. The platform considers the complaint. In case the rights have been violated, the platform can simply remove the object. Further consideration of disputes may keep going on in other instances.
Who is currently considering/resolving disputes on transactions with NFT? Is this the platform where minting and sharing took place? How are the relations of the parties in the NFT market regulated?
The platforms usually do not resolve disputes. The terms of service indicate that all issues between creator and collector are regulated on a personal basis. This is your personal relationship. Disputes between the buyer and the seller are their own business. The marketplace owner does not resolve conflicts. The parties can go to a court or to contact the authorities that protect the rights of consumers.
Usually, disputes are not resolved by the platform itself. However, in general, the Terms of service of a platform is not the only place where the scope of rights and obligations is defined. The owner can himself issue the NFT token and prescribe what rights he transfers when selling it.
What is a platform? This is a user interface and a smart contract. It's just more convenient for you to mint a token on the platform, but it can be issued without a platform - these are purely technical issues. You can create an object, register all the hashes, etc. manually. After all, the platform does the same thing. Formally, the one who issues the NFT can do it themselves. In this case, the scope of rights and obligations will be determined at the moment when the NFT is issued. This will be a smart contract with specific conditions. Everything depends on whether the jurisdiction in which the issuer is located recognizes the smart contract as an alternative to the classic one.
The question is different. This smart contract can define rights and obligations, but, for example, the token issuer may not rely on the smart contract. The contract will be a technical tool, and upon sale, the issuer can sign a classic agreement for the sale of the token and the transfer of exclusive rights to it. If a smart contract is no longer a technical contract and does not establish any rules of law, it will not be the source of legal regulation for these relationships. It is the classic contract that will be the source of legal regulation. If neither the smart contract nor the paper one has clearly defined rights, it is necessary to refer to the standard which was followed when the token was created. For example, in ERC 721 it is possible to set one of the parameters, which determines whether the ownership of the object is transferred or not. In this case, if this was set during creation, then the rights are transferred to the new owner of the token. In the smart contract, when creating an NFT token, you can also register the automatic collection of royalties (fees for using the object). A new standard is being created in addition to 721 and 1115 for this reason. There is a discussion in the Ethereum community about creating a standard that will already include royalties by default, ie. royalties will become unified. Currently, royalties depend on the platform's smart contract and if the NFT has left the platform, then royalties will no longer be charged. That's why they are working on the third standard so that the collection of royalties can be automated on any platform.
Usually, disputes are not resolved by the platform itself. However, in general, the Terms of service of a platform is not the only place where the scope of rights and obligations is defined. The owner can himself issue the NFT token and prescribe what rights he transfers when selling it.
What is a platform? This is a user interface and a smart contract. It's just more convenient for you to mint a token on the platform, but it can be issued without a platform - these are purely technical issues. You can create an object, register all the hashes, etc. manually. After all, the platform does the same thing. Formally, the one who issues the NFT can do it themselves. In this case, the scope of rights and obligations will be determined at the moment when the NFT is issued. This will be a smart contract with specific conditions. Everything depends on whether the jurisdiction in which the issuer is located recognizes the smart contract as an alternative to the classic one.
The question is different. This smart contract can define rights and obligations, but, for example, the token issuer may not rely on the smart contract. The contract will be a technical tool, and upon sale, the issuer can sign a classic agreement for the sale of the token and the transfer of exclusive rights to it. If a smart contract is no longer a technical contract and does not establish any rules of law, it will not be the source of legal regulation for these relationships. It is the classic contract that will be the source of legal regulation. If neither the smart contract nor the paper one has clearly defined rights, it is necessary to refer to the standard which was followed when the token was created. For example, in ERC 721 it is possible to set one of the parameters, which determines whether the ownership of the object is transferred or not. In this case, if this was set during creation, then the rights are transferred to the new owner of the token. In the smart contract, when creating an NFT token, you can also register the automatic collection of royalties (fees for using the object). A new standard is being created in addition to 721 and 1115 for this reason. There is a discussion in the Ethereum community about creating a standard that will already include royalties by default, ie. royalties will become unified. Currently, royalties depend on the platform's smart contract and if the NFT has left the platform, then royalties will no longer be charged. That's why they are working on the third standard so that the collection of royalties can be automated on any platform.
Anyway, Ethereum is used everywhere, isn't it?
