Gaming raises a multitude of legal issues for businesses. In this series of publications, Gaming and law: What businesses need to know, we cover a number of the most topical issues.
In this Part 1: Gaming and Non-Fungible Tokens, Justin Davidson explains what a Non-Fungible Token (NFT) is and the implications for gaming.
Fungible items, like dollar bills or shares, can be readily exchanged for other dollar bills or other shares in the same business and you continue to own the same thing. The item's value defines it, rather than its unique properties.
NFTs, on the other hand, are not interchangeable due to their unique properties. In the same way that you cannot readily exchange one plot of land for another, or one unique piece of artwork for another, without owning something fundamentally different. The value in an NFT is therefore derived from its “non-fungibility”, meaning that the token cannot be replaced with an identical token (giving its inherent scarcity).
NFTs are composed of software code and are typically in the form of one or more smart contracts. Like traditional cryptocurrencies, NFTs in the form of smart contracts are created - or "minted" - on a blockchain (that is, distributed ledger technology) using cryptography, and they can be bought and sold or otherwise exchanged on any NFT market based on the same blockchain.
It is the smart contract constituting the NFT that contains details of the underlying digital or physical asset(s) (if any) to which the NFT relates, and also the rules and rights that attach to the NFT (for example, who owns it, how it can be transferred, what exactly the NFT represents, and perhaps a rule that the original creator of the NFT gets paid a percentage of any subsequent resale value).
Is a smart contract an essential aspect of an NFT?
While many NFTs will be associated with smart contracts, an NFT might also simply be a token that contains additional data or attributes that prevent it from being fungible with other tokens.
The data might be included in the NFT itself – perhaps a gif file displaying a piece of art, or a number corresponding to an entry in a register. In this case, there is no associated smart contract.
Or the NFT may simply be a key that allows you to exercise rights via a smart contract – for instance, ownership of the NFT will allow the smart contract to allocate certain royalties to a licensor. In this case the NFT only has value via the smart contract
Sometimes the NFT exists on a specific platform that is governed by additional terms in a traditional contract. As with other tokens created on a blockchain, the blockchain tracks the transaction history of the NFT from issuance to any number of subsequent transfers, and such record is immutable.
The record, in turn, creates "provable" uniqueness and scarcity, and these concepts are what ultimately leads to value. NFTs, then, are essentially unique digital representations with blockchain-based transferability, authenticity, and ownership properties.
A metaphor to understand NFTs is to consider each NFT to be a briefcase, in a chain of unique briefcases tied together. The process of chaining briefcases together represents the fact that NFTs sit as smart contracts on a blockchain, so that they may not be easily amended or deleted.
In this metaphor, each briefcase has an external luggage label, purporting to indicate what is inside. For example, the label may say, “This NFT is for Leonardo da Vinci’s painting, the Mona Lisa.” What is inside the briefcase may indeed be documents conferring ownership of the painting, or perhaps conferring ownership of a digital photograph of the painting, or merely documents conferring rights to reproduce the digital image under some circumstances.
The documents in the briefcase may confer value in some way, or no value at all (e.g., conferring rights that the creator of the NFT has no legal right to claim), or, indeed, the briefcase may be entirely empty.
Gaming developers and purchasers should keep in mind which blockchain is used to mint an NFT, as many marketplaces will only work with certain blockchains, and once an NFT is minted on one blockchain, at the moment it may not be able to be moved to another blockchain.
The legal nature of an NFT
Is an NFT a type of property itself? Does it confer property (ownership) rights in anything else (for example, an underlying asset or a digitised representation of something)?
With respect to tangible things, there are potentially two forms of property: ownership of the physical thing itself, and sometimes, ownership of intellectual property in it. However, where a thing exists only in a dematerialised form (as in the case of an NFT), is ownership in anything possible other than intellectual property rights? Two recent cases, one English and the other Singaporean, have suggested that the courts may be willing to recognise that NFTs may be a species of dematerialised property, with ownership rights subsisting completely separately from intellectual property – see our blog, Are NFTs a type of property under English law?
Why is this important? End users value ownership. If all an NFT issuer is doing is granting a licence of the intellectual property in an NFT, that may detract from perceived scarcity (and therefore value). Conferring ownership, on the other hand, may augment perceived value, and facilitates the creation of a secondary market for NFT on-sales (and potentially, the payment of royalties to the initial minter in respect of such sales).
