NFT Legal Issues: Laws, Regulations and Legal Risks of NFTs

Although NFTs are non-fungible tokens that live on a decentralized ledger, and just because Web3 is a revolutionary jump to a new era of the internet, that doesn’t mean that they do not comply with laws and regulations. The recent surge in NFT sales and the huge mainstream attraction that these digital assets have yielded have raised some major legal concerns. We have gone past the debate about whether NFTs are legal or not. There is no clear answer to the legal guidelines for selling and trading NFTs. However, some countries, like the U.S., are monitoring carefully how to deal with these non-fungible assets. So, are there any NFT legal issues you should worry about?

This article will guide you through the types of NFT fraud, possible NFT regulations, and whether or not NFT’s existence raises major legal concerns. 

What are NFTs? Legally Speaking

We have established what NFTs are as a technology. But to refresh our minds, NFTs are non-fungible tokens that prove the ownership and authenticity of an underlying asset. These tokens document ownership of any valuable digital item through the identification of their metadata. No two NFTs are the same, which explains why they are non-fungible. Just like cryptocurrency, NFTs get written in the decentralized ledger that is the blockchain.  Moreover, NFTs’ smart contracts assign ownership and metadata to each NFT. 

Great, but what are they? Get your sharp suits and black coats because we are about to see NFTs from the eyes of lawyers. 

Legally speaking, you can see NFTs in different ways. They could be commodities, securities, or intellectual properties. There are still no concrete answers to which of these three categories NFTs fall into. However, we do know the implications of the laws and regulations of each category. So we can better understand the legal issues surrounding NFTs. 

Commodities

One way to view NFTs is to regard them as commodities. According to U.S. law, commodities are interchangeable goods, rights, and services that include currencies, and in this case, cryptocurrencies. NFTs and cryptocurrency share the same aspect of them being tokens on a blockchain. The Commodity Futures Trading Commission (CFTC)’s main focus is commodity exchange and price manipulation, which means the actual transaction of NFTs and not what NFTs present as an actual asset. In this case, NFTs will fall under the Commodity Exchange Act. Which will impose strict disclosure requirements, trading guidelines, and marketing standards. 

Securities

Since most collectors buy NFTs in the hopes that their value will increase in the future, some experts state that NFTs are investment devices aka securities. To make it simple, securities are an investment of money in the hopes of bringing more profit as a result. Basically, like company stocks. However, not all NFTs fall under the securities category. In fact, the U.S. Security Act established a list of regulated securities, and cryptocurrency and NFTs are not part of it. 

However, NFTs can become securities under certain circumstances. If an NFT just represents a certificate of ownership for a digital asset, for example, the proof of owning a BAYC NFT, then no, NFTs are not securities. However, if someone promotes an NFT with a suggestion that it will increase in value, then the NFT will be an investment contract and thus, a security. If indeed deemed a security, the sale of NFT needs to be registered with the Securities and Exchange Commission (SEC). Not following the guidelines, in this case, will generate major legal issues. 

Intellectual Properties

We have previously established that owning an NFT doesn’t grant you the intellectual property right to the underlying asset. However, some NFT collections clearly state in their smart contracts that by purchasing an NFT you also get the copyright of the linked artwork. If the creator of the NFT collection hasn’t stated this fact, however, you will not get the copyright. Most NFT projects do not convey any form of intellectual property or ownership rights of their underlying artworks or media. This is where legal issues arise. The fact that many collectors have either believed they have the right to distribute the work or simply abused the confusion for their gain, is a serious copyright infringement offense. Therefore, in this case, NFTs fall under trademark infringement, copyright, and right of publicity. 

Legal Risks of NFTs

Since NFTs are a bit lost on the legal scale and are not yet subject to regulation, that means that both creators and collectors fall under little to no legal protection. This is where the mayhem of NFT legal issues spiral. When there are no clear laws and regulations, swindles, fraud, scams and many other NFT legal risks start to surface. However, even if NFTs are securities or commodities or even if they’re not, they still must be under the US consumer protection law. Meaning that although transactions of NFTs happen digitally, sellers cannot engage in deceptive or fraudulent acts. 

Risks of NFT trade can be seen in many fake NFT cases, fake NFT platforms, phishing scams, plagiarism, rug pulls, and many more. Since NFTs are unregulated, scammers are exploiting the security gap to make illegal gains. 

