Several factors influence the interest in NFTs, including the popularity of blockchain technology, growing interest in cryptocurrencies, and interest in digital art and collectibles. However, the growth of the NFT market brings about legal risks and issues associated with non-fungible tokens as digital assets.
The NFT market is crowded with lots of NFT projects which makes investors think carefully before buying a digital asset due to the high risk of fraud. Most NFT investors are not fully aware of the legal risks and issues associated with NFTs, though there is currently little legal protection for investors in the NFT market.
In the following, we aim to inform our readers about legal issues and risks associated with NFTs and the market they may face in 2023.
One of the most important issues for an NFT creator is to know the rights they acquire by creating a non-fungible token. If an NFT is produced based on someone else’s work or idea without their consent, it may violate intellectual property rights, called copyright infringement.
If an NFT is produced from a copyrighted work without acquiring the required permissions or licenses from the copyright owner, it is subjected to copyright infringement. Therefore, NFT creators must be aware that anything protected by copyright law is susceptible to infringement if the permissions are not procured.
NFT creators may also face trademark infringement if they employ a trademarked name, logo, or symbol in their NFT without legal permission. NFT creators must consider this case of infringement since trademark owners can easily trace the case and prosecute against them for weakening the value of their brand and confusing consumers to take illegal advantages.
Besides, NFT creators may be accused of Publicity infringement if they use someone else’s name, likeness, or identity without legal permission. Therefore, they need to be careful about unintentional rights and make all terms straightforward to avoid any intentional claims over their digital assets.
Thus, NFT creators should consider the crucial component of the NFT agreement in their smart contracts. NFT buyers, on the other hand, should read the contracts and pay significant attention to the coding embedded in an NFT smart contract, such as royalties.
Lack of Regulations
NFTs exist on decentralized blockchains which are not controlled by any central authorities, like banks or government organizations. Decentralization allows NFT creators to keep ownership and control of distribution as well as monetization of their digital work; however, it makes it extremely difficult to impose uniform regulations on the NFT market.
As you may have already noticed, there are no uniform laws or regulations to control the sale and trading of NFTs, which may lead to the following problems:
- The possibility of minting physical art into NFTs without the original creator’s knowledge or consent, where the profit from the NFT sale goes to the minter, not the art creator.
- The risk of stealing artworks from unrecognized artists by larger NFT creators.
- Lack of regulations around NFT auctions, so that the value of NFTs is not constant and keeps fluctuating.
Ownership dispute is another legal issue reported in the unregulated NFT market. There are artists claiming that their artworks have been encoded into NFTs and sold in NFT marketplaces without their permission.
In general, an original artist or a copyright holder is a person or a company who owns all rights regarding an asset, in our case, an NFT, and has the right to govern an NFT application, distribution, and sale. If, in any case, other individuals or entities take advantage of the NFT with no permission or agreement from the copyright holder, the holder is able to block any activity regarding the NFT in a blockchain.
Since such transactions may include a vast sum of money, the misrepresentation of an NFT can easily end in high-profile legal battles. Although NFT marketplaces apply various artist verification methods, including traditional manual artist verification or warning notices, NFT buyers need to do research about artists and collections they plan to invest in. They can also seek legal help before reaching out for digital assets.
Smart Contract Issues
Although all activities related to an NFT, including minting, ownership, and management of a digital asset, are recorded on a blockchain, there is still the risk of fraud. Smart contracts are an essential part of the legal agreement between the buyer and seller of an NFT. All terms of ownership and sale are provided via a source code in a smart contract.
Thus, smart contracts can present many advantages to both NFT sellers and buyers, which includes a raise to legal questions about their liability and practicality in case of defraud. Buyers should think carefully about the terms provided in a smart contract before they choose to invest in an NFT. They may get assistance from a legal professional to make sure that all the terms and rights regarding an NFT are correctly clarified and reflected in smart contracts. It is wise to only trade NFTs on reputable marketplaces to experience safer purchases.
Money Laundering and Fraud
Even though blockchain technology causes transparency in all data recorded regarding NFTs, all the security provided to NFTs is only available if the data is encoded in the blockchain. Thus, there is always a high risk of fraud in the NFT market.
It is clear that the existing data cannot be forged. However, a bad actor has a chance to embed fraudful data in the blockchain and duplicate the information of an NFT without permission or consent from the original creator. Thus, it can be helpful to study the history of an NFT collection before investing money in it.
The NFT market is also going under careful analysis by Anti-Money Laundering (AML) regulation and Financial Action Task Force (FATF). Although the NFT market is still evolving and includes unique financial challenges, there is an attempt to control potential misuse of the market for laundering money by bad sectors, for example, investing unlawfully acquired money to purchase an NFF and selling it for a higher price.
Due to the decentralized nature of the NFT market, there may be a risk that criminals use NFTs to laundry money. The FATF recommends considering the nature of NFTs and their particular function. The regulation asks for a case-by-case analysis of non-fungible tokens to check if they are used as payment or are purchased as investments since NFTs can easily cover laundering money by ill-intentioned individuals or entities.
Thus, NFT marketplaces must be aware of such risks and make sure to comply with AML regulations. Buyers can also seek legal help to fully understand any potential risks relative to buying, selling, or using NFTs.
NFTs are relatively new and complex digital assets, and there are arguments if these digital assets fit into tax laws. NFTs are subject to taxation around the world, but it is directly dependent on local laws.
We already know that the value of an NFT can rapidly fluctuate, which makes it difficult to determine its cost basis. On the other hand, it is also complicated to determine the value of an NFT, as each NFT possesses a unique and subjective worth. It stems from several factors, such as their scarcity, utility, etc. This creates challenges for tax authorities to estimate the appropriate tax liability for the transactions in the NFT market.
At the time of writing, minting an NFT does not fit the category of taxability. However, selling an NFT is considered a regular business or investment and matches the standards of taxing. Tax rates can be different from country to country, and NFT investors need to check their local tax laws to get a clear vision of tax regulations in their region.
Another important legal risk regarding NFTs is the possibility of data privacy violations. As we know, blockchains are decentralized networks and public ledgers where NFTs are created, and their exchanges and transactions are recorded. Along with the transparency and safety blockchains provide in the NFT market, it also records the personal data of both creators and investors. As a result, personal data can be vulnerable to being known by the public.
It is still unclear how the General Data Protection Regulation framework (GDPR) may apply to NFTs to protect data protection and privacy rights. Since the data recorded on a blockchain network is almost impossible to change, individuals and entities allow the network to permanently keep their personal data which cannot be erased and forgotten. Therefore, NFTs that contain the personal data of creators and investors may violate data protection laws.
Considering the consistent evolvement around NFTs, it seems essential to be aware of new possible legal risks and issues that may emerge in the future. We advise our readers to stay up-to-date on the latest privacy regulations and take necessary considerations before minting or trading NFTs.