For the uninitiated, however, the idea that an NFT can itself be property – that it can be something that is owned to the exclusion of all others – can lead to confusion about what rights the NFT owner has in any underlying/off-chain asset/item to which the NFT refers.
Rights in underlying assets
If the underlying asset/item is:
- Digital, there is typically a link to a digital file on an off-chain server or, less commonly, a digital file stored within the NFT itself.
- A physical asset/item, then there is no option to use a link to the physical world. Most NFTs relating to physical assets/items therefore still rely on QR codes or, more simply, company records that record the link between the NFT and the physical asset/item.
Unless otherwise provided for contractually in some way, the NFT owner may find that it has no rights at all in the underlying asset/item. Rights in the underlying thing would simply be determined by, in the case of an artwork say, normal intellectual property rights principles.
For more information on what rights NFTs confer in underlying assets/items and intellectual property rights, see What are the intellectual property rights issues, below.
UK: digital assets reform
The Law Commission for England and Wales has proposed that, while English law has demonstrated a degree of flexibility in accommodating the use (and regulating the misuse) of digital assets, now is the time to develop a coherent legal framework capable of dealing with all manner of digital assets, including NFTs, instead of relying on the iterative development of the common law.
The Law Commission suggests the creation of a new category of property, known as “data objects”. Certain digital assets, including NFTs (although not necessarily any digital rights linked to NFTs), would fall within this new category. This would provide clarity on the treatment of NFTs within property law. For instance, security could be created over them and they could be subject to proprietary remedies.
Since a consultation on the issue, the Law Commission has now reported on the detailed form that these changes should take. For more information on the proposed changes, see our blogs:
- NFTs, cryptocurrency, digital assets: What are they under English law?
- The Law Commission's 'data objects': digital assets as a new property class
- Law Commission proposes revolutionary rules for ownership of crypto tokens and NFTs
NFTs have many use cases, though gaming (in particular the gaming metaverse(s)) represents some of the key areas in which NFTs may bring radical transformation and enhance user experience. For instance, NFTs can be linked to in-game items such as weapons, vehicles, keys, collectibles and even lands. The inherent uniqueness of each NFT token confers to the game player a sense of ownership and authenticity of the particular in-game item.
There is presently no interoperable standard software code for virtual items, so the products currently exist only in software code in their own compatible virtual worlds (for example, as downloadables in players’ wallets in the particular game/world).
In cases where the item is scarce in the game, it may be possible (online and offline) to sell the NFT representing the item. This allows the player to monetise the effort devoted to obtain the item, while at the same time the game developer may also get a share of the selling price by including appropriate terms in the NFT smart contract.
Although such in-game trading market already existed in some games without involving any NFT technology, such in-game items were tied to the specific gaming platform. The blockchain technology that supports NFTs provides the possibility for the item to exist independently of the gaming platform and to be traded outside the game developer’s system. However, in order for a virtual object from one game or metaverse to be used in another game or metaverse, the gaming companies have to agree on interoperable software coding.
Use case: Gaming in the metaverse
Similar to the fashion industry where an NFT could be tied to a physical item, in the gaming world, an NFT can be tied to certain in-game items such as a character, a "skin" or a rare gaming asset.
Each item can be uniquely coded and would exist in the gamer's account as long as the gamer owns it. It can be transferred, traded or loaned to another account for a certain period of time.
An NFT could also represent an accomplishment in a game - for example, you receive an NFT once you reach level 100.
Another example is with fantasy sports games. Gamers can collect NFTs that represent a certain player on a team. Once you collect enough NFTs, or players, you can field a team to compete against other teams.
Use case: Using NFTs to buy land in a game or a metaverse
It is common for an NFT to be used as part of the process of buying virtual land. What are key legal issues in such context?
- What is it the customer is buying?: Is the customer buying an NFT that represents particular pieces of virtual real estate in the metaverse? This begs the question about what exactly does a “piece of virtual real estate in the metaverse” mean - for example, a hosted space on a supplier’s network accessible via the internet, access, a key or something else?
- Custody of the land once purchased: If the customer agrees that the supplier will hold custody of its land tokens, then the SAFT may need to contain detailed provisions regarding the custody arrangements (e.g. whether the tokens will be held in hot or cold storage) and what the supplier’s liability is if something goes wrong with custody.
