The NFT market grew rapidly in 2021. Reuters estimated that total sales volumes in NFTs multiplied over eight-fold in Q3 of 2021. With that said, NFTs have fallen within the scope of the “crypto winter” in 2022, meaning that sale figures have returned back to previous levels. In the UK, there has been a shift away from NFTs being seen as only a playground for individuals and quirky digital artists. Established institutions in the UK have begun to embrace the technology and opportunities that come with it. The British Museum launched 200 NFTs of postcards of Hokusai digital art to coincide with a Hokusai exhibition that it was holding from 30 September 2021. Similar examples include the Whitworth art gallery based in Manchester which minted a William Blake NFT, becoming the first UK museum-accredited NFT in July 2021. Institutions such as Sotheby’s and Christie’s are also already heavily involved in the auctioning of art NFTs. Manchester City Football Club has launched its third NFT drop in 2022, celebrating the heroes of Manchester. More recently, Rishi Sunak during his time as Chancellor of the Exchequer (and now Prime Minister) announced the “NFT for Britain” project, a Treasury-backed NFT mint intended to be operated through the Royal Mint and it is understood that this project remains in development.

There are no specific regulations aimed at NFTs in the UK. Any applicable legal requirements stem from existing regulatory regimes, including in regard to money laundering and financial services regulation.

Registration with the UK’s financial services regulator, the Financial Conduct Authority (FCA), may be required under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (“MLRs”). It is generally understood that NFTs, in general, will not fall within the scope of the MLRs but this may vary depending upon the characteristics of the NFT in question. NFT providers may need to register if the NFT is a representation of value or gives the holder contractual rights – certain cryptoassets may fall within this category (e.g. where contractual rights are offered through ownership of the NFT), given the particularly broad definition of “cryptoassets” under the MLRs. In the case of NFT artwork, the position is less clear. NFTs that are pure digital representations of art might fall more neatly into the category of “works of art” than “cryptoassets” under the MLRs (although this has not been clarified by the FCA).

NFT issuers should also be conscious of financial regulatory requirements. The FCA’s 2019 guidance indicates that most NFTs would be unregulated tokens, which is helpful for institutions operating in this space. However, NFTs may be regulated if they are equivalent to e-money tokens but only where recognised as a means of payment for a variety of goods and services by parties unconnected to the issuer see section 6 below for a possible future example of such an application). NFTs may also be regulated if they fall within the existing categories of regulated “specified investments” such as shares and bonds. For example, a token could qualify as a share if the token holder is entitled to dividends or voting rights for a particular company.^[1] NFT fractionalisation may also have an impact on the application of existing UK financial regulation, as discussed in section 6.

It should be noted that, in line with recent EU developments in relation to the Markets in Cryptoassets Regulation (“MiCA”), the UK has announced plans to also tackle the regulation of certain categories of cryptoassets. It may be the case that the UK takes a similar approach in response to the EU’s proposed bespoke NFT regulation.

^[1] FCA 2019 guidance case study 9, page 42

There are three main IP issues: ownership, transfer and enforcement.

The purchaser of an NFT will not necessarily own the IP to the underlying creative work, but consumers may not realise this and NFT terms are not always particularly clear to investors. In April 2021, the UK’s Advertising Standards Authority issued guidance^[2] that “owning an NFT does not mean that you own the copyright”. There are concerns in this area in relation to consumer protection regulation as well, and requirements for businesses not to mislead individual consumers of products. The aborted sale of an NFT of a drawing by the artist Jean-Michel Basquiat is one example of a misleading and fraudulent NFT sale where the NFT minter did not own the IP rights that they purported to own through the sale.

Nonetheless, in March 2021 the British musical artist Big Zuu did sell 50% of his copyright for a song, intentionally allowing purchasers to also benefit from royalties. US artist Taylor Bennet sold 75% of the rights to a yet-to-be-released track. The co-founder of Bluebox, the platform that enabled these sales, claimed this was “the first true music copyright NFT”. It is not clear whether there was any intellectual property rights transfer as part of the sale. More recently in November 2022, Billboard indicated recently that while mainstream NFT sales may be waning, sales of Web3 music have been gaining momentum and continue to rise into October 2022.

If an NFT creator does hope to actually transfer IP that it owns to a purchaser, English law requires the transfer to be in writing and signed by the person making the transfer. However many NFT sales may not currently satisfy those requirements and this is an area of law that has not been tested in the English Courts at this stage.

For NFT creators who wish to retain their IP rights but exploit these in exchange for royalties, there are both opportunities and risks in relation to enforcement. Creators of NFTs may program their smart contracts to facilitate royalty payments each time their NFT is sold. However it is also possible for an NFT creator to incorrectly claim that they own the IP rights, which may lead to enforcement action being taken by the true IP rights owner.

^[2] Digital Gold, Cartoon Dogs and the Moon – Advertising Cryptocurrencies - ASA | CAP

A key challenge under English law is the application of common law principles to emerging technologies like cryptoassets and NFTs. There are two established categories of property right under English common law – things in possession, and things in action. Things in possession are capable of physical possession, whereas things in action are intangible but rights may be asserted through legal action or enforcement. NFTs do not neatly fit into either category.

