This article is part of a three-part series on NFTs:
- Part 1: What are NFTs and Where Do They Derive their Value?
- Part 2: NFTs and IP Law
- Part 3: NFTs and the Digital Art Marketplace
Earlier this year, something called an “NFT” sold for $69 million USD at auction. This was likely the first time most people had ever heard the term “NFT.” From that point forward, discussions of various NFTs were everywhere; as a result, they entered mainstream consciousness, much like Bitcoin had nearly ten years ago. In fact, NFT or “non-fungible token” was named word of the year for 2021.
Artists, musicians, and other creatives now saw in their work the potential for monetization. Investors woke up to the value of digital art assets. Indeed, in the first half of 2021, NFT transactions totalled in the billions.
Despite their near ubiquity, it is unclear to many what NFTs are and what role they play in the digital marketplace. Just as it may be unwise for investors, collectors, and creators to ignore the burgeoning NFT industry, it may be equally unwise for those same people to ignore potential issues arising from this new asset class. Even more unclear is what, if anything, these new digital assets mean for the users and owners of intellectual property (“IP”) rights.
This series of articles tries to demystify NFTs and discuss what impact they may have for creators, users, and owners of IP rights. We aim to shed light on the intersection of technology, the creative industries, and IP law that arises with NFTs.
In our first article, we will discuss the nature of NFTs. In our second article, we will discuss the impact of NFTs on IP rights holders. In our final article, we will discuss the applicability of NFTs in the world of digital art.
Part 1: What are NFTs and Where Do They Derive their Value?
An NFT, or non-fungible token, is a unique blockchain-based “token” that represents a digital collectible asset – an artwork, a video, a song, an in-game item, a screen capture of a tweet, a file containing the original code that built the world wide web, etc. The term “fungible” refers to something (e.g. money, commodities, etc.) where one part or quantity may be replaced by another equal part or quantity. Non-fungible simply means that something is unique and not replaceable by something else.
Essentially, an NFT is a unique digital file encoding a representation of a digital asset. Given that identical copies of digital files can be made ad infinitum, NFTs use blockchain technology to create unique digital files (e.g., “tokens”), that cannot be interchanged with other files, hence their non-fungible nature. This uniqueness is what makes NFTS potentially so valuable.
Much like a deed of land does not represent the land itself, NFTs are merely a representation of the digital asset, but are not the digital asset itself. In the case of artwork, for example, the NFT is not the artwork but a representation of that artwork. Despite the popularly held belief, when you purchase an NFT, you are not purchasing ownership of the work itself. You are instead purchasing a set of data with a unique digital ID that represents the digital asset. The digital ID (referred to as a digital signature or “hash”) is what is bought and sold in the case of NFTs.
How do we get from the actual collectible digital asset (e.g. artwork) to an NFT that is bought and sold on an NFT marketplace? The first step is to upload the digital file containing the work to a third-party designated NFT platform or distribution network. Due to the blockchain’s built-in technical limitations, the work itself typically cannot live on the blockchain; its file size is simply too large to be stored there. Hence, the need for an NFT to “stand in” for the underlying work that is hosted elsewhere on the web.
Next, an alphanumeric digital ID of the uploaded file is created by an algorithm. This signature, or “hash,” uniquely identifies that file, as no two files can share the same digital ID. Along with the digital ID, the algorithm generates a metadata file that is tied to the underlying work itself. This file contains information about the digital work but, more importantly, contains the digital ID and a hyperlink to the underlying work.
To complete the process, a URL which points to the metadata file is embedded into a “smart contract,” which is written into the blockchain. This final step creates (or “mints”) the NFT. The person who mints the NFT is deemed the “owner” of the NFT within the smart contract. It is this person, and this person only, who can execute the smart contract such that the “owner” value may be ascribed to another person. An NFT purchaser, therefore, has simply acquired the ability to execute the smart contract tied to the NFT.
The purchaser of an NFT therefore cannot claim ownership over the underlying work, nor does the purchaser automatically have any rights to the work itself. The smart contract embedded in the NFT simply provides the “owner” of the NFT with the exclusive rights to the digital ID and the hyperlink to the underlying work. The work itself may still remain accessible to all. The NFT does, however, provide an unalterable link to a specific version of the digital asset. Where that version or copy of the digital work is the only version, the NFT could be extremely valuable.
This unique chain of digital references, which cannot be broken, is what gives the NFT its inherent value and interest as a means of authenticating and collecting digital assets. Fundamentally, NFTs can be a secure and (practically) foolproof way of authenticating such assets.
Given that digital assets are eminently reproducible, ascribing a unique (non-fungible) token to a specific version of a digital asset makes it possible to confirm that the purchaser is acquiring that specific copy or version of the underlying work. This is because the specific amalgamation of data in that version of the digital file is what generates the work’s unique hash. Changing even one pixel of an image, for example, would necessarily generate an entirely different hash. The NFT proves the provenance of the work on the blockchain and proves to the buyer that the work tied to the NFT is the specific rendering of that work.
This feature of NFTs is unlike other tokens on the blockchain. An NFT, unlike other tokens, cannot be exchanged or replaced by another. In fact, two copies of the identical digital work will necessarily generate unique sets of metadata, if only because two identical versions of the same work would generate slightly different timestamps. Each copy, therefore, would have its own separate and distinct NFT.
In our next instalment in the series, we look at the impact of NFTs on intellectual property law and IP rightsholders and users.
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 NFT or non-fungible token is Collins Dictionary’s word of the year, see https://www.bbc.com/news/newsbeat-59401046.
 See for example, OpenSea or a decentralized file distribution network such as InterPlanetary File System.
 A smart contract, despite what its name might suggest, is not a contract legally speaking, but rather a computer program that executes commands under pre-determined conditions (ex: if bidder “x” bids amount “y” on NFT “z”, x becomes the owner of z).