esports-law-gaming

What Are NFTs (Non-Fungible Tokens)?
A Look At NFTs in the Art, Entertainment, Music, Sports, Esports and Video Games Worlds
By Justin M. Jacobson, Esq.

NFTs or “non-fungible tokens” are all the buzz in today’s entertainment, sports, art, esports and video game industries. This includes musicians earning millions of dollars through releasing their own NFTs, celebrities like Tom Brady and Jay-Z investing (and launching) in NFT distribution companies, and the trending NBA Top Shot taking over social media and press outlets everywhere, including breaking “$1 billion in sales” on the platform. In fact, there has also been a rapid expansion and usage of NFTs in the entertainment and sports collectibles market, the art world and most recently in the esports and gaming space. This might include utilizing NFTs to secure rights to a particular piece of physical artwork and digital pieces, an “in-game” digital character or a “skin,” a digital sneaker from Adidas or Nike, or digital art “camo” print from BAPE, or even a video “moment” or other unique collectible from current or legendary professional athletes and teams, such as NFL and NHL athletes and even WWE wrestlers. Professional soccer superstar Lionel Messi has even agreed to take a portion of his upcoming salary in his team’s “crypto token.”

What is An NFT? How Does It Work?

An NFT is a type of cryptographic token that is not mutually interchangeable with something else that exists. This means that there is only one “original” copy that cannot be replicated or otherwise divisible no matter what. In fact, NFTs are “coded to have unique IDs” and underlying “metadata” that another token cannot reproduce which is where much of the value lies. This unique crypto token is managed on a “blockchain,” which acts as an official transfer ledger to trace and delineate the ownership and the full transaction history of an associated NFT. In practice, this creates an automated and computerized ownership verification process and database for a specific asset which is authenticated on a “back-end blockchain” technology, such as Ethereum. Additionally, other technology platforms such as FLOW are used by Dapper Labs for the administration of its extraordinarily successful NBA Top Shot NFT.

What is A “Smart Contract”? How Does It Apply To NFTs?

In practice, NFTs are written with a software code referred to as a “smart contract.” A “smart contract” proscribes the permissible actions for an NFT, including assisting in verifying the ownership and managing the transferability of the digital asset. Similarly, a “smart contract” could be coded to automatically allocate a portion of any the amount paid in any subsequent sale of the NFT back to the original owner. This unique attribute provides the original owner with the ability to earn income from the “secondary marketplace” for all the subsequent sales of a digital item. This means that when a creator makes or “mints” an NFT and engages in an “NFT Drop,” they are actually creating and inserting applicable “smart contract” code into an NFT to govern it. When creating these “smart contracts,” many established blockchain platforms follow the “Non-Fungible Token Standard” articulated under ERC-721, including Ethereum. In particular, the ERC-721 Token Standard governs the distribution and maintenance of non-fungible tokens. More recently, a more agile and versatile Token Standard, the ERC-1155 has been developed and is beginning to be implemented by some platforms. The new ERC-1155 is said to increase the ability to more efficiently and cost effectively transfer NFTs as this new “Multi Token Standard” permits “transferring [of] multiple token types at once [which] sav[es] on transaction costs.”

What Are Some Benefits of an NFT?

Another unique feature of an NFT is the ability to be easily transfer it from one owner to another through the existing blockchain technology. Generally, when a user earns an “in-game” item or any other digital asset, it is usually difficult to assign, trade, transfer or otherwise sell the item; however, an NFT solves this problem as the digital item can now be easily managed and transferred through a secure platform, such as “Trust Wallet,” whch include both custodial and non-custodial options. The owner’s asset can be traded or sold in various “marketplaces,” such as OpenSea, Mintable, and the Worldwide Asset eXchange (WAX). This means that an ERC-721 token purchased in a marketplace is stored in a user’s associated Ethereum “wallet address” so that it can be transferred or otherwise sold at a later date by the buyer. Additionally, it is important to be aware of the proposed EIP-2981 standard related to the administration of the residual royalty payments owed to prior owners of an NFT when a subsequent transfer of the asset is initiated.

A revolutionary attribute of an NFT is that one could also derive some unique value based on its current and previous owners, thereby creating an inherent value in the particular digitized asset. This is because the ownership history that is publicly available on the blockchain records provide an easily obtainable and fully transparent listing of the true NFT owners. Consequently, if a famous or other notable person owned the digital item, this might factor into a specific NFT’s value on the marketplace.

