(Co-Publication) NFTs: A Technological and Legal Primer 2022

Non-fungible tokens or NFTs are a new asset class seeing exponential growth. A frenzy of activity in 2021 saw leading brands, artists, creators and entrepreneurs create or invest in their own NFTs, as consumers sent more than $30bn worth of cryptocurrency to NFT related smart contracts that year. The surge gives rise to many questions about the technology, regulation and applications of NFTs.

This primer is divided in two sections. The first provides an overview of NFT technology, illustrating current and future use cases in art, collectibles, fashion, gaming, the metaverse and real estate, with an emphasis on Indian developers and entrepreneurs. It introduces the stakeholders in this ecosystem—including creators, investors, and decentralised autonomous organisations or DAOs.

Section 2 highlights the interface of NFTs with existing regulations. It assesses the validity of smart contracts under the Indian Contract Act, and describes the initiatives taken by other nations to legalise smart contracts. The implications of classifyingng NFTs as commodity derivatives, securities and digital goods are also discussed. Policymakers in the US and EU are regulating NFTs based on their underlying use, on a case by case basis. This approach will help protect consumer interest without constraining innovation.

With NFTs being used mainly in the creative industries, intellectual property has been another focus of legal scrutiny. We chart the interface between NFTs and intellectual property, in particular copyright and personality rights. Key questions include the transfer of rights in the underlying work when an NFT is purchased, the copyrightability of an NFT, and the possibility of copyright infringement. With NFTs also being used to commercialise personality rights, like the name, image or likeness of celebrities, there is a risk they will be used to exploit individuals’ personality rights without their consent. We suggest measures for marketplaces and creators to mitigate the risk of IPR abuse.

Financial considerations in the use of NFTs are also discussed, including the potential of NFTs to be used for money laundering. Marketplaces could adopt KYC/AML obligations to help trace money flows and engender transparency. With most NFT marketplaces currently outside India, the purchase and sale of NFTs also gives rise to foreign exchange management concerns. We illustrate how the provisions of the Foreign Exchange Management Act might apply to NFT transactions, and the possible impacts on marketplaces and creators. Uncertainty around the tax treatment of NFTs is also discussed. Guidance from tax authorities including the Central Board of Direct Taxes will help stakeholders determine the taxes owed, ensuring greater revenue flows for the exchequer. Possible NFT marketplace obligations under the Consumer Protection Act are also discussed.

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