- Insolvency of supplier: There may need to be provisions concerning transfer of any rights owned by the customer on termination / insolvency of the supplier.
- Access to the land: The customer will wish to provide for access to the land and remedies when the customer / its own customers are unable to do so. The customer may also want to provide for access for developers and other third parties as required by the customer to develop content on the land.
- Security: The customer will wish to consider provisions on security of the metaverse platform in general and specific security provisions that relate to the land owned by the customer, and remedies if security is compromised.
- Location of the land: The customer will wish to include contractual provisions detailing the precise location of the land and provisions detailing proximity to particular areas in the metaverse. It may also want potential controls around companies purchasing land in close proximity to avoid reputational harm.
- Regulatory: Does the purchase or holding of the land NFT tokens constitute a regulated activity?
There are a number of ways in which NFTs might deal with intellectual property rights:
- Intellectual property rights are purported to be assigned (transferred) to the NFT owner in relation to the underlying asset.
- A licence of intellectual property rights in the underlying asset is granted.
- No intellectual property rights are granted at all in relation to the underlying asset. At best, the NFT may operate as a mechanism for certifying provenance of the underlying asset.
The obvious way that an NFT can be monetised is by selling it to a third party. However, for the buyer, the reality of purchasing an NFT is often not as straightforward as purchasing a physical asset. While the owner of an NFT can prove it owns the NFT, it does not necessarily own anything more than that.
An NFT is essentially metadata about an asset which is added to a blockchain. This means that, while an asset is used to encode the NFT to make a unique representation of that asset, the NFT is not usually - unless there are terms to the contrary in the smart contract encoded in the NFT or in any associated terms of sale - the actual asset itself.
To use an analogy of the limited edition print of an artwork, if a collector owns a physical limited edition print, the collector would own the physical print itself but would not usually own any proprietary rights in the original artwork. This is an important distinction. Those buying an NFT should carefully consider what they are getting when they purchase an NFT, as the ownership of an NFT does not automatically give rise to any ownership rights in the underlying asset.
Assigning intellectual property rights in an underlying asset
An NFT seller (assuming the NFT seller is also the owner of any intellectual property rights in the underlying asset) can, of course, transfer those intellectual property rights to the buyer.
However, to do so, the intellectual property laws in many jurisdictions (the UK, for example) provide that the intellectual property must be assigned in writing. Without express written terms stating otherwise, either in the smart contract or elsewhere, this will not happen automatically on sale of an NFT.
Selling an NFT and the underlying asset
An NFT seller can sell both the NFT and the underlying asset together. The NFT can then be used as a digital proof of ownership. This raises two important considerations:
- Ownership of the underlying asset
The purchaser of the NFT should check who owns the underlying asset. Typically, the sale of the NFT does not include sale of the underlying asset or any intellectual property rights that vest in it.
- Possession of the underlying asset
The purchaser of the NFT should also check who has possession of the underlying asset, particularly where the underlying asset is a digital file - for example, a digital piece of art.
An NFT is linked to the underlying asset either by the digital work being encoded in the NFT (which is not very common) or by the NFT containing a cryptographic code that links to, or that can be used to identify, the digital copy of the artwork (which is the more common).
In the latter scenario, the NFT will typically contain what is known as a “hash” of the digital file. The hash is produced by applying a cryptographic mathematical function to a digital file to get an alpha-numeric string of characters, which acts as a unique identifier of the original file.
The hash value is used to authenticate that the NFT relates to that digital file. It is not possible to reverse engineer the digital file from the hash, so the hash in the NFT does not give the purchaser of the NFT the ability to possess the digital file to which the NFT relates. The purchaser will still separately need a copy of the digital file in addition to the NFT.
The purchaser should consider:
- Where the digital file will be stored and who will be responsible for maintaining it. In some cases, the digital file is hosted online and the NFT would then contain a URI or URL that points to the webpage where the digital file is hosted.
- What assurances it has that the digital file is going to continue to be hosted on that webpage, and that the file that is hosted there is not going to be altered. This should be included in the terms of sale of the NFT and/or the smart contract encoding the NFT.
Where NFTs are on-sold, how does:
- The subsequent buyer enforce rights under the NFT against the original issuer?
- The original issuer enforce restrictions (if any) against subsequent purchasers?
