CHAPTER 9
Now that you’re creating, selling, and buying non‐fungible tokens (NFTs), it’s essential to know how NFTs may be affected from a legal perspective. With any new use of technology, it usually takes a while for regulatory agencies, legislatures, and the courts to catch up to the technology’s rapid adoption. In the meantime, we can extrapolate how the law will be applied based upon how similar technologies, and aspects of the new technology, pertain to settled legal doctrine. No specific legal doctrine has yet been set for NFTs, but we can deduce how the law may be applied by looking more generally at how the law is applied to cryptocurrencies, art, and collectibles.
Although Matt Fortnow is a lawyer, nothing in this chapter is intended, nor should it be construed, as legal advice. It’s merely an overview of legal aspects affecting NFTs.
Are NFTs Securities?
Back in the ICO (Initial Coin Offering) heyday in 2017, new coins were popping up all over the place. Although some of these coins were founded on solid technology that provided real solutions, many were based on hype and hope, while others were just out‐and‐out scams. Some speculators looked for a quick 2x return, while others would hodl (crypto for “hold”), hoping the coin would go to the moon. And the scam coins were effectively nothing more than pump‐and‐dump schemes perpetrated by the coin’s founders. Too many investors filing complaints raised the ire of the U.S. Securities and Exchange Commission (SEC). But this begged the question: were cryptocurrencies securities? And why does it matter?
It matters because if a particular investment is a security, then the offering of that security must strictly adhere to rules and regulations promulgated by the Securities Act of 1933. Notice the date of the Act. It was enacted after the great stock market crash of 1929 to protect investors from being defrauded by requiring that investments be subject to various registration requirements (or fall within specific exceptions).
Needless to say, these ICOs were not registered in accordance with the Act. That’s fine if the cryptocurrency was not a security. So, were they securities?
The Howey Test
To know whether a cryptocurrency is a security, we must first understand what a security is. We’re all familiar with stocks and bonds as securities. But securities also include certain kinds of notes and investment contracts.
In 1946, the Supreme Court of the United States heard the case of SEC v. Howey, which involved whether a specific leaseback agreement should be considered an investment agreement. If so, that would make it a security and subject to SEC regulations. The defendants in the case sold land in Florida on which there were orange groves. They then offered the purchasers of the land the opportunity to lease back the land to the defendants, who would then manage the groves, produce the fruit, and share the profits with the land purchasers. Not being farmers or knowing how to manage an orange grove, most purchasers took the defendants up on their offer and leased back the land.
The SEC stepped in and sued the defendants, claiming that these transactions constituted investment contracts and thus were securities. The defendants argued that they were merely selling property and then leasing it from the owners.
In its landmark decision, the Supreme Court outlined four factors for determining whether an investment is a security, to become called the Howey test:
1. An investment of money
2. In a common enterprise
3. With the expectation of profit
4. To be derived from the efforts of a promoter or other third party
The Court determined that:
1. The purchasers invested money.
2. There existed a common enterprise of the defendants managing the orange groves on multiple tracts of land.
3. The purchasers had an expectation of profits from the land.
4. The profits were derived from the efforts of the defendants managing the land.
Thus, the Court concluded that the defendant’s scheme did constitute a security, stating:
“Thus, all the elements of a profit‐seeking business venture are present here. The investors provide the capital and share in the earnings and profits; the promoters manage, control, and operate the enterprise. It follows that the arrangements whereby the investors’ interests are made manifest involve investment contracts, regardless of the legal terminology in which such contracts are clothed.”
Using the Howey test, the SEC determined that ICOs were indeed securities offerings:
1. The purchasers invested money or cryptocurrency (something of value).
2. A common enterprise existed in that ICOs were generally run by one organization or group of people that created, operated, and promoted the underlying cryptocurrency and ICO.
3. The purchasers had an expectation of profits from their investment in the ICO.
4. The profits were derived from the efforts of the organization or group of people running the common enterprise.
This meant that ICOs would be required to adhere to the SEC filing regulations or utilize an exception such as Regulation D, which has its own set of requirements. The SEC cracked down on specific fraudulent ICOs, declared Bitcoin and Ethereum not securities, and suggested that all other cryptocurrencies were likely securities. This specter created a major damper on ICOs and the whole cryptocurrency market, driving ICOs overseas, in which U.S. investors could not participate. Unable to sustain the mania, the cryptocurrency market crashed in 2018 and lay dormant for a few years.