However, some NFT legal offenses have gone way beyond hacks and copyright infringement. Considering their digital nature and the fact that they live on the new iteration of the internet, which is confusing to some, NFTs have been the cover-up of major money laundering activities and mega fraudulent transactions. An example of this is the infamous Hashflare Ponzi scheme that pulled off $575 million by using the company as a fake crypto mining service and money laundering facade. 

Types of NFT Fraud

There are many types of NFT fraud that can get past the legal system’s radar since no clear regulations are yet to be imposed. 

Wash Trading 

Wash trading is a type of NFT fraud when buyers manipulate NFT transactions by trading them with themselves, creating the allusion of a high-demand NFT, which increases the floor price. Although it doesn’t seem a big deal, increasing the floor price of an NFT collection attracts more buyers for something that isn’t valuable. Wash trading is illegal under U.S. laws. 

Plagiarism

NFT Plagiarism happens when someone steals an artist’s work and mints it as an NFT. This is a prominent case in the NFT world as art platforms like DevianArt witnessed many art thefts that were turned into NFTs. 

Money Laundering

NFTs are transactions on a decentralized blockchain. That means, there is no central authority that regulated the platform. Therefore, NFTs make a convenient way to launder money by concealing it as a digital asset. Since buying an NFT doesn’t require providing ID documents to assist in validating ownership, criminals have the opportunity to launder their money without arousing any suspicions which is a major legal issue. 

Impersonation

There are a handful of scammers that will create fake social media accounts or websites that impersonates a famous NFT creator in order to deceive people into buying fraudulent NFTs. An example of this is when someone falsely claimed to be Banksy and sold a fake NFT for £244,000. Some states consider impersonation to fall under identity theft and therefore being a major felony. 

NFT Legal Issues and Pitfalls

Other than the big legal offenses that NFTs are potentially causing, there are still many legal considerations that are still undefined. 

Data Hosting 

Since NFTs are linked to an off-chain media file that resides somewhere on the web, there’s a chance that the server hosting the file gets shut down or hacked. Meaning that the NFT you bought will become invaluable since it has a broken link. Which will leave you owning nothing. Therefore, there should be a regulation that protects the NFT holder from losing the NFT’s underlying asset. However, no law has yet addressed this situation. Moreover, if you do end up losing the media file, you probably can’t sue anyone. 

Data Protection

There’s a law that gives you the right to erase all your private information from public and private businesses. You can literally ask to be “forgotten”. This law is enforced in the EU under the General Data Protection Regulation framework and the same goes for the U.S. under the Consumer Privacy Act. Therefore, the immutability of the blockchain breaks this law. Meaning that NFTs with private data contradict data protection laws and personal rights and therefore it’s a concerning legal issue. 

Royalties

One of the many attractions of NFTs is their ability to generate royalties from resale for the creators. However, in most cases, smart contracts ensure the automated payment of royalties only when the resale of an NFT occurs on a specific marketplace. So when a resale happens on a different platform, the creator will not get any royalty payment. The U.S. law and 70 other jurisdictions however don’t distinguish resale rights to creative works. That means if a creator doesn’t get compensated through royalties from a resale, no law can protect his rights. 

Estate and Succession Planning

There’s an important question to ask in the NFT scene: What happens to someone’s digital assets and NFTs after death? Accessing NFTs can only happen if one knows the private key and password. Therefore, if the holders of an NFT died before sharing the private keys with someone else, the digital assets will be lost. 

NFT Taxation

Taxation laws have been lacking when regarding NFTs. Taxation laws differ from one country to another, but the important question is: Are NFTs taxable in the first place? Well, creating an NFT is not taxable, selling it however is a different story. If a creator sells an NFT on a marketplace, he will have to pay an income tax. Moreover, the Internal Revenue Service has stated that all digital assets or NFTs are treated as property for taxation purposes.  Meaning that any revenue that comes from sales is taxed as property and therefore subject to capital gains tax. 

The Future of Legal Applications

It is clear that the legal systems haven’t yet caught up with the fast and ever-so-expanding nature of NFTs. However, that doesn’t mean that things will remain vague regarding NFTs’ legal regulations. Therefore, before jumping into the NFT pool, make sure to consider every legal regulation that might cause a problem in the future. It is also advisable to refer to a legal counsel to explain all the underlying legal issues surrounding NFTs.