Such matters could be addressed at the minting stage by a combination of smart contract terms in conjunction with the grant of third party rights.
Licensing of intellectual property rights in the underlying asset
A more common approach than for an NFT seller to sell the underlying asset is for NFT seller and IP rights owner to license use of the intellectual property rights in the underlying asset to the purchaser of the NFT for certain purposes.
Such licence should be set out in the smart contract or in a separate agreement between the NFT seller and purchaser. In the absence of an express licence, under English law principles at least, a licence will be implied, but will probably be quite narrow. Depending on the circumstances, in the case of an NFT relating to a digital asset, the licence may be limited just to the right to use or display the underlying digital asset for personal use and for the purposes of re-sale of the NFT.
Royalties on subsequent sale
NFTs open up a potential new revenue stream for asset owners, as it is possible to code an NFT’s smart contact to make a royalty payment automatically to the original NFT seller on each onward sale of the NFT. The royalties are normally paid as a percentage of the secondary purchase price, and open up the possibility of ongoing revenue streams.
This aspect of NFTs is of particular interest to digital content creators within the gaming sector, where financial benefits to creators can incentivise game developers to record their ownership of in-game items and help to fuel in-game economies. See NFTs in gaming and the metaverse, above.
Misuse of IP and potential infringement
With all the opportunities that NFTs present for a business, there is also the inevitable opportunity for misuse of a business’s or brand owner’s intellectual property rights held in any underlying asset through minting of unauthorised NFTs. For instance, who has the right to mint (create) an NFT based on an underlying digital (or other) asset? Minting an NFT without securing rights in the underlying asset (whether by ownership or a licence) could constitute copyright infringement.
Screenplay excerpts as NFTs
Film Director Quentin Tarantino announced that he would be auctioning as NFTs excerpts from the original handwritten screenplay of the 1994 film, Pulp Fiction. This resulted in legal action by the production company Miramax, who filed proceedings against Tarantino in California asserting copyright infringement and breach of contract on the basis that they, rather than Tarantino, own the rights to the film and Tarantino’s screenplay. The case was settled confidentially in September 2022.
For more information, see our blog, NFTs and copyright infringement: Miramax v Tarantino.
Taking English law as an example, there are two main types of infringement that may arise as a result of the unauthorised minting of an NFT relating to a digital asset:
- Infringement of the reproduction right (i.e. the restriction against reproducing or copying copyright works).
- Infringement of the communication right (i.e. the restriction against communicating copyright works to a new public not originally envisaged by the copyright owner).
With respect to the reproduction right, if the NFT includes a digital copy of the asset, there is potential for this to amount to an unauthorised reproduction that may amount to infringement of copyright. However, in circumstances where there is no reproduction of the underlying asset in the creation of an NFT, there is arguably no infringement.
With respect to the communication right, the minting of an NFT linked to an underlying asset is arguably a different act from that of making the asset available in a new forum. On the other hand, if the NFT does include a digital copy of the asset, the act of minting the asset may well amount to a communication to a new public that was not envisaged by the copyright holder.
Minting NFTs with third-party copyright materials - a Chinese case study
Shenzhen Qice Diechu Culture and Creativity Co., Ltd. (the plaintiff) is the copyright owner of a cartoon tiger. Hangzhou Yuanyuzhou Technology Co., Ltd. (the defendant) operated an NFT trading platform on which an NFT linked to the cartoon tiger was available for sale.
The plaintiff sued for copyright infringement and the defendant countered that the NFT was uploaded to the trading platform by a user, and that the defendant had deleted the NFT promptly upon being informed of the alleged infringement.
The Hangzhou Internet Court held that the unauthorised sale of the NFT linked digital work was an infringement of the copyright owner’s right to copy and right to disseminate information over networks. The defendant, as the platform operator, was held jointly liable for lacking a due diligence system in place for verifying copyright in NFT digital works traded on the platform.
Another issue that arises is how will the location of NFT use and jurisdiction be established. Most IP rights are territorial, so how will this work for NFTs in virtual worlds where it is harder to make the connections to a particular jurisdiction (compared with the use of country domains / languages / currencies on websites)?
Similarly, identifying the real-world parties may be an issue because, even though the blockchain ledger may verify the NFT owner, online anonymity may still not help point to an actual individual or organisation for enforcing a claim or making a real-world infringement claim.
