Non-fungible tokens may be here to stay: how can technology law harness them?

Although the increase in interest regarding NFTs has stemmed from the tokenisation of digital artworks, any unique thing (even physical assets) can be tokenised with an NFT. For this reason, it is possible that in the future, NFTs could be used as a valuable technological legal tool to authenticate unique items and to confirm provenance and originality. Please refer to our earlier article, ‘Non-fungible tokens (NFTs) and copyright law’ and ‘Non-fungible Tokens: what’s all the fuss?’, for a brief overview of what an NFT is and the use cases for NFTs.

What does fungible mean?

NFTs are ‘non-fungible’, meaning each NFT is unique and cannot be replaced with a different item of the same kind. Contrast this against many digital assets, which are ‘fungible’, meaning that they are mutually exchangeable with a different item of the same kind and are equal in value. 

Fungibility is an interesting concept, and people often incorrectly assume that if something is ‘non-fungible’ it is unique and if something is ‘fungible’ it is not unique. However, uniqueness and fungibility are different concepts. For example, the $20 note in my pocket is unique and is different to the $20 note in yours. However, because they represent the same thing (value) and are readily interchangeable, they are said to be fungible.¹  Put simply, you and I can exchange $20 notes. On the other hand, if you and I both own the same model of expensive sports car, they are not readily interchangeable (there could of course be all sorts of differences between them), meaning they are not fungible.

The most important characteristic to remember about fungibility is the ability of the good or asset to be readily interchanged for another of a like kind, implying that they have the same value.²
Fungibility is also an entirely different concept to the ability to copy i.e. if I sends you a mp3 file of my favourite song and you download the file and make a copy on your computer, although the files are the same, that does not necessarily mean that the files are fungible (although they may be). This is often referred to as the double spending problem, which is a particular risk for digital currency and assets.³

 

Fungibility in the context of blockchain and NFTs

Whilst blockchain has more typically been used to create fungible cryptocurrencies, for example Bitcoin, where one Bitcoin is exchangeable for another Bitcoin, NFTs are different because they have a unique code and properties that aren’t interchangeable. 

An NFT is therefore non-fungible and enables the creation of unique  digital assets or identity enabling it to be distinguished from other tokens.  Of course, a person may still own a separate copy of the digital thing; they just don’t own the copy with the unique NFT attached. The concept of an NFT can be likened to the concept of a limited edition print or signed copy of a book – although there are still copies of the book that others can read and own, only one or few people own that particular limited edition of the book. 

Because NFTs are non-fungible, they are an important tool to create a market of scarcity, which in turn (just like physical assets) can drive up the value of the asset. The creator of an NFT can decide its scarcity by deciding whether there is only one NFT or a small number of NFTs attaching to one or a small number of assets. Having one or few NFTs creates a scarcity market, regardless of whether the asset can be or has been reproduced or copied. 

NFTs and immutability

Another important element of an NFT is that it is immutable, meaning they cannot be changed or amended in the future, giving creators of NFT the power to determine the terms of the NFT. This enables (for example) a creator of an NFT to facilitate that royalty fees (usually between 5 and 10 percent) are automatically paid to the creator each time someone re-sells the NFT, creating a secondary market. 

For example, Serwah Attafuah was one of the first Australian artists to sell an NFT of their work, with her piece ‘Voidwalker’ selling for $2,000.⁴ The NFT is programmed such that Ms Attafuah retains 10% equity in the NFT such that when the artwork is re-sold in the future, she will get 10% of the sales price, whatever the sales price is. This is a revolutionary feature for creators, as a secondary market was previously very difficult to enforce in the context of standard or “old world” contracts. Due to the immutability of a “NFT contract”, each time a NFT asset is sold between different parties, the parties cannot ‘contract out’ of the equity that the creator has written into the NFT contract at the time the NFT was minted. 

NFTs also make it easier to control the authenticity of items and offer prospective purchasers a clear transaction history that can be traced back to the creator.  There is an interesting question for the future, with technology changing so fast, to ensure that NFT’s can be verified in years to come (like trying to find a VHS player to play an old video tape).  The parallels to art provenance are clear.

All in all, NFTs change the ground rules of ownership in a digital environment (and beyond), and potentially maximise earnings for creators.  

Are NFTs also going to change technology transactions

Although, to date, NFTs have mostly been used in the context of digital assets, they can be used to tokenise anything, meaning they could theoretically replace contracts, deeds and certificates of title. The tokenisation of physical items has not yet developed as much as the tokenisation of digital items, however, there have been some limited cases where NFTs have tokenised physical items. For example, Nike has trademarked a platform for NFTs called ‘CryptoKicks’ where they plan to attach a NFT to each pair of sneakers purchased, which remains a placeholder but demonstrates the possible application of NFTs in the luxury fashion industry. 

It is possible that NFTs may transform other markets as well.  Including perhaps the music industry, fashion industry, property market, diamond market or any other market you can think of where scarcity is a relevant factor. This is because the creator of an NFT can determine an item’s scarcity by deciding whether there is only one NFT or a small number of NFTs that are minted. Having one or few NFTs creates a scarcity market and drives up the value of the asset that is represented by the NFT, regardless of whether the asset can be or has been reproduced or copied. 

NFTs also open new possibilities such as NFTs being used a collateral for loans and NFTs facilitating fractional ownership, where NFT creators can create ‘shares’ for their NFT and give investors the opportunity to own part of an NFT without having to buy the entire thing. 

At minimum, it seems clear that NFTs present a new frontier for technology law and its current uses are just the tip of the iceberg of what is to come.

However, existing regulatory frameworks that may not yet be fit for purpose will continue to apply to the use of NFTs so creators, users and token holders should seek advice on the conditions of transfer and on any laws that may regulate the transaction that is being facilitated.  

 

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¹_{Fungibility’ is defined in the Financial Dictionary as the state of being interchangeable, for example money and stocks and states that they are fungible because there is no difference in value between one dollar and another dollar.} 

²_{Fungible’ is defined in the Cambridge Dictionary as ‘easy to exchange or trade for something else of the same type and value’, with examples given of fungible goods/ commodities and fungible assets/ bonds.}

³ _{See ‘Double-Spending’ information page on Investopedia.} 

⁴ _{See ABC article ‘NFTs or non-fungible tokens: The new kind of digital art that could prove a bonanza for creators’.}