So, Are NFTs Securities?
Being that the SEC deemed that ICOs are securities offerings and that most cryptocurrencies may be securities, one might presume that NFTs, also being cryptocurrencies (with a supply of 1), are likely to be deemed securities as well. But most feel that NFTs are probably not securities. However, the SEC has not issued any guidance on NFTs yet, so one must still be aware of the possibility that it may land on the side of NFTs being securities.
Let’s utilize the Howey test:
1. Purchasers of NFTs invest money or cryptocurrency (something of value).
2. There generally do not seem to be common enterprises associated with NFTs. Instead, most NFTs are one‐offs or limited editions of digital art, are collectibles, or have some utility, such as an in‐game item.
3. Some people may purchase NFTs as an investment, with an expectation of profit, while others purchase NFTs for their subject matter and for building a collection.
4. Generally, there’s no third party promoting the value of NFTs that have been sold.
There’s no definitive answer, but NFTs (being non‐fungible) are more akin to works of art or collectibles, which are not securities, than to fungible cryptocurrencies. If an NFT has a massive supply or a vast number of editions, it leans more toward a fungible token, and the line becomes less clear.
It’s not just the seller of such NFTs who needs to be concerned with it being deemed a security; the exchanges must be concerned as well. If exchanges are providing markets for securities, they must register with the SEC and comply with SEC regulations.
Fractional NFTs
The line becomes less clear, and could even lean toward securities for certain fractional NFTs. Fractional NFTs are tokens that represent a fractional ownership of an NFT. For example, the Unicly CryptoPunks Collection (UPUNK) token represents a fractional ownership in a collection of 50 CryptoPunk NFTs. There are 250,000,000 UPUNK tokens in circulation with a market cap (as of this writing) of nearly $30 million.
The UPUNK tokens are similar to cryptocurrencies, fungible with a large supply and an obvious means of investing in valuable NFTs. Also, when it comes to fractionalized art ownership (of traditional physical art), while companies have different business models, most file with the SEC. Accordingly, we feel it’s likely that certain fractional NFTs may be considered securities.
Intellectual Property Rights
Intellectual property rights play a significant role with NFTs and art in general. Intellectual property is property that derives from creativity. It’s a type of property that does not exist in physical form. Intellectual property encompasses copyright, trademark, patent, and trade secrets. For the purposes of NFTs, we’re going to focus on copyright and trademark.
Copyright
A copyright is, in essence, the right to make copies. According to Dictionary.com, a copyright is “the exclusive legal right, given to an originator or an assignee [transferee] to print, publish, perform, film, or record literary, artistic, or musical material, and to authorize others to do the same.”
A copyright is created once the work is fixed in a tangible medium. This means that the work must be on a canvas, written down, recorded, saved onto a disk or drive, or any other kind of tangible medium. In other words, the work can’t just be in your head, spoken, sung, or performed, unless the latter three were recorded. A creator does not need to register a work with the U.S. Copyright Office to obtain a copyright, although registration does confer certain advantages.
The copyright is separate and distinct from the actual work. The actual work is the physical artwork, such as a painting, digital work, JPEG image, video, or song. The copyright is the intangible right pertaining to the work that is endowed upon the creator of the work.
When Buying NFTs.
When you purchase an NFT (or any other work of art), you are not purchasing the copyright in that NFT. The creator (or artist) retains the copyright. You have the right to use and display the NFT (the copy of the artwork that you have) for personal, and not commercial, purposes. You do not have the right to distribute or sell copies of the NFT’s content. Also, you do not have the right to make derivative works (other works based on the NFT’s content). Of course, you do have the right to sell the NFT at any time.
Note that you can purchase the copyright in a work, but only if there’s an express written agreement assigning the copyright from the creator (or current copyright owner) to you.
Bottom line: Be careful what you do with the NFTs you buy or receive and their content, so that you’re not violating the creators’ copyrights.
When Creating NFTs.
If you’re making an NFT, it’s always best to create an original work of art or original design. You cannot use any old image, video, or audio recording that you find on the Internet. Every photo, piece of artwork, and other images, videos, and sound recordings on the Internet (and elsewhere) are protected by copyright. If you use a work that you did not create, then you may (and likely will) be violating the image creator’s copyright. In such a case, you may be liable for monetary damages and will likely have to take the offending NFTs off the market.
