Navigating Contractual Relationships In The NFT Market – Fin Tech


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Overview of Common NFT Contractual Relationships

Participants in the fast-moving – but legally uncertain -
non-fungible token (NFT) marketplace can maximize their business
opportunities and mitigate risk by delineating their specific role
early and clearly defining where their obligations begin and where
their responsibilities end. Understanding and defining your role,
and the role of your counterparties, is critical. Here are some of
the key contractual relationships that NFT market participants can
expect to encounter.

1. Seller Terms of Use

The artist who creates the underlying media content that is
linked to the NFT (NFT Media) legally owns the intellectual
property rights to the artwork. Unless the artist conveys these
rights in selling the NFT, a buyer does not automatically receive
the right to commercially exploit the artwork. The terms of use for
the NFT sale will govern what an NFT buyer can and cannot do with
the NFT and NFT Media.

2. Trading Platform Terms of Use and
Agreements

Trading platforms where NFTs can be created, listed, sold or
bought will have terms of use that govern the responsibilities and
disclaimers of the NFT marketplace operator toward its customers.
These terms of use will also apply between buyers and sellers of
the NFTs featured on the trading platform. NFT trading platforms
may also enter into specific agreements with NFT sellers or
technical vendors.

3. Technical Vendor Agreements

NFT sellers often hire technical vendors to perform NFT
customizations and other deliverables on behalf of the seller, such
as create or mint NFTs, process the NFT sale, or provide cloud
accounts or decentralized storage solutions for hosting the NFT
Media. These agreements may include certain work-for-hire
provisions.

4. Cryptocurrency Payment Processor and Exchange
Agreements

Cryptocurrency payment processors allow NFT sellers to accept
cryptocurrency payments and convert those cryptocurrency payments
to fiat currency. In some cases, these services may extend to
exchange- and wallet-hosting services that allow NFT sellers to
store cryptocurrencies, and even store NFTs, in hosted wallets.
These agreements govern the use of cryptocurrency payment gateways,
and cryptocurrency and NFT custody, for NFT sellers.

5. Intellectual Property Agreements Related to NFT
Media

The artist of media that is used to create an NFT can modify the
original media to create new NFT Media that is jointly owned by the
artist and a second owner without encroaching on the sole copyright
of the original artist. Agreements between the original copyright
owner and any joint owners in the new NFT Media will govern this
relationship.

6. Sale Agreements Related to Commercial Exploitation of
NFTs

Third-party vendors may provide display and viewing
opportunities for NFT owners, such as digital art frames that give
NFTs a lifelike form and virtual land (e.g., digital malls) to show
off NFTs. Opportunities for use of NFTs in the metaverse may also
be offered by certain third-party vendors. Terms of use, and
sometimes bespoke agreements, will govern relationships with these
vendors.

Key Issues to Address/Consider in NFT Contractual
Relationships

Although NFTs are fraught with legal issues that have yet to be
explored, the business opportunities in the NFT marketplace show no
signs of slowing down. On the seller side, the main goal is often
to secure future revenue from an NFT through initial sales and
perpetual royalties. On the buyer side, the main goal is often to
leverage the NFT for various consumptive or other benefits. On the
thirdparty vendor side, the main goal is to extract the value of
the deal without lingering obligations after performance is
completed. These different interests mean, among other things, an
increased focus on negotiations over rights such as the underlying
intellectual property rights of the seller, the resale rights
limitations of the buyer and the controlled access by the
third-party vendor. As these negotiations develop, there are some
key contractual provisions to consider.

1. Defining the ‘Services’

Vendors should clearly define the scope of their services and
avoid tertiary obligations past their services under use or service
agreements. Terms and conditions for the sale of an NFT in the
primary marketplace should align with consumer protection laws to
prevent misleading a buyer into buying stolen work, a trademarked
brand or a celebrity likeness.

2. Perpetual Royalties

It is in the artist’s and/or NFT seller’s best
commercial interest to receive future royalties from any subsequent
sale(s) of the NFT in the secondary marketplace. After all,
royalties can grow over time as the NFT appreciates in value in the
secondary market. To the greatest extent practicable, royalty
rights should be both articulated in contract terms and programmed
into smart contracts code, to ensure that NFT artists and sellers
receive royalties as designated.