What Are Some Legal Considerations For An NFT Project?

An important legal consideration is what actual ownership rights the purchaser of an NFT receives from the original NFT “minter.” In these cases, the terms of an NFT are generally governed by any existing license or any other applicable “terms of service” or “terms and conditions.” This means that an NFT purchaser does not necessarily automatically have the sole and exclusive rights to all of the original content owner’s enumerated rights under § 106 of the U.S. Copyright Act. For instance, if a license does not include any “derivative” rights or the right to reproduce the NFT in a physical item, then it is fair to assume that the buyer does not receive these rights through its purchase of a specific digital asset. Accordingly, absence language to the contrary, an NFT purchaser only receives the rights listed in the transfer agreement. In some cases, this might only be the license “to display the related media in their token wallet for personal purposes only.” Moreover, the operator of the NBA Top Shot, Dapper Labs provides an alternative NFT License template that outlines rights that might be licensed to the buyer. Additionally, the current “Terms of Service” for NBA Top Shot provides the owner of an NFT “Moment” (the basketball highlight) with “the right to swap [the purchaser’s] Moment, sell it, or give it away with the actual [o]wnership of the Moment […] mediated entirely by the Flow Network.”

Two dominant forms of NFTs in today’s marketplace are “fully digital” NFTs as well as those that exist as digital “placeholders” for actual “real world assets,” such as a painting or a signed jersey. In some cases, such as in the entertainment world, an “NFT Drop” might actually be a combination of both of these types. For example, the token might be for a purely digital item such as a digital song or music video playable through the purchaser’s digital “wallet” as well as acts as a digital “placeholder” for a signed item or for a concert ticket or some other fan “experience” that is also stored in the owner’s “wallet.” In practice, this means that the particular NFT’s blockchain technology permits the secure transfer of the ticket directly into the fan’s digital “wallet” or if the original party desires to sell the ticket to another individual, the NFT helps facilitate the transaction and track and payout the income generated through a “second sale” of the item. Additionally, if the NFT is programmed to, it may provide a set royalty payment directly to the original minter, the musical artist or other rightsholder such as a recording label.

There are also some other legal and business benefits that NFTs provide to rights holders. For instance, the owners of a specific painting, sculpture or other artwork piece is able to list the work as an NFT to prove their ownership of it in order to prevent forgery and any other potential fraud. The usage of this technology also permits the creator to seamlessly sell their works in established marketplaces such as CryptoArt.io and SuperRare. In fact, Sotheby‘s just generated over $15 million through its first hosted NFT that included NFTs solely tied to digital assets as well as those linked to a digital as well as a physical art piece, including the unique “CryptoPunk NFTs”. The same is applicable for unique physical memorabilia such as digital racing horses, baseball cards, Pokémon cards, stamps, jewelry, autographed items, virtual and physical concert tickets, songs and even unique “in-game” items such as a limited edition or unique weapon, avatar, sticker, badge or anything else that is earned or purchased within a particular gaming title. This means that existence of an NFT permits the item purchaser to acquire “digital ‘collectible’ versions of a record” or other “fan experiences (either looks backstage or during the artistic process itself), all of which the buyers could ‘own,’ sell, display, [or just] revel in, how cool it is” to own this exclusive item.

