NFTs: A Look at the Art Market’s Newest Trend, Common Misconceptions, and Thoughts on the Future
03/15/2021There has been a lot of buzz—okay, that’s an understatement—about NFT art lately, and it may feel confusing to those who hail from the more “traditional” art world. Here at Grossman LLP, we’ve been intrigued by this phenomenon, and now this post aims to discuss some of the basics about NFTs and some widespread misconceptions about them. We also offer some thoughts on how they may potentially impact the art market going forward.
As you have probably gathered by now, NFT stands for non-fungible token. There are a number of good primers out there on NFTs (see here for one such helpful resource), but in short, an NFT is a unique cryptographic asset linked to an object. NFTs are stored as alphanumeric code on a blockchain, an innovative type of database that creates a digital ledger (a list of records that are linked using cryptography). A blockchain is decentralized, meaning that there is no central computer system or network managed by a central authority; rather, the blockchain is distributed through peer-to-peer networking, which, in theory at least, ensures that past entries cannot be edited.
It’s important to understand that while NFTs may feel brand-new to some, markets for them have been developing for years. The most commonly used blockchain for NFTs is the “Ethereum” blockchain, launched in 2015. And beyond Ethereum, there are already full-fledged ecosystems that are providing the infrastructure for this NFT market, including companies that enable users to contribute or “mint” items to the blockchain; online marketplaces and platforms to engage in commerce around these NFTs (MakersPlace, Rarible, Opensea, and Nifty Gateway are just a few of the players in this space); and companies that provide services related to cryptocurrency, such as digital wallets and cryptocurrency exchanges. Online communities have been playing games involving NFTs for a few years now. Bands have released albums using NFTs. Quirky NFTs have been traded like rare baseball cards among their cult followings (go ahead and Google Cryptokitties and Cryptopunks if you’re curious). And their potential value has been celebrated by celebrities from Mark Cuban to Grimes.
But last week, NFTs formally crossed the Rubicon and became part of the fine art landscape when blue-chip auction house Christie’s auctioned off an NFT of a digital artwork by artist Mike Winkelmann, who goes by the name Beeple—for over $69 million. (The auction was also notable in that it was the first time a major auction house agreed to accept cryptocurrency—in this case, Ether, the currency of the Ethereum blockchain where Beeple’s NFT was minted—to purchase artworks.) The work itself is monumental, made up of 5,000 separate images created over the course of more than a decade, but some have suggested that the staggering price may have been at least in part motivated by the historical significance of the work as the first true intersection between the traditional art world and the world of the internet.
Now, as the dust settles from that massive shock wave, the art world is considering what role NFTs may play in the art market going forward. As we sifted through the conversations, we noticed a number of misconceptions that are worth addressing.
MISCONCEPTION: NFTs are digital artworks that are stored on a blockchain.
The media coverage of NFT art sometimes uses shorthand that conflates NFTs with the assets they represent, such as artwork. But they are not the same thing. As an initial matter, NFTs need not have any relationship to any artwork; for example, an event ticket could be an NFT. When NFTs do relate to digital artwork, the artwork itself is usually not on the blockchain. Rather, the NFT is on the blockchain, and contains code that “points to” and represents the artwork. (See here for more on this.) The artwork itself is stored elsewhere, generally on an off-chain storage site. There may be rare cases where the artwork itself might be stored on the blockchain, and perhaps that will become more common in the future, but right now, this generally doesn’t happen because it would be prohibitively expensive for the artist to put a large file on the blockchain. On many NFT trading platforms, users are responsible for paying for the computing energy required to process and validate transactions on the blockchain. These costs, called “gas fees,” fluctuate constantly based on how much activity is happening. For more on fees associated with NFTs, see here and here.
Another important clarification here is that NFTs need not involve digital assets at all. An NFT could be the digital representation of a traditional, tangible work of art, such as a painting. This representation could be done in various ways; for example, QR code on the back of a painting could link the work to an NFT by providing the original address of when it first entered the blockchain. In fact, Christie’s auctioned off a physical artwork linked to an NFT last fall; see here and here for more on that.
MISCONCEPTION: NFTs are a brand-new kind of art, totally different from anything that has come before.
