Blog 4: NFTing* – the act of creating a non-fungible token

Authored by: Alison Cripps, Legal Writer, Practical Guidance: Cybersecurity, Data Protection and Privacy & Greg Dickason, Managing Director, LexisNexis^® Pacific

We have all been there: That moment in a meeting when someone announces:

“We should get our external lawyers to have a look at this”

For our non-lawyer readers, perhaps this is the moment that you imagine your project slowing down or your profit margins shrinking. But I can hear all the lawyers who are reading this blog let out a collective sigh of relief – because it is usually a sensible decision to be calling upon your legal experts when you are about to embark on a project that has the risk of bringing your profits or your reputation under fire.

And so, it was late on a Monday afternoon when we found ourselves drinking real coffee, in a virtual room, with our advisors from Herbert Smith Freehills, discussing these blogs and the ever many legal issues that arise when embarking on a project to mint a token.

Of course, it is important to be aware of, though not alarmed by, the risks associated with minting an NFT. Whilst the risks will be unique to your organisation and project, we share with you here the common pitfalls to be wary of and what we are doing to manage our own risk.

1. What is the actual token?

It’s rather awkward when your legal advisors identify errors of grammar in your previous blogs. Yes, “technically”, NFTing is not a verb, and so you can’t, in a legal sense, NFT anything, but the beauty of being a writer, is that you are harnessed with a tool, unavailable to lawyers, known as ‘poetic license’ to bend and twist the English language for your own benefit.

And so, with the poetic license in mind, I am going to use my ‘inner lawyer’ to assert that there was no mistake in our previous blog when we announced that we were *NFTing a guidance note on NFTs.

*NFTing – the act of creating a non-fungible token.

In any event, it’s important to take stock of what LexisNexis is actually creating. LexisNexis is creating a non-fungible token. The token we are creating is for a digital image (the artwork) of a guidance note on NFTs. The actual guidance note on NFTs exists and will continue to exist in our Cybersecurity, Data Protection and Privacy Practical Guidance module, and is not the token. The guidance note will likely change over time. It will get updated as the market evolves. The token, however, will never change. It is a static, point-in-time digital image of the guidance note as it was published, on the day it was minted.

2. Once I auction my NFT, what can the buyer do with it?

As lawyers, we are often, for good reason, hyper-aware of the need to protect corporate rights and it is no different when your organisation embarks on the process of creating a token. Organisations need to carefully define IP rights to the token, ensuring that they are not giving away more than they have intended. Of course, once purchased on the blockchain, your token is free to be sold on – so defining liabilities for second-hand sales need to also be carefully considered.

As we know, none of these rights and liability considerations are particularly unique to tokens. The same risks arise when textbooks are sold and can be easily photocopied in a library, or organisational logos are downloaded off a website, but perhaps what is most unique to the minting and sale of a token is that unlike a physical artwork which (which could be photographed with a smartphone from the gallery but can't easily be changed or altered), a token is a virtual asset – capable of much easier manipulation and resale. Could our buyer obtain our NFT (which will be in SVG format – for why: See our previous blog here), simply convert it back into a PDF form, re-mint it and re-sell it as a brand-new token on the blockchain?

There are, in fact, three separate items that need legal protection in this project: the token; the artwork (in this case the digital image of a guidance note); and the guidance note itself! Our terms and conditions for the purchase of the token must ensure that we protect the potential re-sale of the token and derivative works of the artwork.

Like any contract, it is perhaps not sufficient to simply have these fabulously drafted Ts and Cs “floating” somewhere nearby hoping they will be absorbed by the buyer. Where do we put our Ts and Cs to ensure that our token buyer is contractually bound by them? It is unlikely to be sufficient for consumer and financial law purposes to simply put it on a website and hope that our buyer has seen them, but nor can we paste the (now potentially quite lengthy Ts and Cs) all over our token (unless we were *NFTing the Ts and Cs themselves – a creative project perhaps for another day). And so, like all organisations that embark on token creation, we need a solution to ensure that the terms and conditions of the purchase are clearly accessible.

Over the second cup of coffee in our virtual meeting room, we saw three options: we could place the Ts and Cs in the code (the smart contract) (is this enough? Will the smart contract allow this?); we could put a link to our Ts and Cs on our NFT (recognising that this requires us to maintain that link); or, we could pull out the most important terms of our licence and display them on the token, linking out to the rest.

Tune in to our forthcoming blogs as we reveal our solution!

3. Is my NFT a financial product?

If it looks or feels like a financial product, well it probably is one and you are therefore required to hold a financial services license to trade your token. Our tokenised Guidance Note does not fall into this category, but organisations looking to set up their own NFT should be alert to this possibility.

4. What if I am a listed entity?

Anonymity is an important feature of the crypto world and private keys are used to maintain such anonymity. Listed entities must consider whether they are meeting their ASX obligations of disclosure when they embark on a project involving token creation.

5. What risks are there in engaging with third parties including crypto exchanges?

Organisations should consider the risks, including reputational risks, operational risks and even financial risks associated with any third parties they engage with and undertake appropriate due diligence. What would happen if your crypto exchange fell under fire for receiving illegal monies or for ‘supporting terrorism”? Can you distance yourself enough from the fall out? What if the exchange were to be hacked? Could my exchange be shut down? It is important to remember however, whilst these risks are real, they undoubtably exist in most third-party transactions. Examine all your contracts. Do your due diligence.

6. What if my NFT has a physical asset attached to it?

As NFT use cases explode – so do novel ideas of physical assets that your token can attach to. From NFTs that give you rights to expensive (and real) bottles of whisky (see Blockbar) or NFTs that can be redeemed for loyalty points or used to represent ownership of carbon credits, the possibilities are exciting, often entertaining and sometimes mind-boggling. For the lucky owner of our NFT, they will be given not only a token but also the opportunity to have their name displayed on our NFT guidance note within our Cybersecurity, Data Protection and Privacy Module.

But how are these rights realised? On the blockchain, ownership rights are transferred in real-time (such is the beauty of the blockchain marketplace). Of course, where a token gives rise to rights for a physical asset, the transfer of ownership or granting of rights usually requires the act of an intermediary (someone to deliver the whisky). Thus it is possible that, even if we were to engage the most up-to-date robots with the latest AI technology, there will likely be a lag between the change of ownership of the token and the exchange of the ‘real-world’ benefit (in our case, the owners name appearing on our web platform).

Since we can’t magically resolve this issue - we need to ensure that our terms and conditions don’t guarantee that names will appear on the platform immediately or automatically and don’t promise that LexisNexis will be checking for ownership changes hourly. To avoid these pitfalls, ownership should be displayed as current at ‘x date’, as claimed by the owner, and perhaps we could link out to the actual smart code should anyone wish to look up the current owner on the blockchain.

And there is another issue. What if our winning bidder doesn’t want their name displayed on our platform (blockchain, is, after all, anonymous) or if our winning bidder has a name we don’t wish to display? Whilst they could call themselves something amusing like “Wonder Woman” it is not going to be so funny if the name we are displaying lacks professionalism, taste or doesn’t align with our values. We need to ensure that our terms and conditions grant a right to request that a name be displayed, not a guarantee that a name will be displayed.

Of course, these are not the only issues that organisations will face when they embark on a journey of token creation. It is important to be aware of the issues, but not to be scared. Digital assets are a key part of our future, and we are all on an exploratory journey to understand how quickly and how comprehensively they will change our world.

*NFTing – the act of creating a non-fungible token

READ NEXT: Blog 3 on Creating an NFT.