As a result of the existence of the fully “digital tradeable tokens” as well as “hybrid” NFTs, many traditional entertainers, sports leagues, professional gaming entities and creative artists are starting to offer them for sale. For instance, some artists have created “branded NFTs” that are similar to traditional physical collectibles but are now a fully digital version. In fact, some of these have been extremely successful, such as the recent Kings of Leon album that generated $2 million from its sale. The musical artist Grimes sold nearly $6 million dollars’ worth of a “one-of-a kind video” as well as sold other “short videos.” EDM producer, 3LAU made over $11 million through the sale of “digital-tokens” exchangeable for “special edition vinyl 3LAU albums, unreleased music [and other] special experiences.” Similarly, musician Don Diablo sold an NFT with rights to an “hour-long concert” for $1.2 million.  The NBA has licensed its various basketball game highlights to Dapper Lab to create the NBA Top Shot product, which operates with multiple levels of rarity for specific NFTs (a highlight) with different market values based on the different “levels” and scarcity of the “Moment” in the marketplace based on each card’s serial number, including a LeBron James Top Shot that recently sold for “over $387,000” and other “Moments” selling for six figures. There also have been some other unique athlete driven NFTs such as Sorare’s digital soccer cards, NFL player Rob Gronkowski as well as MLB Champions,Topps’ digital baseball cards and MLB’s highlight and memorabilia driven NFT.In fact, one of Sorare’s digital trading cards sold for $65,000 and is an example of how sports, esports and other entertainment properties can expand their reach and further diversify their revenue streams. In addition, NBA team the Golden State Warriorsbecame one of the first U.S. professional sports teams to mint their own NFT. More recently, the New Jersey Devils were the first NHL franchise to create their own fan “NJD NFT Digital Marketplace” for its own created NFTs. Finally, NBA player LaMelo Ball has released the first ever “dynamic NFT” that has the possibility of “evolving” over time and includes access to unique perks in addition to the digital asset itself. The NFT craze has expanded to collegiate sports as Miami University has begun minting its own digital “commemorative” NFTs for their college national championships.

With the success of NFTs in other entertainment and sports fields and with the concept of digital items already engrained in the gaming world; these digital assets are prime for growth and expansion. In this regard, an NFT could apply to any “in-game” purchased items such as any collectible, skin, weapon, “champion,” “hero,” “card” or any other in-game playable “character” or avatar. For example, a highly successful NFT is CryptoKitties, which is administered by Dapper Labs and permits a user to “breed and trade digital kitties using Ethereum-based smart contracts.” This was so successful that it led to a collaboration with Warner Music for the creation of a “rock-inspired” CryptoKitties NFT line. Another unique gaming NFT use is that of Axie Infinity, the creator of a “digital pet universe,” wherein an individual purchases “larva” and then evolves and grows the creature over time. The creation of this digital metaverse caused a company to spend $100,000 to purchase 88 digital “plots” within the Axie Infinity universe. There has also been the creation of a sleuth of mobile gaming apps that permit the transfer and sale of various in-game items to other players, such as World of Ether, God Unchained, Chain Clash, Esports Fight Club, and Mythical Games’ and its “Blankos Block Party” title.

Similarly, some esports content rightsholders, such as game publishers and esports organizations, are exploring these integrations of NFTs into their consumer offerings. For example, a unique highlight of an iconic League of Legends match or play owned by Riot Games could be “minted” and sold to the consuming public. There are also opportunities for digital player cards, similar to those that currently exist in other sports, such as unique “1 of 1” or other limited-edition collections of a professional gamers, streamers or content creators. Some esports teams, such as 100 Thieves, Dignitas and Simplicity Esports have all begun exploring incorporating NFTs into their business through the use of digital “gamer” cards and potentially with creating NFTs linked to iconic images or other photographs that the esports organization owns rights to. Previous to this, esports organization, OG Esports “minted” their own NFT for a 2018 Dota championship ring digital collectible that was available for purchase. ESE Entertainment announced the creation of a “Virtual Pitstop” tied to its new digital “motor sports simulation platform” for the creation of “animations [and] skins,” among other computerized items. Previously esports teams have also created fan crypto tokens that can be purchased or earned. Additionally, superstar gamer, streamer and content creator, Turner “Tfue” Tenney released his own limited edition NFT that included “3 Bobblehead NFTs that bring Tfue to life.” Most recently, esports league operated by top esports organizations, Flashpoint minted a player-focused NFT that also included a print physical card for the purchaser.

As more and more dominant content owners, especially those in the large entertainment, sports, esports and other related media world begin understanding and further utilizing NFTs as part of their business model, the more relevant legal and business considerations come into play, including the potential tax treatment of these transactions, the ownership rights of the actual IP as well as information related to Ethereum Gas Prices and associated fees. It will be interesting to see how professional gamers, musicians, athletes, celebrities and influencers as well as more esports organizations, game publishers, event organizers, recording labels, sports leagues and any other individual or company who owns rights to original material begin, if at all, offering NFTs or other blockchain linked assets.

This article is not intended as legal advice, as an attorney specializing in the field should be consulted.

© 2022 Justin Jacobson Law, P.C.