Is the NFT bubble about to pop or could it float higher?

Is the NFT bubble about to pop or could it float higher?

Non-fungible tokens (NFTs) have, over the last couple of years seen a meteoric rise in popularity and notoriety, slowly solidifying itself in the zeitgeist. We have seen these tokens go from the unknown to items everyone wants a piece of, with some spending millions  such as Beeple’s The First 5000 days which sold for $69,346,250 and CryptoPunk 7523 which sold for $11,754,000. But, is this NFT bubble about to pop.

What is an NFT?

Many of you will now be aware, non-fungible means a unique asset whose value cannot be replicated, with examples such as works of art. NFT assets are individual and irreplaceable, digitally generated, with unique values according to each specific asset. NFTs are also used to prove ownership of an asset and are indivisible, creating digital scarcity. Each NFT on the blockchain (in this new language it means record of transaction, see below) has an owner, with an account associated with the ownership. The blockchain acts as a ledger of items, tokens, and cryptocurrency, recording who owns each NFT at a particular point in time. Owners of these crypto-assets have their own private key that allows them to transfer ownership of the item over to someone else. NFT transactions are recorded on the blockchain and ownership is updated via a decentralised immutable ledger where no data can be altered. As such, it is almost impossible to create counterfeits.

NFTs facing a slump?

The first potential warning sign is that the NFT market has started to slow, with prices starting to drop and NFT works losing significant value. This isn’t just the case for your run-of-the-mill NFT, but the high profile, well know NFT’s, such as CryptoPunks and Board Ape Yacht Club. OpenSea, one of the premier NFT market places reports, at the time of writing, that CryptoPunks value is down 81.80% over the last 30 days while Board Ape Yacht Club is down 70.44% over the last 7 days. While it should be noted that this may just be the market correcting itself after the meteoric highs and huge NFT publicity, the clear volatility of NFT’s isn’t something to be taken for granted.

Legal issues

Taking a step into the legal realm, the current legal issues with NFT’s may also be impacting the market.  While there are issues in relation the SMART contracts (pieces of computer code designed to carry out a set of instructions, designed to enforce the terms of an agreement, and will automatically execute when pre-defined conditions are met), for example what happens when information is inputted incorrectly creating a contract neither party intended, and in regard of taxation, determining where NFTs are situated for tax purposes. However,  the two most prominent issues potentially influencing the market are intellectual property and regulation.

Intellectual property considerations

In relation to intellectual property, issues may arise  where an individual, such as a music artist creates and subsequently sells an NFT linked to say music royalty steams that may not necessarily belong to the music artist in the first place. This exact issue has arisen in the recent United States Jay-Z NFT case. To briefly summarise the case: Jay-Z co-founded a record label with Damon Dash, called Roc-A-Fella Records. Jay-Z and Dash each own one-third of Roc-A-Fella, however, importantly, Roc-A-Fella owns the copyright in Jay-Z’s debut album called Reasonable Doubt. In June of this year Dash sought to auction off his share of the copyright to Jay-Z’s debut album Reasonable Doubt as an NFT, through NFT platform SuperFarm. This was picked up by Roc-A-Fella Records, who intervened and sued Dash in order to prevent him from selling the copyright. Roc-A-Fella’s commented that not only was this not Dash’s product to advertise, as Dash only owns a minority share in the company, but he also had “no right to sell a company asset” as an NFT or otherwise. A temporary restraining order prohibiting Dash from selling the album as an NFT was granted and SuperFarm subsequently cancelled the auction. This case serves as a cautionary tale to both buyers and sellers of NFTs to ensure each party understands exactly what's being sold, and whether it can be sold. The case additionally goes to highlight the importance of expert legal advice when creating an NFT i.e. uploading an artwork or other appropriate item to a given marketplace platform  and issuing a token to guarantee its authenticity (otherwise known as minting ).

Is regulation the answer?

Moving to arguably the key reason why the NFT market may be in a slump is an issue that has been ever present since its inception, regulation. Looking at the figures spent on NFT’s in the last year alone, along with the transactions being facilitated largely through the use of cryptocurrency, concerns have been, and will continue to be raised about the legitimacy of these transactions and whether they are being used to circumvent anti-money laundering regulations. This point was echoed on an episode of the Waldy and Bendy’s Adventures in Art podcast, where artist David Hockney, when asked about NFT’s commented “I think it’s I.C.S… International crooks and swindlers.” Taking a look at the current rules and regulations in place, on the 10 January 2020 The EU’s Fifth Anti-Money Laundering Directive (5AMLD) came into force, increasing the crypto currency regulations and subjecting all ’art traders’ to various new rules, such as the requirement to undertake client due diligence to verify a purchaser’s identity and their source of funds prior to any transaction taking place. What is unclear however, is whether  NFTs fall within the regulations scope, as “work of art” is defined by reference to the 1994 Value Added Tax Act, which failed to reference NFTs or other digital art forms. This regulatory uncertainty around NFTs is something that may not only impact people’s faith in the market, but also increase the risk of high-value NFT transactions being used as a means of circumventing the current anti-money laundering regulations.

I have in previous articles posed the question of will NFTs be a success? This question, has been well and truly answered as yes in the short term, BUT the billion dollar question facing NFTs is one of longevity and survival. Is the NFT bubble about to pop? With mass adoption and integration of NFTs now underway, what will be the next step for NFTs. We will need to see law making bodies impose strict but workable regulations regarding the transfer and sale of NFT’s, however if regulators go too far they will they will regulate NFTs out of the market and away from the public consciousness. NFTs will likely have to embrace a level of regulation if they are to continue to survive and thrive. The Potential for NFT’s is mammoth and it is easy to see how they could be adapted  into a tool for utility, with the potential to diversify even further to property ownership, concert tickets and identification documentation.

Disclaimer: This document does not present a complete or comprehensive statement of the law, nor does it constitute legal advice. It is intended only to highlight issues that may be of interest to clients of BLM. Specialist legal advice should always be sought in any particular case.

Arthur Caplin, Solicitor at BLM