If there’s an existing work that you would like to use, you may be able to get a license from the copyright owner. A license will grant you certain rights to use the copyright in an NFT. In return, you would pay the licensor (copyright owner) a royalty (percentage of sales). The licensor may also request an advance (an up‐front payment). Licenses are generally valid for a specified time period in a defined territory. For NFTs, a license should be valid in perpetuity throughout the world.
Certain websites offer royalty‐free licenses for images and videos, so you would be able to use those works for free. However, make sure to read the license terms because there may be some restrictions or requirements. For example, you may be restricted from using the work for commercial purposes, or you may be required to attribute the work to the website (write in your NFT’s description where the work came from).
You are free to use images or videos (or any other type of work) that are in the public domain. Copyrights last only a limited period of time. For works published in 1978 and later, the duration of copyright in the United States is generally the life of the author plus 70 years. However, for works published before 1978, the duration of copyright in the United States is generally 95 years. So, if a work is more than 95 years old, it’s likely in the public domain. Refer to the Resources page of the website (TheNFThandbook.com/Resources) for royalty‐free and public domain websites. Note that different countries have different copyright laws and different copyright durations.
Maybe you would like to hire someone to create the artwork or design that you have in mind. If you do, make sure to have a written agreement that expressly states that the work they are creating is a work made for hire or work for hire. This is a specific legal term that confers copyright ownership upon the party hiring the artist. The other way that a work may be considered a work for hire is if it’s prepared by an employee within the scope of his or her employment. The latter would apply only if you’re an employer, and it’s part of your employee’s job to create works of art or designs.
Copyrights as NFTs.
Copyrights can potentially be the main content of an NFT. For example, music artists Taylor Bennet and Big Zuu have apparently sold NFTs comprising 1 percent of the sound recording copyright for particular songs. However, upon closer inspection, the purchasers do not own 1 percent of the copyright, but rather a perpetual license to receive 1 percent of the digital royalties earned by a particular song designated in the NFT’s description. It may seem like we’re splitting hairs, but there’s a big difference between owning a copyright and owning a portion of an income stream.
If you owned 1 percent of the copyright, you would be entitled to 1 percent of all income earned from the sound recording, not just 1 percent of the digital royalties. So, for example, if the sound recording were licensed for use in a movie or TV commercial for $50,000, an owner of 1 percent of the copyright would receive $500, while an owner of a license to receive 1 percent of the digital royalties would receive nothing from this use.
So, if you’re going to invest in a “copyright” NFT, make sure that you know exactly what you’re getting. Read the fine print. And if you don’t understand it, ask a lawyer.
Each “copyright” NFT by Taylor Bennet and Big Zuu sold for 100 USD Coin (USDC), a value of $100. This type of NFT, a participation in an income stream, seems like an investment, and might be considered a security by the SEC.
Trademark
A trademark is generally a symbol, design, word, or phrase (or combination thereof) that identifies the source of goods (products). We’re all familiar with the trademarks of Coca‐Cola, Apple, Nike, McDonald’s, and many others. When you see a phone or laptop with the Apple logo on it, you know that Apple created it, which you also mentally associate with a certain level of quality, reliability, coolness, and a host of other attributes. That’s why companies invest lots of money in how their products are perceived.
A service mark is similar to a trademark, but it identifies a service, not a product. For example, “Fly the Friendly Skies” is a service mark of United Airlines, a transportation service. Generally, “trademark” is a broad term that encompasses both trademarks and service marks.
If you see the ® symbol next to a company’s name, logo, or slogan, it means that the trademark has been registered with the U.S. Patent and Trademark Office. Registration provides trademark protection throughout the United States. If you see “TM” or “SM” (for a service mark) next to a company’s name, logo, or slogan, it generally means that the trademark has not been registered yet. The use of ®, “SM,” or “TM” is not required, so if a logo, name, or slogan doesn’t have any such designation, it does not mean you are free to use it.
The main crux of trademark law is preventing consumer confusion regarding the origin of goods. Trademark owners are also concerned about potential dilution of their mark, which is when the public’s perception of the mark’s uniqueness is reduced.
For example, in 2017 In‐N‐Out Burger sued In‐N‐Out Cleaners, claiming that the latter’s name and logo was confusingly similar to, and diluted, their trademark (see Figure 9.1). In other words, In‐N‐Out Burger was concerned that consumers would think they were somehow involved in In‐N‐Out cleaners, and also that In‐N‐Out Cleaners’ logo reduced the uniqueness of In‐N‐Out Burger’s logo.
