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Digital images of rocks are selling for millions of dollars.

To be crystal clear, they are just images of rocks.

There are no underlying assets and they have no practical use. The developer behind these “Pet Rocks” admits they “serve NO PURPOSE beyond being able to be bought and sold, and giving you a strong sense of pride in being an owner of 1 of the only 100 rocks in the game”.

Pictures of rocks are not the only digital images you can purchase for millions of dollars.

You can also buy Bored Apes and CryptoPunks. Christie’s recently achieved the third-highest auction result ever for a living artist, by auctioning off Beeple’s digital artwork for an eye-watering $69.3m.

Nifty NFTs

This is the new world of NFTs: a world where many are in constant disbelief and regulatory shortfalls and legal challenges are likely to abound.

Last year, when the global art market shrank by 22%, as the pandemic halted fairs, auctions and exhibitions, NFT sales jumped from $13.7m in the first half of 2020 to $2.5bn in the same period in 2021.

So what are these NFTs attracting billions of traditional and virtual capital?

An NFT, or non-fungible token, is a cryptographic token made up of information stored on a blockchain (a decentralised digital ledger). In layman’s terms, it is a piece of code which can be used to store information relating to digital content such as an image, video or song.

It can assign provenance, and authenticity to digital content, and is itself unique, which makes it a digital collectable.

Intellectual property

There are three principal issues relating to the intellectual property rights of NFTs.

The first aspect to grasp is that NFTs are separate from the digital content associated to them. An NFT is similar to a certificate of title or authenticity for physical art. It is the underlying code that confirms the ownership of a given piece of digital content, but it is not the digital content itself. This means that the owner of an NFT may have no rights over the digital content associated to it.

This disjointed construct may cause complications when trying to display, license or otherwise use the digital content in question. These are sometimes resolved by contract or smart contract.

This may not be an important issue, however. Using the analogy of a physical collectable such as a stamp, it is perfectly possible to own a copy of the collectable without having any rights over the image. The copyright status of a digital image may be entirely independent from its NFT without causing any problems.

Secondly, there is doubt over whether an NFT benefits from intellectual property protection per se. In order to do this, it must display some degree of originality. Making an entry onto a blockchain hardly qualifies as original, as it follows a predetermined coding format.

Some have argued, however, that portions of the underlying code could qualify as literary works and thus be entitled to copyright protection. This ambiguity has yet to be tested in court, but may not be an issue either. As with a certificate of authenticity, the document proves something related to an object but has no value without reference to that object.

Finally, the real problem may arise from an unauthorised party minting (creating) an NFT associated to a piece of digital content.

As minting is open to anyone, one could theoretically upload any image and claim it as theirs to mint.

The solution the market has found to this, at the moment, is to have specialised gatekeepers. These may be auction houses or curated websites that have direct relationships to the content creators and thus give collectors the confidence to buy new NFTs.

Money laundering

Concerns have been raised over the use of cryptocurrencies and NFTs by criminals. With no underlying tangible assets, NFTs are easy to move incognito and are often bought using cryptocurrency. These tactics, it is argued, may serve to hide illicit funds.

Money laundering concerns are likely to increase as the popularity of NFTs grows and will probably lead to new regulation. Both Gary Gensler, the chairman of the SEC, and the Financial Action Task Force have recently referred to the entire blockchain space as the “Wild West”.

An alternative view argues that the presence of, and opportunity for, criminal activity on blockchain is limited.

A former director of the CIA even argues that blockchain is a blessing for global law enforcement because of the transparency and traceability inherent in its functioning.

Investing criminal gains into NFTs is, arguably, an inefficient and risky way to launder money. On one hand, the dirty money would need an ‘on ramp’ to convert traditional currency into cryptocurrency. This means getting through the Know Your Customer measures of traditional banks. For some, the volatility in the price of NFTs also seems like an unnecessary financial risk to take.

Finally, blockchain transactions are public and traceable. Should a criminal get caught using blockchain, their entire network and history of transactions could be mapped out very quickly.

Rolling Stone or cornerstone?

There is scepticism regarding the artistic and financial value of NFTs. Snubbing new forms of art is nothing new, of course. The first Impressionist exhibition in Paris in 1874 drew large crowds who attended just to mock this novel artistic movement. The term ‘Impressionism’ itself was adopted after it had been used with derision. The press was equally hostile and a journalist in La Patrie preferred the term “LUNATICS” to describe these new controversial artists.

As Harvard Law professor Rebecca Tushnet argues, however, an NFT “is worth whatever humanity collectively or individually decides it’s worth”. The staggering amounts spent on NFTs are either some of the greatest wastes of money ever witnessed or the investments of visionary early adopters. Only time will tell.

As for regulation, the challenge will be to balance a need for clear rules with the breathing space required to foster innovation.

With my thanks to Dr Leonardo Davoudi for assistance provided in compiling this article.

Milton Silverman is senior commercial dispute resolution partner at Streathers Solicitors LLP, London.