3. Rights in the NFT Media

a. Reproduction/Monetization

The right to exploit the NFT for commercial gain depends in
large part on whether, and to what extent, the seller actually
conveys the underlying intellectual property rights with the
transfer of the NFT. The rights of NFT sellers and buyers should be
explicitly defined in this regard. Key intellectual property issues
to consider include rights in the media used to generate the new
NFT Media as well as rights of the copyright owner(s) to use the
NFT Media vis-à-vis NFT buyers, any other contract parties
or other third parties that may have an interest in marketing the
NFTs.

b. Display, View, Use

At the very least, the buyer of an NFT receives the basic
bragging rights that come with owning an NFT. Basic NFT buyer
rights should present ample opportunities for the buyer to enjoy
the NFT, such as displaying it in a metaverse or using it in a
gaming application. However, any rights beyond display, view and
consumptive use should be carefully considered before being
provided to NFT buyers.

c. Offensive/Inappropriate Content

While no clear distinction exists between art and adult content,
some NFTs have already been taken down for allegations of
inappropriateness, or sometimes even without an explanation as to
why. If necessary, adult content should be carefully crafted when
incorporating it into an NFT. Additionally, NFT marketplaces and
sellers should consider contract terms that grant protections from
offensive and inappropriate content in an NFT that may cause
business disruption or reputational damage.

4. Smart Contracts

Smart contract coding and deployment will often be a core
component of agreements related to NFTs. One key issue that parties
should consider, and memorialize in contract terms, is whether or
not the NFT smart contract will be programmed with a “kill
switch” that allows the smart contract code to be altered or
updated.

In certain circumstances, there may be advantages to programming
the smart contract without a kill switch. For example, the absence
of a kill switch may provide the market with a higher degree of
confidence that the NFTs will not be altered post-sale. On the
other hand, the ability to alter smart contracts code may offer
certain advantages, especially as the technology continues to
develop and new technical functionality becomes available. One
particular area of relevance here relates to securing perpetual
royalty features. As the open-source coding community continues to
find creative ways to improve perpetual royalty functionality, NFT
sellers may benefit from being able to implement smart contract
upgrades to enhance these capabilities as new techniques are
deployed, tested and validated.

Third-party audit rights are another area that should be
considered. Providing for a third-party technical audit of the
smart contract code will provide assurance that the code will
function as intended. The cost of a third-party technical audit,
and the costs of any work required to correct any identified
deficiencies, is a point of contract negotiation. Similarly, the
parties may have an interest in defining certain key smart contract
functions and designating responsibilities and remedies in the
event these functions are not implemented correctly.

5. Data Privacy and Security

Data privacy issues should be carefully considered during NFT
contract negotiations. At a minimum, contract terms should address
privacy policies and compliance with applicable privacy laws.
Depending on the nature of the transaction, additional data privacy
issues may need to be incorporated, such as remedies for privacy
violations and data breaches as well as related insurance and
indemnification. Security incidents and notification procedures
should be clearly defined. In some cases, a separate data privacy
and security addendum may be appropriate.

6. Access to Sales/Customer Data or Other Valuable
Data

In some cases, technical service agreements involving NFTs may
result in the collection and generation of valuable data. In these
instances, data privacy provisions will have to be integrated with
provisions that govern the rights of the parties to access, use and
claim ownership of certain data. This data may be especially
valuable because the NFT market is so new and reliable market
benchmarking data is not readily available. In some instances, one
contract party may seek ownership of certain data while the other
party may seek a limited license to use the data in a way that
mutually benefits the parties. The parameters of these arrangements
should be well evaluated and clearly defined in the contract terms.
To the extent that a party is allowed to maintain and use data
owned by the other party, the contract terms should articulate
standards for anonymizing and/or de-identifying any data that could
be considered personal data under applicable privacy laws.

7. Digital Millennium Copyright Act

The Digital Millennium Copyright Act (DMCA) will provide certain
remedies in scenarios where NFTs are created and sold using NFT
Media in a manner that violates a third-party’s copyright. NFT
marketplaces and other vendors involved in the minting and initial
sale of NFTs should have a clear DMCA public notice as well as an
internal DMCA response plan to combat intellectual property
violations. DMCA notice procedures and a designated DMCA agent are
also required and should be incorporated into terms of use.

8. Standard Terms Are No Longer Standard

As with the cryptocurrency market, the unique aspects of the NFT
market call for certain updates to contract clauses that typically
govern things like termination, indemnification, limitation of
liability and other concepts that are sometimes thought of as
standard clauses. With respect to termination, market conditions
may call for provisions that reflect the evolving balance of power
between different market participants. Indemnification and
limitation of liability provisions should address
copyright/intellectual property, technical aspects of decentralized
blockchain networks and other NFT-specific issues.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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