Both logos contain the same name (In‐N‐Out) and colors, nearly identical typefaces, and similar placement and angle of the design element (the arrow and the hanger). Although the companies provide distinctly different goods—burgers versus dry cleaning—it seems likely that consumers would be confused as to whether In‐N‐Out Burger was associated with In‐N‐Out Cleaners. It also seems that the uniqueness of In‐N‐Out Burger’s logo would be reduced as well.
FIGURE 9.1 Logos of In‐N‐Out Cleaners and In‐N‐Out Burger
When it comes to creating NFTs, and artwork in general, it’s generally OK to use a company’s trademark for commentary, criticism, and parody purposes. The main concept to keep in mind is whether consumers or viewers of your NFT would think that the trademark owner created or endorsed your NFT or its content. Note that the criticism or parody must be aimed at the trademark, not at an unrelated party or issue.
Also, be careful about using a trademarked name or phrase as part of your NFT’s name, username, or collection name on an NFT marketplace.
One artist intentionally created an NFT with the logos of every Fortune 100 company. See Figure 9.2.
This NFT seems like a commentary on society, and it would not likely cause viewers to believe that the piece was created or endorsed by any or all of the companies presented, although you never know.
Unfortunately, there’s no bright line test to determine whether your use of a trademark is appropriate. Again, we suggest consulting with an attorney.
FIGURE 9.2 “®” NFT
Right of Publicity
The right of publicity is the right of individuals to control and profit from their identity (or persona), which includes their name, image, likeness, voice, and other unique identifiers. An obvious example would be that you can’t sell T‐shirts with Kevin Hart’s face on them without his permission. But what about a TV commercial that featured a robot in a blonde wig, gown, and jewelry that turned letters on a set similar to Wheel of Fortune? In 1993, the Ninth Circuit Court of Appeals (one step below the U.S. Supreme Court) took the right of publicity to the extreme, holding that the commercial had violated Vanna White’s right of publicity, even though the commercial did not contain her image, likeness, name, or voice.
What does this all mean? Generally, you can’t use an image or video of someone else in an NFT without their permission…but it’s not black and white. The previous examples were uses of celebrities’ identities for commercial purposes. Artists and NFT creators have a First Amendment right of free speech (at least in the United States), which conflicts with a person’s right of publicity, creating a gray area. Are you creating art, or is the use of the person’s likeness for commercial purposes?
Let’s say that you want to make an NFT of a celebrity such as Snoop Dogg. If you don’t intend to sell your NFT or otherwise use it for commercial purposes, you should be fine without his permission. However, if you want to sell it, that could be considered “for commercial purposes,” and you might need Snoop’s permission. If you made an edition of 100 NFTs of Snoop Dogg, that would weigh in the direction of it being “for commercial purposes,” more likely requiring Snoop’s permission. So, how can you be more certain whether you’re violating a person’s publicity rights?
The Transformative Use Test
Gary Saderup is an artist who created a charcoal drawing of The Three Stooges. He then sold lithographs and T‐shirts containing the drawing. Comedy III Productions, Inc. owned the publicity rights of The Three Stooges and sued Gary Saderup and his company for misappropriation of the Stooges’ publicity rights. The case went all the way up to the California Supreme Court.
The court adopted a transformative use test. They asked, “whether a product containing a celebrity’s likeness is so transformed that it has become primarily the defendant’s own [artistic] expression rather than the celebrity’s likeness.” The court also expressed that “Another way of stating the inquiry is whether the celebrity likeness is one of the ‘raw materials’ from which an original work is synthesized, or whether the depiction or imitation of the celebrity is the very sum and substance of the work in question.” So, in essence, is the drawing in question more of a work of art or more of just an imitation of The Three Stooges? Although the drawing was an artistic rendering of The Three Stooges, the court determined that it was not transformative enough. In other words, people were buying the shirts mainly because they had The Three Stooges on them, not because they were works of art.
So, when creating NFTs containing a celebrity’s likeness (or anyone’s for that matter), make it a work of art, not just an imitation of the celebrity.
Getting back to Snoop Dogg, there are actually multiple NFTs on OpenSea (the largest NFT marketplace) that contain his likeness. For example, there’s the aptly titled “Snoop Dogg #2,” the main image of which is pictured in Figure 9.3. Scrazyone1, the creator of this NFT, is obviously not shy about using Snoop Dogg’s name either.
