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Navigating the Legal Landscape of NFTs | A Short Review

Story Highlights
  • What Are NFTs?
  • What Are NFTs Used For?
  • What Does the Law Say Regarding NFTs?
  • Are NFTs Securities?
  • Are NFTs Commodities?
  • What are the Intellectual Property Considerations?
  • What are the Tax Implications?

NFTs have been the talk of the town for quite a while. From platforms where digital artists can make money to celebrities buying ape art for millions of dollars, NFTs have attracted quite a bit of attention, but what exactly are they, what they can be used for, and whether or not they should even be used are questions that we do not readily find answers to.

What Are NFTs?

NFTs or Non-Fungible Tokens are digital items that gain their value from inherently being noninterchangeable, as the name indicates. Everyday items such as money or shares of common stock can be exchanged for another of the same. These items are defined by their inherent value and are thus interchangeable. NFTs gain that value from being noninterchangeable and purely unique.

In much the same way as cryptocurrencies are “minted” on a blockchain, so are NFTs. Each NFT has its data, and depending on the blockchain it exists in, that data may represent who minted it, who owns it, and the details of its transfer history, along with tags and markers that make it unique from any others like it. All this ensures that there cannot be two identical copies of one NFT, and thus what separates the ownership of an NFT from a simple screenshot.

What Are NFTs Used For?

NFTs are mainly used as digital art or collectibles. Artists on the internet found a way to make money off their art with the arrival of NFTs. Much like traditional art may be sold at an auction, platforms now allow artists to mint their art into NFTs and auction and sell it. Videos, GIFs, music, and other forms of audio can also be minted into NFTs and done with as the creator pleases.

Apart from this, NFTs have recently been introduced as cosmetic items in video games, most notably by Ubisoft, one of the biggest publishers in the gaming industry. They may be attached to tickets to prevent scalping, products like limited edition shoes and clothing lines to confirm authenticity, and real estate and automobiles to prevent theft and fraud. They may even be programmed to give the creator royalty payments with every transfer.

What Does the Law Say Regarding NFTs?

Laws regarding a new subject originate from two main sources. They may come from government legislation or through court precedent from cases involving the subject. In Pakistan, as far as NFTs are concerned, there is no such law in place, so it would be best to instead look at it from the place of origin (The US), as that is probably what Pakistan will end up replicating anyway, however, even in America the situation is quite speculative.

We shall look at it in terms of whether or not NFTs can be considered securities or commodities, what the situation would look like concerning intellectual property, and what the tax implications are. Generally, however, any fraud, deception, or misrepresentation will be dealt with regularly in law. Moreover, these NFTs have smart contracts attached to them, and breach of those contracts would also lead to legal consequences.

Are NFTs Securities?

The answer to this question is complicated, but we will attempt to simplify it. Security is a thing deposited or pledged as a guarantee of the fulfillment of an undertaking or the repayment of a loan to be forfeited in case of default. Firstly, what if the NFT is seen as an investment? In US law (according to SEC v. Howey), an investment is seen as a security if four conditions are met; there is an investment of money, a common enterprise (investor derives profit from someone else’s effort), an expectation of profits, and control by a third party.

This means that if the NFT is bought purely as a collectable, it is not a security, but if it is attached to an investment, for example, if NFTs are sold as shares to fund the construction of a building, and then the profits of that project are to be dispersed among those shareholders, then the whole package would constitute a security.

Apart from this, fractionalized NFTs are securities. Fractionalized NFTs are NFTs held in one place, with more than one owner, each having a token representing their fractional ownership of the NFT. If an NFT fulfills the requirements of being a security, then the policies and regulations of the Securities and Exchange Commission (SEC) will apply.

Are NFTs Commodities?

The US Commodity Futures Trading Commission (CFTC) has said that cryptocurrencies like Bitcoin and Ether are commodities, so if NFTs are kept under the same umbrella, they may also be considered the same.

What are the Intellectual Property Considerations?

This depends upon the contract that the NFT is sold under. Just because a person owns an NFT of an artwork does not mean that they would have the right to reproduce and distribute it.

Intellectual Property rights may still be attached to it by the issuer or the original creator. Of course, owning collectables does not mean owning what those collectables represent; for example, the NBA is creating NFTs of “moments” in basketball matches, and owning those collectables does not give one the right to copy and profit from them.

What are the Tax Implications?

As far as the US’s Internal Revenue Service (IRS) is concerned, NFTs are treated as property, with their own short and long-term capital gains/losses to be incurred when the NFT is disposed of. There would be greater tax implications if cryptocurrency is used to purchase or sell the NFT (however, that is not even a debate in Pakistan, with crypto being illegal). There is a small chance of NFT trade being used as a tax evasion tactic, but that is a complicated topic for another time.

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