This article was first published by Business Leader on 6^th January 2022.

NFTs continue to take the crypto world by storm, their impact and applications to the various industries are yet to be fully realised. Below, India Atkin outlines the possibilities and risks within the sector.

With players from Elon Musk to Melania Trump, whether you have an interest in NFTs or not, there’s a good chance it’s popped up on your social feeds. But with a vastly unregulated space and lots of uncertainty surrounding NFTs themselves, figuring out how they work and how they can be profitable continues to be a thorny issue.

NFT stands for ‘Non-Fungible Token’, which, at its simplest, is a digital or physical asset created on the blockchain, a digital, decentralised ledger. Being created on the blockchain encodes the NFTs most valuable characteristic – its uniqueness, since the NFT contains within itself information about its origin story, and its chain of ownership.

The Play to Earn Model

Supported by a vast network of over 3.24 billion gamers and counting, the digital entertainment industry is worth an eye-watering $160 billion. If you’re a gamer, it’s easy to understand why – it’s fun. The Play to Earn (P2E) model is gaining popularity in the gaming space, where players can earn money through the acquisition of NFT versions of popular in-game items (such as skins and weapons) which players can keep, trade or cash-out on digital marketplaces.

The rise of the P2E model hints at a future where workplaces are in online games. Vietnamese games developer Sky Mavis’s blockchain game Axie Infinity, for instance, was able to pay a rate reported three times better than minimum wage in the Philippines amid the 40% unemployment rate.

In spite of this, P2E is not the norm for gameplay, and this is due to a plethora of reasons from environmental impact to high barriers to entry. Setting up a digital wallet, obtaining the requisite cryptocurrency, and overcoming the initial upfront cost is by no means a simple process. With AAA developers from Ubisoft to Square Enix embracing the idea of NFTs in games, we may see this process streamlined and costs reduced. A mainstream P2E game could be in our near future, with a compelling world that keeps players coming back. This could be through offering real-world value NFT drops from established brands and artists and offering players the chance to directly monetise these through an active, decentralised marketplace.

The Risks

NFTs are not currently specifically regulated in the UK, which means that there is a lot of uncertainty surrounding how they will be treated legally, particularly as they are still relatively in their infancy. This lack of regulatory oversight breeds uncertainty for NFT collectors and creators alike.

Cybersecurity

NFTs are vulnerable to loss or theft, such as hacking a digital wallet account. Motivational speaker Calvin Becerra recently claimed to have had three pieces of NFT art stolen. Following this, he successfully petitioned three of the major NFT platforms to have the NFTs removed from their marketplaces. Ironically, Berecca’s note to the scammers has since been turned into an NFT. Though this can be seen as a win for Becerra, it does call into question perhaps the blockchain’s biggest selling point, its decentralised nature, as it becomes clear that major trading platforms have the power to simply blacklist or invalidate an NFT.

When dealing with NFT theft, an NFT collector should consider what rights and remedies they have if the underlying digital asset disappears or changes and against whom a claim could be made. Since NFTs are unique and cannot be replaced, a collector might be left without recourse.

IP Ownership

Purchasers of NFTs should be aware of what they are (or often more importantly, what they aren’t) buying. Generally speaking, the purchase of an NFT only grants ownership of the specific copy or version of the work that the NFT represents. An NFT does not (unless stated otherwise) represent ownership of the underlying asset.

For example, the NBA retains ownership of the intellectual property in its TopShot NFT, which portrays game highlights, and commercialising the NFT is prohibited. On the other hand, the digital cat collectibles game Cryptokitties, permits commercial use by the NFT owners to use the NFT art on merchandise on the basis that they do not make more than $100,000 revenue per year.

The relationship between parties in an NFT transaction is contractual in nature, and the agreement will ultimately control the relationship. This is critical because the agreement will outline various rights and obligations of an NFT collector, including in the event of a dispute. Careful review of any attached terms is therefore vital for the collector to understand the scope of their acquisition. Collectors of NFTs should be clear on exactly what rights they are getting, such as whether they can copy or modify the NFT, use it in their game, resell it or ask for royalties upon re-sale.

If you are a brand with a valuable IP, you should be aware that the minting and sale of NFTs is susceptible to the infringement of intellectual property rights in the underlying work.

While registries such as Artory exist to enable users to register their artworks for verification purposes, NFT creators might want to consider whether their work could qualify for patent protection if they are an inventor on the blockchain. The US has seen growth in blockchain patent filings with Nike recently obtaining a patent for ‘generating cryptographic digital assets for footwear’. Additionally, NFT creators may benefit from setting up a watch service to detect any unauthorised uses of their content.

Regulation

Whether an NFT exhibits certain characteristics and functions determines if it will fall within the current regulatory perimeter for financial services. Based on the current FCA guidance, it is likely that most NFTs would be classified as unregulated tokens. However, tokens that have characteristics similar to those of traditional securities, like NFTs that represent shares of a company, could trigger a licensing requirement and ongoing conduct of business obligations. This might also be true of fractionalised NFTs, where buyers acquire a proportion of the NFT rather than the whole, much like shares in a company.

Also of concern to the UK government are the gambling-like mechanics already common in games, having called for evidence on the impact of loot boxes and whether they should be covered by UK gambling legislation. NFTs being monetised in similar ways such as through randomised NFT ‘loot drops’ could be subject to any regulatory crackdown, such as requirements to disclose drop odds, drop contents, or even being banned entirely.

UK regulators are actively looking into the crypto space and it’s clear that updates to legislation are due considering the rise of NFTs. However, claims that regulation is imminent will be largely subject to the pace at which regulators can keep up with technological development. Loot boxes were raised as an issue in parliament in 2019, around a decade after the introduction of these mechanics in games. The first NFT was minted in 2014, so I’ll let you extrapolate from there.