FIGURE 9.3 Main image of “Snoop Dogg #2” on OpenSea
Does this NFT featuring Snoop Dogg pass the “transformative use test?” We won’t know unless Snoop sues and it goes to court. But for all practical purposes, Snoop (or any other celebrity) probably won’t bring a lawsuit unless you’re making significant money with his likeness. More likely, you’d get a cease‐and‐desist letter. But again, this is not legal advice. We suggest that you consult with an attorney if you plan to use someone’s likeness in an NFT.
Licensing Publicity Rights
If you’d like to use the name and likeness of a celebrity, you could make the official NFTs of that celebrity by licensing their publicity rights. A license is a contract in which the owner of the rights (the licensor) grants you (the licensee) a limited right to use the name and likeness (and possibly other identifiers) of the celebrity.
Some of the main points of such a license would include the following, among others:
· Property: The celebrity (or a movie or comic book character, for example).
· Licensed Subject Matter: Name, likeness, voice, trademarks, and so on.
· Articles: The items to be manufactured or created and sold, in this case, NFTs.
· Territory: The geographic area to which the license is limited. In the case of NFTs, it would be the world, as they’re sold worldwide on the Internet.
· Term: How long the license lasts.
· Exclusivity: Whether or not the licensor can license the rights to someone else during the Term in the Territory.
· Royalty Rate: The percent of sales the licensor gets.
· Advance: An up‐front sum (if any) payable to the licensor.
· Guarantee: The minimum amount of royalties (if any) the licensee will owe the licensor regardless of whether there were enough sales to cover it.
As you can surmise, a license of this nature can be quite complex. So, if you do go this route, we highly recommend that you consult with an attorney.
Posthumous Publicity Rights
Is it OK to use the name and likeness of someone who’s dead? It depends. While copyright laws are federal laws, publicity rights are left to the states. So, in some U.S. states, dead people (or rather, the deceased person’s estate) don’t have any publicity rights. In other states, dead people have publicity rights, which the deceased person’s estate can enforce. The determinative factor is where the person was domiciled when they died. If it was in a state that doesn’t have posthumous publicity rights, then you can generally use that person’s name and likeness.
When Marilyn Monroe died of a drug overdose in 1962, she had residences in both New York and California. Although she was living and working as an actress in California at the time, and was seemingly domiciled in California, her estate argued that she was domiciled in New York. They did this to save on estate taxes, which were significantly higher in California. It seemed like a good idea, right?
Fast‐forward 50 years. The Marilyn Monroe estate sued various photo libraries that were selling photos of Marilyn Monroe, claiming it violated her posthumous publicity rights, which are protected by California law. One case went up to the Ninth Circuit Court of Appeals, which determined that since Marilyn Monroe’s estate had argued decades earlier that she was domiciled in New York at the time of her death, then New York law should apply. Unfortunately for the estate, New York (until last year) did not provide posthumous publicity rights, and thus the defendants were free to use Marilyn Monroe’s image. Since this 2012 case, people have been freely using Marilyn Monroe’s image on all types of products. For example, see the Marilyn Monroeji app, pictured in Figure 9.4.
So, what seemed like a good decision to save taxes after death turned out to be disastrous for the estate. In 2012 Forbes estimated that the estate’s royalties from Marilyn Monroe’s publicity rights were $27 million a year, putting her third on the list behind Michael Jackson and Elvis Presley.
FIGURE 9.4 Marilyn Monroeji app
The lesson here is if you want to use the name or likeness of a dead person, find out where they were domiciled when they died and whether that state’s law provides posthumous publicity rights. Note that some states have not formally addressed the issue. Bottom line: We recommend consulting with an attorney.
Keep in mind that just because you might be able to use the name and likeness of a particular dead person, you must still be wary of using an image or video of that person because that particular image (art or photo) or video is most likely protected by copyright. See the previous section on copyright.
Newsworthiness
One caveat to the right of publicity is newsworthiness. The First Amendment protects the reporting of newsworthy people or events. Accordingly, courts have generally held that using a person’s name or likeness in the news or a literary work, movie, or other entertainment story concerning something newsworthy does not violate that person’s right of publicity. However, with respect to NFTs, it seems that this caveat would generally not apply because NFTs are generally not considered a medium for reporting the news.