In 2019, the UK Jurisdiction Taskforce – a task force formed of prominent lawyers, regulators and members of the judiciary (“UKJT”) - issued a paper providing a detailed overview and analysis of the legal treatment of cryptoassets, which asserted that cryptoassets had all of the indicia of property under English law, and should not be disqualified from being considered property purely because they are intangible assets that do not fit into existing categories. Although the findings of the UKJT paper were not legally binding, the English Court has since confirmed that cryptoassets such as bitcoin are considered property. This analysis has been subsequently confirmed in relation to NFTs as well in a more recent case.^[3]

The UKJT’s analysis also indicated that taking security over cryptoassets was unlikely to work in the same manner as with traditional asset classes. For example, in principle, a pledge or lien requires the ability to transfer physical possession of an asset but it is not clear whether holding a private key would constitute physical possession – as the private key constitutes information and is not itself property. The UKJT concluded that it is not clear that a pledge or lien would be possible in respect of unregulated cryptoassets. The UKJT also indicated, however, that it believed a mortgage or equitable charge could be created over cryptoassets in the same manner as other intangible property, and subject to the same requirements.

The Law Commission in England has subsequently published a public consultation (dated July 2022) that addresses the challenges inherent under English common law and makes recommendations in relation to the categorisation of cryptoassets (including NFTs) within the existing framework. The Law Commission recommended that a third category of personal property – known as “data objects” – be created through legal reform to accommodate cryptoassets and ensure further certainty for cryptoasset owners. In relation to the application of traditional security mechanisms to the proposed “data objects” category, the Law Commission indicated that it sees limited value in possessory security arrangements (e.g. pledges, liens) in relation to this category of personal property. The recommendation instead is that reforms are developed to create more robust cryptoasset collateral arrangements and therefore to strengthen non-possessory security mechanisms. The Law Commission’s recommendations will now be considered further and policy reforms may be developed to implement certain of these recommendation – we will await further updates to clarify the direction that will be taken.

^[3] Osbourne v (1) Persons Unknown and (2) Ozone trading as Opensea [2022] EWHC 1021 (Comm)

NFTs have perceived value due to the immutable record of ownership provided on the underlying blockchain. It will always be possible to confirm that you own an “original” and not a counterfeit. This can cause some friction with data protection principles.

While NFTs themselves do not necessarily contain personal data in every case, NFTs by design can be customised at the time of minting. The “minter” of the NFT could choose to include elements of personal data within the digital file that is tokenised, meaning that this personal data is embodied within the NFT forever. Data minimisation or data erasure under the UK GDPR or GDPR regimes becomes very challenging in this context. The visibility of wallet addresses, which are likely to constitute pseudonymised data in most blockchain networks, must also be properly addressed from a transparency perspective and NFT platform operators must consider the contractual framework put in place with customers to this effect.

NFTs in a cybersecurity context present a particular challenge as each NFT is unique. If an owner’s wallet, or an NFT platform that might be used to store the owner’s private key, were to be hacked, then this would mean the entire value of the NFT would be lost to the owner and very difficult to recover.

There are numerous exciting opportunities and developments to be found in the NFT space:

• Fractional ownership: A number of companies are exploring the possibility of dividing NFTs into shares, offering each NFT holder “fractional” or partial ownership. The investment platform London Trade Art allows customers to purchase affordable “shares” of artworks to make “art accessible to everyone”. Purchasers can sell their NFTs to others on a site that “mirrors the stock market” and receive dividends if the art is rented to museums. The co-founder of Bluebox, the platform that sold Big Zuu’s NFT, has argued that it might soon be possible to trade fractions of copyright for fractions of real estate. If the regulatory questions can be answered by firms in the space, then fractionalised NFTs might open up the market to an entirely new category of purchasers. This type of activity raises legal questions regarding whether the token has the characteristics of a regulated specified investment in the UK, as explained in section 2 above, and we suspect that such projects will face regulatory hurdles.
• Metaverse: The metaverse would allow people to interact with virtual objects and avatars in a 3D universe layered on top of the physical world. In the US, Meta (formerly Facebook) has altered its entire brand to reflect the concept but the UK has also seen some exciting developments. The auction house Sotheby’s has created a “metaverse” where users create a digital avatar to bid for various NFT artworks. At a larger scale the technology company Improbable is working on the technology that would enable a metaverse to host thousands of users simultaneously.
• Gaming: NFTs in the gaming space are uniquely interactive. For example, in the game Axie Infinity players battle opponents using “Axie” creatures, each of which is an NFT to authenticate the Axie’s identity and unique qualities. Established developers like EA and Ubisoft have also indicated interest in the space. NFTs could eventually become a virtual in-game currency that may be tradable between players and even between different games, though such application raises questions regarding e-money regulation and could impact analysis of whether an NFT is truly an NFT, or whether it is in fact used for payment purposes.