The breathless excitement over NFTs has sometimes painted them as a totally new phenomenon, a paradigm shift. But NFTs may not be as much of an alien species as you’d think. They in many ways echo artistic concepts that are already familiar to people who have been hanging out in the art world for some time. For example, the idea of scarcity has always been an important component of the art market, driving the market for original art, limited edition prints, and collectibles. Indeed, some NFTs are reminiscent of digital baseball cards, rare books, stamps, or coins—the scarcity and uniqueness are a major component of what makes them valuable. Likewise, the idea of owning a concept as opposed to a tangible chattel is not new; consider art like Maurizio Cattelan’s banana duct taped to the wall, or Dan Flavin’s lighting art, where replacement parts can be purchased at your local hardware store. Some aspects of the NFT market also echo longstanding dynamics in art and culture generally; specifically, they play on the idea that being a provably early adopter of something that later becomes “cool” has value in and of itself. (In an intriguing cultural side note, one observer has mused that the pandemic-prompted lockdowns perhaps fueled interest in NFTs as a way of engaging in conspicuous consumption during a time period when fewer people are able to see your fancy watch, your expensive car, or your designer handbag. As our lives have increasingly moved online, this seems like a logical extension.)
NFTs are also not brand-new in a temporal sense. It may feel like they’re bursting onto the fine art scene rather suddenly, but they have been an important and growing business in other arenas, including online gaming, sports, and entertainment. (The NBA sells NFTs representing “moments” of NBA games via its “NBA Top Shot” system, and stores those NFTs on a proprietary blockchain; since its advent in mid-2019, it has generated more than $200 million in revenue.) What this means is that there is already a category of “collectors” of NFT who are familiar with the technology, dynamics, and culture of these ecosystems—they just may not be the usual “collectors” who have been active in the more traditional art market. For example, at the Christie’s Beeple auction, out of the 33 active bidders, over 90% had never bid at Christie’s before, and more than 60% were under age 40 (likely digital natives who have grown up paying for purely-digital products). The corollary, of course, is that anyone from the “traditional” art world who is interested in NFTs would do well to spend some time making sure you understand the lay of the land, which includes not just the NFTs themselves, but the various marketplaces and how they work, how to use cryptocurrency and digital wallets, and other aspects of the systems, environment, ethos, and culture in which these artworks are being traded.
MISCONCEPTION: When you buy an NFT, you control the original artwork.
Digital art can take many forms, including an image file like a JPG, a 3D file, a music file, an animation, a video. (Someone recently bought an NFT for a GIF of an internet meme called NyanCat—for the equivalent of over half a million dollars.)
But when you buy an NFT, you don’t own the only copy, although you possess what might be thought of as an “original,” with an immutable record to prove it. For example, the buyer of Beeple’s work at Christie’s receives the NFT; the address of the token attached to the transaction on the Ethereum blockchain is placed in their digital wallet. The buyer will also receive a high-resolution JPEG of the work. But there is nothing to stop others from saving images of the artwork to their own desktop. (For more on this, see here.)
Another important aspect of “owning” an NFT is that—as with most art sales—when you buy an NFT, you are generally not acquiring any copyright or intellectual property rights in the work itself. Unless a contract says otherwise, those rights remain with the artist. When you buy a Keith Haring painting, that does not give you the right to make and sell shirts with images of the painting on them; the same goes for when you buy an NFT of a digital artwork. That said, some NFTs do grant their owners a license to do certain things with the underlying asset, but the contours of those rights will depend on the specifics of the contract. (For more on that and other IP issues raised by NFTs, see here.)
MISCONCEPTION: NFTs are a form of cryptocurrency.
NFTs are not cryptocurrency, although they are related to them in certain ways. NFTs, like cryptocurrency, run on blockchain technology; in fact, blockchain technology was developed to support cryptocurrency, and only later began to support other use cases. And because NFTs are primarily being minted on the Ethereum blockchain, many NFT art transactions involve Ether, which is the native cryptocurrency of the Ethereum platform.