Right of Privacy
Often, people use “right of publicity” and “right of privacy” interchangeably. However, that would be incorrect because these rights are distinct. The right of privacy encompasses a person’s rights to the following:
· To not have personal, private information made public
· To be left alone
· To be free from unwarranted government intrusion into our personal lives
With respect to NFTs (and artwork in general), we’re concerned about the first aspect, revealing a person’s private information. Private information can comprise details of a person’s personal life that are not generally known. So, if you’re aware of a person’s private information, do not include it in an NFT. We like to go by the motto “When in doubt, leave it out.”
Public Figures
A caveat to the right of privacy is public figures (celebrities, professional athletes, politicians, and the like). In the United States, because of freedom of speech and the belief that the public has a right to know matters of public concern (further based upon the assumption that everything a public figure does is a matter of public concern), public figures have much weakened privacy rights, similar to the newsworthiness caveat discussed in the previous section regarding publicity rights.
So, with respect to privacy rights, there’s less concern if the subject of your NFT is a public figure. However, note that this caveat affects a public figure’s privacy rights, not their publicity rights. You must still fully respect (or license) a public figure’s publicity rights, as discussed in the previous section.
Contracts
Contract law comes into play when the NFT seller offers perks or includes unlockable content in the NFT.
A contract is a binding agreement between two or more parties. For a contract to be created, there must be three elements:
· An offer
· Acceptance of the offer
· Consideration, which is what’s being provided to, or undertaken by, each party
Let’s use the sale of an NFT as an example. Let’s say that you list an NFT on a marketplace with the price of 1 ETH. This is an offer; you are offering the NFT for sale. Someone then purchases the NFT. They do this by accepting the offer of 1 ETH. Via the marketplace, both parties provide the consideration. You provide the NFT, and the purchaser provides the 1 ETH in exchange. Another example would be where you have an NFT on a marketplace and someone offers 1 ETH for it. You accept the offer, and the exchange is made. Both of these examples are pretty straightforward.
Perks
If you’re offering perks with your NFT, those perks become part of the consideration. The purchaser is making a bid or accepting the price you offer based in part on the perks, and the seller is contractually obligated to deliver the perks as specified (in the description of the NFT). Also, the perks should be delivered or provided in a reasonable, timely manner.
It’s vitally important to describe the perks with specificity so that there’s no misunderstanding as to what must be delivered. It may help to include detailed terms and conditions in the NFT’s description.
The website for Rob Gronkowski’s NFTs (GronkNFT.com) has extensive “TERMS & CONDITIONS OF SERVICE FOR NFTS BOUGHT AS PART OF THE ROB GRONKOWSKI CHAMPIONSHIP SERIES NFT AUCTION,” which cover several areas, including dispute resolution, in the finest of legalese. These terms begin with this statement:
“These Terms and Conditions of Service (“T&Cs”) constitute a legally binding agreement (the “Agreement”) between you (also referred to herein as “User”) and Medium Rare Mgmt, LLC (“MRM”) governing your purchase of NFTs as part of the Rob Gronkowski Championship Series NFT Auction.”
The problem that Gronk’s (or Medium Rare Mgmt, LLC’s) lawyers may have overlooked is that these terms are not referenced in the NFTs or in the description of the collection. So, how can someone be subject to terms of which they were not made aware?
If you have a dispute concerning the purchase of an NFT, we suggest reaching out to the marketplace (on which the NFT was purchased) for support, although there might not be much they can do. So, particularly when it comes to perks, it’s “caveat emptor” (buyer beware) when purchasing NFTs.
NFT Content
As we discussed in Chapter 3, “Why NFTs Have Value,” an NFT’s main content and unlockable content are not stored on the blockchain. Therefore, it’s possible that the location where the content is stored might not be continuously maintained, which could lead to loss of the content, resulting in complete loss of value of the NFT. This is of primary concern for unlockable content, which is more likely to be stored on a personal server or via the creator’s personal account on a cloud storage service.
The question arises as to whether the NFT creator is contractually obligated to maintain the NFT’s content in perpetuity (forever). Perpetuity is a long time, but one of the main draws of NFTs is their permanence. Since NFTs are blockchain assets, people assume that their existence will be permanent, which would lead to an expectation that the NFT remain permanent. And this expectation would seem to include the NFT’s content, both the main content and unlockable content.
