By Catherine Zhu and Louis Lehot
With growing interest from consumers and asset managers, investors as well as entrepreneurs interested in digital assets, we have created this checklist for monetizing items with unique artistic content characteristics through non-fungible tokens. (NFT).
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We have seen companies aggregating content for monetization on an NFT, while others ride the tokens or create NFT marketplaces, and many more who mediate payment transactions between creators, licensors, markets and the buyers, sellers and exchanges in which they trade.
Each of these types of businesses, and the transactions in which they participate, will need to consider the legal ramifications of the still developing laws, policies and regulations applicable at each link in the NFT trade chain.
But first, a quick introduction: An NFT Marketplace is a platform that connects content creators with NFT buyers and NFT sellers. Sellers create NFT tokens with the digital asset created on this platform, and buyers can browse the listed assets and buy or participate in an NFT auction. There are primary and secondary sales of NFT in the market with different transaction costs depending on how the market operates and who facilitates the sale.
With the expansion of NFTs into mainstream consciousness, what are the main legal, policy and regulatory considerations that you need to be aware of?
Key Legal Considerations When Building an NFT Marketplace
- Training: You will need to create a legal person before launching a marketplace. This will provide your business with the most substantial liability protection, greater capacity, and greater credibility when seeking funding from external sources.
- Code of conduct : Most NFTs, given the predominance of user-generated content and transactions in NFT marketplaces, include an additional layer of legal restrictions in the form of codes of conduct to govern interactions on the platform.
- Smart contracts: The unique digital creation must be independently identifiable, with ownership transferable under the smart contract. Creators need to integrate the economics of commerce: how much for a primary sale, how much for secondary sales, royalties, transaction costs and other secondary market features to enable commerce, with funds going to the appropriate parties by design.
- Terms of sale: Sellers or creators who list their NFTs on an NFT marketplace may wish to impose additional terms of sale on buyers of their NFTs, particularly if the platform’s terms of service do not sufficiently take into account the risks for the seller or the creator.
- Protection of intellectual property: It is essential to verify the intellectual property rights of each participant at every stage of every NFT transaction. Make sure to allocate intellectual property rights between creators / artists, buyers / collectors and other relevant parties. The ownership of the original work is the property of the copyright, which belongs to the creator of the original work. If a TVN is struck and sold, the purchaser will receive a bundle of intellectual property rights from the creator as part of the possession of the TVN. The seller of the NFT determines the rights that accompany an NFT. When considering ownership of the content you seek to tokenize, consider the rights of ancillary parties: is there a record company, studio, sports franchise that has the right to participate in the monetization of the content?
- Securities law compliance: To ensure that your newly created token does not have the characteristics of a security, it is essential to design characteristics that demonstrate the distinction between your NFT and what governments seek to regulate. For example, the proceeds of primary and secondary sales should not be used to build other NFTs, the platform or the market. Because currency is fungible, this requires careful planning.
- Payments: If payments are processed on behalf of the counterparties, the party receiving the money may be a “money transmitter” with its activities governed by applicable treasury, state and local registration regulations. To avoid the complex registration process in countless jurisdictions, many marketplaces partner with already registered entities, acting as content creators rather than payment processors. But keep an eye out for commissions, gasoline charges, and other transaction costs associated with validating transactions and processing payments. How is each payment characterized? Are these fees for creating content or passing on money? This is a key issue for compliance
- Consumer protection: Most major jurisdictions have laws to protect consumers. Suppose an NFT marketplace does not properly inform its customers about what they are buying and the risks involved. The FTC can then claim misleading or unfair advertising, which can lead to heavy fines. NFTs will likely be targeted by cybercriminals for financial gain. Your platforms will need robust controls to guard against such risks. You may also need to implement KYC, anti-money laundering, and other regulatory requirements.
- What else is in the kitchen sink? The existing regulatory and legal environment was not designed for the rapidly evolving metaverse, where digital assets predominate. Nonetheless, some key issues have emerged as investors, financials, and fintech companies explore this space. Is there a gateway to your platform to protect you from money launderers and bad actors subject to government sanctions?
- Show me the money: With each piece of content and each medium in which it is reproduced or symbolized, different license fees may be payable to a different entity in the trade flow. Determine if an album art or music recording is subject to royalties to record companies, agents, libraries or artists, and if payment is only due on the initial sale or on each subsequent resale in the secondary market . Analyzing every contract involved in content monetization is a key task, and care should be taken to keep track of every transaction in the metaverse.
Put it all together
If the past two years have taught us anything, it’s that technological paradigms are changing faster than the speed of law, policy and regulation. While contracts between two parties can be concluded and changed in a fraction of a second, the legal regime governing them does not always keep pace. Like all things, however, law, policy, and regulation are catching up. Sometimes they land in unexpected places not foreseen at the time of the contract. This checklist should help those involved in creating NFT marketplaces navigate the legal metaverse.
Catherine Zhu and Louis Lehot are business lawyers with Foley & Lardner LLP in Silicon Valley. Zhu advises Web 3.0 companies on business development, go-to-market and commercialization, IP licensing, and compliance with data privacy, governance and risk management. Lehot is a member of Foley’s NFT working group. He assists and advises his clients at all stages of their life cycle.
Illustration: Dom Guzman
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