It is already possible to release NFT on the Binance Smart Chain since Ethereum is very expensive. For example, on the Binance smart chain, I can make a transaction for 10-20 cents for a regular transfer, while it would be $20 if I used Ethereum. Ethereum, as an ecosystem, is heavily loaded and therefore it is very expensive. The three most in-demand eco-systems currently are Ethereum, Binance Smart Chain, and Solana. But for now, the release of NFT can be carried out on Ethereum and Binance Smart Chain. However, it is only a matter of time. Something new and better will appear.
It is already possible to release NFT on the Binance Smart Chain since Ethereum is very expensive. For example, on the Binance smart chain, I can make a transaction for 10-20 cents for a regular transfer, while it would be $20 if I used Ethereum. Ethereum, as an ecosystem, is heavily loaded and therefore it is very expensive. The three most in-demand eco-systems currently are Ethereum, Binance Smart Chain, and Solana. But for now, the release of NFT can be carried out on Ethereum and Binance Smart Chain. However, it is only a matter of time. Something new and better will appear.
Does the ability to resell NFTs inherent in their smart contracts allow them to be considered as investments? Can they then be classified as securities?
Let's say NFT is a blank sheet of paper. You can print a photo, bill of exchange, or contract on it. If you integrate in the NFT the rights for the owner, which correspond to the rights of the owner of the security, it will be a security. For an ordinary collector of pictures with an attached NFT, in 90 percent of cases, this will not be a security. In essence, it can be anything, depending on the content. In case of questions and disputes it will be up to the regulator to determine whether a particular NFT is classified as securities, depending on the legislation of the country, for example, Securities and Exchange Commission in the United States.
Let's say NFT is a blank sheet of paper. You can print a photo, bill of exchange, or contract on it. If you integrate in the NFT the rights for the owner, which correspond to the rights of the owner of the security, it will be a security. For an ordinary collector of pictures with an attached NFT, in 90 percent of cases, this will not be a security. In essence, it can be anything, depending on the content. In case of questions and disputes it will be up to the regulator to determine whether a particular NFT is classified as securities, depending on the legislation of the country, for example, Securities and Exchange Commission in the United States.
What will be the taxation of transactions with the purchase and sale of NFT?
Each country has its own taxes and its own taxation system. There are different types of taxes, in this case, we are talking about income tax. Usually, it is paid at the end of the year if it has made a profit or income.
Will the laws on sanctions be applied?
Oh sure. You can sell the sneakers to a citizen of a sanctioned country, or you can sell the NFT. Nothing changes. But everything will be checked according to various sanctions lists, which clearly state what information can be transferred, and which assets can and cannot be sold as well as to the jurisdiction where the transaction takes place. There is no full embargo for a specific country, you need to study the details.
Imagine a future where most of the resources on the Internet run on the blockchain. In what areas can NFT be used?
In fact, any. That's where we started our conversation. What we now understand by NFT is the most basic beginning. At its core, NFT is a technical standard that can be applied in any field. For example, it could be an electronic certificate. However, for it to become an electronic certificate, it is necessary to carry out global work on changing the legislation. Consider a trademark. A trademark certificate today can be paper or electronic. You get it in your country from the designated registration authority, but through it, you can also apply for registration in any other country. There is a procedure, fees, and in the end, you can get certificates in all the countries you need and protect your trademark without leaving your country. If, for example, registration authorities switch to blockchain and start issuing an electronic certificate, this will work in all countries that have joined the blockchain. But for this it is necessary to sign many international conventions, the base must be united, and the issues of interaction at the national level must be resolved. It sounds great, but this is a huge work at the state level, which should be reflected in the legislative framework.
In other words, you can draw as many logos as you like and attach NFTs to them. However, the situation when you go to court with them to protect them from being used by third parties is similar to souvenir dollars - you can print them and have fun, but until they are recognized by the authorities, they have no legal force.
The NFT itself is a piece of code that has several hashes, a link, and an indication of who released it. This is all you can do. NFT apart from some kind of contract is nothing. Well, what are you going to do with it? The question is either to the smart contract that issued it or to the contractual relationship that is created around it.
NFT is a technology that will have a huge impact on all areas of our lives because it allows us to digitize the interaction with any virtual and physical goods.
In other words, you can draw as many logos as you like and attach NFTs to them. However, the situation when you go to court with them to protect them from being used by third parties is similar to souvenir dollars - you can print them and have fun, but until they are recognized by the authorities, they have no legal force.
The NFT itself is a piece of code that has several hashes, a link, and an indication of who released it. This is all you can do. NFT apart from some kind of contract is nothing. Well, what are you going to do with it? The question is either to the smart contract that issued it or to the contractual relationship that is created around it.
NFT is a technology that will have a huge impact on all areas of our lives because it allows us to digitize the interaction with any virtual and physical goods.
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