Non-fungible tokens (NFTs)

The popularity, volatility and value of non-fungible tokens (NFTs) are divisive topics. This is partly because the market, which exploded in popularity in 2021 due to landmark sales like the USD69.3 million auction of a single NFT, grew so quickly that traditional investment schemes were left out to dry.

As their values soared, NFTs were touted as being integral to the next iteration of the internet with one 2022 survey suggesting that 800,000 Britons bought into the craze during its peak. Unfortunately, within 18 months the tide went out and many who invested got burnt, with spending on NFTs plummeting by 87% throughout 2022 according to blockchain adviser Chainalysis.

Despite issues, the NFT industry has worked to turn the page and attempted to reignite consumer enthusiasm for NFTs. Status tokens like Bored Apes, whose record sale remains a USD3.4 million (or 852 Ether) transaction of #8817 at Sotheby’s in January 2022, are still ranked as the top category of collections on OpenSea (at the time of publication), despite trading at more than 90% below the all-time highs of 2022. There are still opportunities – you just need to tread with caution.

Although NFTs soared as an asset class during the crypto boom of 2021-2022, they took a real beating during 2023's crypto winter. Like any speculative investment, investors should do their due diligence before purchasing an NFT.

Michael Adams, Lead Editor of Investing, Forbes Advisor

Here to stay?

In their pandemic-era heyday, NFTs were hailed as a groundbreaking, paradigm-shifting innovation at the intersection of blockchain technology and digital art. Many of the eye-watering sale prices in 2021 and 2022 reflected this excitement. Beeple’s Everydays: The First 5000 Days sold at Christie's in March 2021 for USD69.3 million (or, more accurately, 42,329 Ether). Similarly, CryptoPunk #5822 sold for USD23 million (or 8,000 Ether) in February 2022, and many other CryptoPunks sold for single or double-digit millions.

But this period of overexuberance has passed, and the values of NFTs have generally fallen substantially since their 2021/22 peak. This is despite Bitcoin reaching a new all-time high price of USD75,830 on 14 March 2024. Some would say that the wider fall in the NFT market since 2022 belies an optimistic future, as creators and collectors continue to recognise the applications for, and benefits of, NFTs in representing value, scarcity and uniqueness in a virtual landscape.

However, this may be a longer-term play. Data from Statista in July 2024 revealed the market was projected to experience a contraction in its annual growth rate of 11.01%, resulting in a total revenue of USD608.6 million by 2025.

NFTs are still being minted, and ventures in the fashion and luxury goods sectors in particular are continuing steadily, in part, thanks to moves to make NFTs more transparent and accountable, providing proof of ownership and ensuring provenance. Brands are continuing to release NFTs, not only for the use of products in the metaverse but also as a means for their followers to secure other exclusive goods and services in the real world.

High design and high tech are increasingly being combined, and Louis Vuitton is at the forefront of this movement with their luxury NFTs. The release of a new varsity jacket designed by Pharrell Williams, priced at EUR7,900 and limited to 200 pieces available only to holders of Louis Vuitton’s Via NFTs, was one of the highlights of their Men’s Fall-Winter 2024 Show held in Paris in January. Prada also utilised cutting-edge blockchain technology using NFTs as passes to its Milan Fashion Week in September 2023.

On the digital art scene, Christie's launched Christie’s 3.0 in September 2022, an on-chain auction platform dedicated to NFT art. Likewise, Sotheby's launched Sotheby’s Metaverse in May 2023 as a secondary marketplace for digital art.

As with any new technology, NFTs present both opportunities and risks for early adopters. Some of the key issues to consider are summarised below. These are primarily concerned with purchases of digital art, but they can be applied to NFTs that point to other assets or items.

Intellectual property

One important consideration when purchasing an NFT is the ownership of the intellectual property (IP). Buying an NFT does not necessarily transfer the copyright or other IP rights of the underlying asset or item to the buyer. Creators of NFTs often retain these rights, which can lead to disputes if the NFT owner reproduces, modifies, or distributes the item without the creator's explicit permission. Similarly, if the NFT itself reproduces a third party's work without permission, this can give rise to copyright infringements by future owners of the NFT.

Given these issues, buyers and their advisers should carefully review the terms of any NFT purchase, particularly concerning the rights in relation to future usage and commercialisation of the IP of the artwork, image, video, content or other work of authorship linked to the NFT. Likewise, sellers should make it clear what IP rights are included in a sale and include appropriate disclaimers in any documentation.

The devil's in the smart contract

NFTs rely on blockchain platforms that support smart contracts, with the Ethereum blockchain being the most popular choice. As smart contracts are self-executing, buyers should review the underlying code for any frauds, exploits or unusual functions or requests for authorisation.

For digital art, royalty mechanisms can be included in the smart contract, enabling creators to receive a percentage of future sale prices when their works are sold in secondary markets. Such payments are in addition to any royalties payable under the EU's Artist’s Resale Right Regime (and the application of this regime to NFTs remains untested).