Thus, it appears that you should be obligated to maintain an NFT’s content in perpetuity. However, in some U.S. states and other jurisdictions, perpetual contracts are unenforceable or terminable as a matter of public policy. It will be interesting to see how courts rule on these competing interests.
Taxes
Unfortunately, NFTs are not immune from taxes. This section explores different areas where taxes may apply to NFTs. It’s an overview of the potential tax issues pertaining to NFTs and should not be considered tax or legal advice. We highly recommend that you consult an accountant or lawyer concerning tax issues.
Sales Tax
Generally, sales taxes are applied to the sale of goods and services by the U.S. state (and sometimes local) government in which the sale occurred. With the sale of NFTs, the first question would be, where did the sale occur? Which state’s (or other jurisdiction’s) sales tax should apply? If goods are shipped out of state, then usually no sales tax is applied, but instead, a use tax may apply in the purchaser’s state.
Some states don’t charge sales tax on digital items. Are NFTs digital items? Apparently, but some states define digital items as items that were downloaded. Since NFT’s are not downloaded (they remain on the blockchain), they might not fall within the digital items’ exception in these states.
What if sales tax doesn’t apply to digital items, but the NFT contains perks that are physical items or services? Sales tax, in this case, might be applied to the value of the perks. But how should the value of the perks be determined?
Just like Amazon started charging sales tax nationwide in 2017, we wouldn’t be surprised if at some point NFT marketplaces unfortunately started charging sales tax on every NFT sale.
Income Tax
If you’re creating and selling NFTs, you’ll be responsible for paying taxes on your income from those sales. However, you should be able to deduct the expenses that you incurred in connection with your creation, minting, listing, and promotion of your NFTs.
It may be advantageous to form a business and run the NFT sales through that business. We suggest talking to an accountant. Note that there are other potential advantages to forming a business, such as the limited liability a corporation or LLC (limited liability company) provides.
Capital Gains Tax
Generally, if you have an asset that you sell, you will have to pay tax on the gains, the difference between the price you paid for the asset and the price at which you sold it. Like income tax, capital gains tax is charged both at the federal and state levels.
It appears that NFTs are subject to capital gains tax. For example, if you bought an NFT for 1 ETH and sold it for 3 ETH, you would have 2 ETH of gains. However, the IRS is concerned about the value in dollars, not in ETH. Therefore, the gain in value of the NFT would be the dollar value of the NFT when you sold it (the value of 3 ETH at the time you sold the NFT) minus the dollar value of the NFT when you bought it (the value of 1 ETH at the time you purchased the NFT). Again, please consult an accountant.
Note that capital gains tax is owed only when you sell the asset. Once you sell the asset, the capital gains are “realized.” Before you sell the asset, any gain in value is considered “unrealized.”
Long Term vs. Short Term.
If you sell an NFT that you held for less than one year, that would be considered short‐term capital gains, and the tax you owe would be based on your regular income tax rate for both federal and state taxes.
If you sell an NFT that you held for at least one year, that would be considered long‐term capital gains, and the federal tax you owe would be based on the capital gains tax rate, which is generally more advantageous than your regular income rate. Although the current rate varies from 0 to 20 percent for stocks and similar investments, NFTs will likely be considered collectibles, which currently have a capital gains tax rate of 28 percent. However, one may argue that certain types of NFTs, such as digital real estate and domain names, are not collectibles.
Note that most U.S. states do not distinguish between long‐ and short‐term capital gains, which are taxed at your regular state income tax rate. However, some states do provide favorable tax treatment for long‐term capital gains.
When Buying NFTs.
You may be subject to capital gains tax when buying NFTs if you purchased the NFT with cryptocurrency. For example, if you bought 1 ETH a while back for $1,800 and then later purchased an NFT for 1 ETH when the value of 1 ETH was $3,800, you may owe capital gains tax on the ETH, which increased in value by $2,000. This is because you realized the gain on the ETH when you used it to purchase the NFT. If you bought the NFT more than one year after you bought the ETH, the long-term capital gains tax rate would apply.
The NFT you purchased now has a cost basis of $3,800. So, if you later sell the NFT for a value of $5,000, you will have $1,200 of realized gains on the NFT, for which you will owe capital gains tax.
Overall, keep taxes in mind when buying and selling NFTs, because you don’t want to have any surprises later from the IRS or your state or local tax authorities. And, of course, consult an accountant or lawyer regarding tax matters.