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Drawing inspiration from the past to shape the future of non-fungible tokens

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Matthew Estabrooks, the author of this article. Source: Gowling WLG website

It is no exaggeration to say that 2021 has undoubtedly been the year of non-fungible tokens or JNFs (non-fungible tokens, or NFTs). Indeed, sales of these tokens have exploded from $80 million in 2020 to $17 billion (yes, you read that right) in 2021.

But in June 2022, the JNF market fell to its lowest level in a year. Some brokers and developers in this field even wondered if JNFs were really revolutionary or just a speculative flash in the pan.

By means of such tokens, it is possible to “own” intangible works of digital art, infinitely reproducible. Anyone can copy and paste the JPEG of a Bored Ape (digital image of a humanized ape), but only the JNF holder can prove they “own” the “original”.

This innovation is enticing, but when the market crashed, many of the most popular JNF holders felt like they were the owners of mere sequences of worthless numbers and letters. However, despite market volatility, the promise of JNF technology remains attractive and development in this area continues to move forward.

This article provides an overview of a new legal solution with the potential to transform JNF transactions into an instrument for promoting the exchange of intangibles. But first, let’s shed light on some of the major misconceptions floating around about JNFs and what they actually stand for.

Limitations of JNFs

One of the common challenges affecting many JNF projects is that their intrinsic value often seems unrelated to their usefulness. Recall that a JNF simply consists of a cryptographic string of characters linked to a particular address and recorded in the distributed ledger of a chain of blocks.

No more no less. Many JNFs encode a URL address where the image is held, but beyond that the only objectively provable fact is that the JNF whose number is xyz is held by the digital wallet address ABC.

Misconceptions surrounding JNFs and what they are supposed to accomplish are at the heart of the problem. The main misconception is that JNFs magically grant ownership of the asset associated with it. Let’s take the real example of SpiceDAO to better illustrate this misperception.

SpiceDAO is an autonomous decentralized organization (think crypto company) created for a single purpose: to acquire a rare copy of a proposal document prepared by the director Alexander Jodorowskypresenting his vision for the film adaptation of the novel Dune by Frank Herbert.

After purchasing the document for $3 million, SpiceDAO tweeted its intention to “make an exclusive original anime series from the book and proposal document, and sell it to a streaming service. »

The problem? SpiceDAO had only obtained a physical copy of the proposal document for the adaptation of the novel, not the underlying intellectual property of the document, or even the novel itself. Indeed, to create content related to the Dune universe, the company would have had to license or acquire the underlying copyright from the Herbert family.

Just as owning a physical copy of the Dune novel grants no rights to the underlying IP, owning a JNF depicting the book or an image of it (or anything else) grants no legal rights to the work in question.

Another example: the owners of a sketch by the artist Basquiat who saw their attempt to create a JNF blocked by the estate of the artist, the real owners of the copyright linked to the work.

The same goes for other types of IP: owning a pair of Adidas sneakers doesn’t give you the right to use the company’s logo, just like owning an iPhone doesn’t give you the right to make one. yourself.

The issue here has nothing to do with the fact that NFJs are incorporeal – the law recognizes and protects ownership rights to incorporeal property (intellectual property, easements, goodwill, personality rights, etc.).

For example, a copyright is a valuable asset because it is protected by a legal mechanism (copyright law) and a powerful forum (the courts). It is a fictitious legal element: an intellectual concept, but with real consequences and value. The value of the legal right is distinct from tangible (book, iPhone) or intangible (JNF) property.

Rather, the real problem is that in the case of a JNF, unless the cryptographic data of the latter is linked to an enforceable legal right, nothing binds the sequence of numbers and letters of a JNF to the underlying intellectual property (IP).

JNFs are typically built using a technology called “smart contracts,” but this terminology is often misleading. A smart contract is nothing more than automatically implemented computer code, and is not necessarily an enforceable legal contract.