At the moment there appear to be more questions (and arguments on each side) than there are answers. Where this lands will ultimately depend on the individual facts of each case and also any policy drivers that a court takes into account.
U.S. perspective: potential infringement – copyright
Ownership of copyright provides the owner with a set of exclusive rights under 17 U.S.C. § 106 — the right to reproduce the work, prepare derivative works, distribute copies, display the work publicly, and perform the work publicly.
The sale of an NFT that relates to a work does not transfer the underlying copyright in the work without language in the contract expressly transferring the copyright. Absent such language, the copyright is "off-chain" to the purchaser.
This is the case when selling a physical copy of nearly any type of creative work - the transfer of the underlying copyright is up to the creator or copyright owner, and no rights to the copyright transfer to the purchaser simply by virtue of the purchase of the NFT.
Creation of an NFT which reflects all of, a portion of, or is derivative of, a copyright work is likely to lead to questions of infringement of the copyright in the original work. An NFT can be categorised as a copy or even a derivative of the original work ("a work based upon one or more pre-existing works" such as an "art reproduction … or any other form in which a work may be recast, transformed, or adapted.": 17 USC § 101).
Thus, under U.S. copyright law, the copyright owner is generally the only one with the authority to transform the original work into an NFT absent a licence to another to do so.
Copyright owners must develop effective strategies to protect and enforce their copyright from “entrepreneurs” and copyists. In the NFT context it is particularly important to guard against others offering an artist’s work as an NFT without the artist’s permission, assuming that the artist has maintained ownership of the copyright in the work.
Access to viewing NFTs on the various NFT platforms is public. This is useful for copyright owners in identifying potential unauthorised reproductions or derivative works of their copyright work.
For example, on 1 July 2021 NFT CryptoPunk creator Larva Labs used the takedown procedures available under the U.S. Digital Millennium Copyright Act (DMCA) to request the NFT Platform Foundation to remove the online display of CryptoPunk work offered by Ryder Ripps as a work of his own.
The number of gaming and metaverse platforms is growing, and it is important for the copyright owner to employ and rely on effective enforcement techniques, such as watermarks and (in the case of the U.S.) DMCA takedown notices.
In the U.S. it is also expected that the Copyright Management Information provisions of the DMCA (17 USC § 1202) will likely provide copyright owners with a robust tool to police misuse of the copyright work.
In addition, trade mark infringement may arise where an unauthorised party mints an NFT linked to the underlying asset, without the asset owner’s permission, and advertises, offers for sale and/or sells the NFT using the asset owner’s registered trade marks. This is often an issue where branded (physical) goods are reproduced virtually via NFTs for use in a virtual environment. For more information, see part 2 of this series, Gaming, IP rights and the metaverse.
Concerns over scenarios where branded (physical) goods are reproduced virtually (say, via NFTs) for use in a virtual environment like a game or a metaverse have led the European Union Intellectual Property Office to publish its recommendations regarding the class to be opted for when applying for a trade mark designating virtual goods, NFTs and other products displayed in the Metaverse. For more information, see our blog, Guidance on metaverse and NFTs trade marks.
Counterfeiting in relation to NFTs raises significant risks to brands, particularly in virtual environments such as games and the metaverse.
Although the unique digital token associated with an NFT will be securely stored on a blockchain, this does not mean it is free from risks relating to counterfeiting – for example, what is to stop a minter from creating numerous NFTs, all of which are - in and of themselves - unique, but which each produce the same underlying digital asset? The value in an NFT – its scarcity – is immediately eroded in such cases.
How can a business protect itself from infringement?
There are certain steps that a business can take to monitor and enforce its intellectual property rights in connection with NFTs. These include:
- Watching NFT marketplaces. The business may have watch notices in place that it could extend to key marketplaces.
- Take action where appropriate. This may include steps vis-à-vis:
- Minters who do not have authorisation to mint an NFT linked to the business’s underlying asset.
- Marketplaces where NFTs are available for sale (issuing take down notices and requesting details of prolific unauthorised minters so that steps can be taken directly).
- Purchasers of NFTs insofar as the purchaser of the NFT is not acting in accordance with the smart contract (or any other contract) and/or are infringing the business’s rights, which may give rise to claims for breach of contract and/or IP rights infringement.
- Train staff. Staff should be trained that unlicensed use of IP – be that in an NFT or otherwise – is not permitted.