Another consideration when purchasing an NFT is to verify the storage and authenticity of its metadata. For digital art, the most important piece of metadata is the image file itself, or the URL where it is stored. As all the metadata for an NFT is often too large to store directly on the blockchain (due to the limitations of block sizes, as well as gas fees), typically all that will be stored on the blockchain is a link to an off-chain storage network like the InterPlanetary File System (IPFS).

The IPFS is a decentralised and distributed file storage system designed to provide permanent and censorship-resistant storage for files and data. It is essential that the NFT being purchased links – via the smart contract – to the correct file stored on the IPFS.

Finally, while it is possible to trade NFTs relying solely on smart contracts, it’s often advisable to have a natural language contract that accompanies the transaction. This should be consistent with any coded terms but can cover a broader range of issues (including intellectual property, applicable law and court jurisdiction).

Tax uncertainty

The tax treatment of NFTs in the UK, as with other cryptoassets, is still, to some degree, uncertain. The UK has no specific legislation dealing with the taxation of NFTs or specific guidance from HM Revenue & Customs (HMRC). While HMRC has published guidance on cryptoassets and DeFi transactions, this goes no further than acknowledging that cryptoassets and NFTs are separate assets.

The current UK tax treatment of a particular NFT will depend on its specific characteristics. If an NFT provides no ownership rights in the underlying item or asset, then it’s likely that the UK tax treatment for other cryptoassets would apply; any value increases would, in principle, be within the scope of capital gains tax, but income tax may apply instead if a person crosses the line between 'investing' in NFTs and 'trading' in them.

One major uncertainty that remains in relation to the UK tax treatment is situs, or the location of cryptoassets for tax purposes. HMRC's guidance continues to state that, in its view, cryptoassets are located where the beneficial owner is a resident. While HMRC has not commented on NFTs specifically, it seems likely that the same treatment would apply to NFTs (again, assuming the NFT provides no ownership rights in the underlying asset).

Liquidity and volatility

The NFT market is still relatively small compared to the markets for other traditional asset classes. This has an obvious and direct impact on liquidity, as access to secondary markets can vary from token to token. In addition, some NFT projects have lockup periods or restrictions on when the NFTs can be resold. This can also affect liquidity and should be checked before any purchase.

As with cryptoassets more generally, the prices of NFTs are the subject of much volatility. The value of an NFT is highly subjective and therefore may surge or plummet based on the perceived worth, rarity and demand in the market. This is an important consideration given that NFTs don’t typically generate income, and so investors will be relying on capital appreciation to profit on a future sale.

The first NFT ever created,

‘Quantum’ by Kevin McCoy,

was minted in 2014 on the Ethereum blockchain.

NFTs: when issues arise

The speed with which NFT technology has been adopted and the uncertainty surrounding ownership and property rights of NFTs has given rise to various types of disputes.

IP disputes

One of the main areas of NFT-related litigation involves IP disputes. Artists, creators and copyright holders have encountered situations where their work has been turned into NFTs – 'tokenised' – without consent. This has led to allegations of copyright infringement.

While NFTs are unlikely to enjoy copyright protection because they merely represent certain works on blockchain technology, the underlying artwork or content that they depict might be subject to existing copyright frameworks. Several high-profile lawsuits have emerged, pitting artists and copyright holders against both issuers and owners of NFTs.

Title and ownership disputes

Another major issue surrounding NFTs revolves around ownership and title disputes. Due to the anonymised nature of the blockchain, it’s crucial to establish a clear chain of ownership for NFTs and disputes can arise when different owners claim rights to the same work or challenge the authenticity and originality of the tokenised asset. These conflicts may require parties to present evidence such as transaction records and timestamps to establish rightful ownership.

Fraud and misrepresentation claims

Various fraud and misrepresentation cases within the NFT industry have highlighted the need for proper due diligence and transparency in transactions.

In 2022, hackers famously got their hands on Family Guy actor Seth Green’s NFTs by using corrupted smart contracts, which, under the guise of a legitimate transaction, seized control of his wallet. He ended up paying almost USD300,000 to recover his stolen tokens.

In some cases, sellers or NFT sale platforms may be accused of misrepresenting assets, providing incomplete or misleading information, or failing to disclose material details about the NFT. Interestingly, the immutable nature of blockchain records has the potential to help victims of fraud as it provides a permanent record of transactions and ownership in a way that isn’t always possible for traditional artwork.

Licensing and royalty disputes

Smart contracts allow for the inclusion of royalties and licensing terms that generate revenue on each onward sale of the NFT. Enforcing these terms can be challenging and can lead to claims from artists that they haven’t received their rightful share of proceeds from secondary sales or that licensing agreements have been breached.

Platform liability and regulation

The liability of NFT platforms for the actions of users has also been subject to scrutiny. Questions arise regarding the duty of platforms to mitigate fraudulent or infringing transactions and whether they have the responsibility to implement measures to protect users. Platforms that fail to moderate content effectively or provide insufficient security measures may find themselves facing legal action, requiring courts to assess the legal responsibilities and obligations placed upon them.