Several JNF projects attempted to bridge the gap between law and technology in the “English” realm of real estate and music rights, but these projects often involved external contracts based on traditional legal constructions, not blockchain technology.

For acquirers of JNF, understanding the notion of underlying rights is crucial. Yuga Labs, creators of the infamous Bored Apes, added a clause to their terms and conditions that reads: “By purchasing a JNF, you own the underlying Bored Ape, the Work, in its entirety.”

But what does that really mean? Is this the assignment of copyright in the work Bored Ape? If so, who was the original owner, and is this assignment of rights really valid?

Also, what happens if the original holder sells the JNF to a new buyer? By what mechanism is the transfer of the underlying IP effected? What are the buyer’s expectations for exclusivity, if any? More importantly, can generative works of art such as Bored Apes be considered original works “in English”?

In short, for JNFs to be of real use, the cryptographic elements must be linked to enforceable rights. The remainder of this article will outline a method for securing this connection in a way that is simple, elegant, and based on well-established legal processes.

A solution inspired by the past?

The solution to energizing JNFs may lie in the past: the distant past and the law of trusts. The living trust has been part of English common law since the Crusades, while the testamentary trust dates back to the Roman Empire.

The former was a real legal innovation at the time and continues to be a powerful and flexible tool used in common law countries globally. Here’s how a trust essentially works: full legal ownership of an asset (real estate, bank account, copyright, etc.) is transferred to a trustee.

The transfer documentation also specifies the names of the beneficiaries of the trust. Under trust law, even though the trustee is technically the legal owner of the assets of the trust, he holds them only for the benefit of the beneficiaries. The trustee is obligated to manage the assets of the trust according to the best interests of the beneficiaries.

The trust-based model for JNFs that I propose marries the technology of JNFs with the legal mechanism of JNFs. In the case of JNFs representing intellectual property rights, the original IP owner creates a JNF (or more) related to the IP and, at the same time, confers legal ownership of all vested rights in the IP to a trustee .

The terms of the Trust Agreement specify that the Trustee holds the IP Rights in trust for anyone who owns a Related JNF. This trust document can even be created on the blockchain to provide further transparency.

The trust therefore establishes a link between the ownership of the legal rights and that of the JNFs. Provided that legal ownership of intellectual property is transferred into the trust in an enforceable and legally recognized manner, this system allows for the securing of ownership rights to the JNFs themselves.

The law will recognize beneficial ownership of the underlying IP for each JNF holder, allowing each to act as if they were the legal owner. No new contract is required to transfer effective rights from one JNF holder to another.

To complete the copyright assignment, simply send the JNF to a new digital wallet. These transfers could even take place through automated smart contracts with certain terms and conditions (deadlines, fees, payments, etc.)

This model has several other possibilities. First, there is nothing that restricts its use only to the world of intangible intellectual property assets – indeed it could apply to other types of property.

Second, the trust document may specify that the trustee is entitled to compensation for their services. In the field of computer smart contracts, these fees could be automatically collected as a percentage on each subsequent sale of each JNF.

Finally, subject to local rules regarding the establishment of trusts, a Decentralized Autonomous Organization or DAO (Decentralized Autonomous Organization) could act as trustee, which would allow the management of the trust in a decentralized manner.

Conclusion

There is no denying that JNFs are a fascinating and very promising technological development. However, JNF’s projects could face legal complications, as the question of the link between cryptographic ownership and enforceable rights is not fully resolved.

The model proposed above offers a solution by relying on the well-established law of trusts to link the past to the future, attaching legally binding forms to cryptographic data.

By combining modern technology with these ancient legal forms, JNFs could transform the concept of ownership, especially for intangible assets such as copyrights, trademarks and patents.

About the Author

Matthew Estabrooks is a partner at Gowling WLG in Ottawa. He practices in the areas of copyright, appellate advocacy and administrative law. He provides legal advice on matters relating to Canadian copyright law and drafts copyright assignment and license agreements.

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