Further, NFTs are linked to cryptocurrency as a matter of culture. The NFT market arose out of and has been shaped by internet culture. And it’s possible that the current NFT boom is in some ways a product of the rise in cryptocurrency; some people have recently watched their cryptocurrency holdings increase dramatically in value, and are now investingsome of those gains in NFTs, with prices for NFTs driven up by these investors’ sense that they are “playing with house money” as well as a sense that they would like to keep those gains within the blockchain ecosystem, as opposed to converting them to fiat currency and investing in more traditional forms of assets.
But NFTs are not cryptocurrency; each NFT is unique and non-fungible, as opposed to fungible assets where one Bitcoin, one dollar, or one share of Apple stock is interchangeable with any other.
MISCONCEPTION: NFTs are fraud-proof.
Much has been made of the fact that NFTs, due to their blockchain technology, have the advantage of providing a clear record of a work’s title and provenance. This can, for example, permit a potential buyer to confirm that they are buying a genuine work from the true owner—a clearly attractive prospect given the current art market, in which title and authenticity problems are sadly common.
But that doesn’t mean NFTs are immune to scamming and fraud. For example, some artists have discovered that an NFT has been minted against their art without their consent—an unauthorized NFT. Here, the blockchain does not prevent the copyright infringement, which occurred before the NFT was created.
MISCONCEPTION: NFTs allow collectors to stay totally anonymous.
Blockchain is a bit paradoxical when it comes to anonymity. It is anonymous in the sense that one’s personal identity does not appear on the blockchain; rather, users generally have an address that does not reveal anything about their identity. So if you were to buy an NFT from another collector, you could be sure you were purchasing from the correct person—the real holder of the NFT—but you would not necessarily know who that person is.
On the other hand, every transaction involving a given address is stored in the blockchain and is publicly available. If your address is ever linked to your identity, every transaction you’ve engaged in using that address could become publicly linked to you.
Also, because NFT art transactions often involve cryptocurrency, users often have to use exchanges, such as Coinbase, to convert currency. And there are often anti-money-laundering policies involved at these exchanges, which can, in some cases, connect addresses to real-world identities.
Overall, it remains to be seen how NFTs will interact with anti-money-laundering systems, which are becoming an increasingly hot topic in the art market given recent governmental scrutiny. Blockchain technology may pose both challenges and opportunities for parties who need to abide by anti-money-laundering regulations and policies.
Finally, in case you’re curious, here’s what we know so far (as of this writing) about the buyer of the Beeple work, who has apparently come forward of his own accord—pseudonymously.
MISCONCEPTION: NFTs always entitle artists to resale royalties.
In the traditional art market, artists make most of their money by selling a work for the first time after its creation (sometimes called the primary market); but the artist generally does not get any direct financial benefit from secondary-market sales (i.e., when the work changes hands in later transactions between collectors). The issue of resale royalties has been much-discussed in the art world— see here and here for more on how music producer and art collector Swizz Beatz has been advocating for contracts providing for resale royalties as a way of addressing inequity in the market, or here, for coverage of California’s ill-fated attempt to create a state-law resale royalty mechanism.
Now, NFTs are touted as artist-friendly, giving artists more agency and autonomy through greater control of marketing, distribution, and especially resale royalties. Thanks to “smart contracts” on the blockchain, an artist can specify that, when an artwork changes hands on the secondary market, a percentage of the sale automatically and immediately goes back to the artist in the form of a royalty (no collection efforts needed). The artist must stipulate the royalty during the process of creating, or “minting,” the NFT. That said, it’s also important to understand that the royalty mechanisms vary between marketplaces, and often do not transfer between marketplaces. This means that if an artist mints and sells an NFT, opting to include a royalty provision, on one marketplace, the artist will receive the royalty as long as future secondary-market sales happen in that same marketplace, but if a collector eventually chooses to sell the NFT on some other marketplace, the artist will not receive the royalty. (For more on this, see here.) In other words, at this writing, this much-vaunted newfound agency afforded to artists by the blockchain is really only as deep as the marketplace—the layer over the blockchain.
We are lawyers, not fortune tellers, so we will not venture a guess as to how long the current excitement and astronomical prices will continue. But we offer a few thoughts on how the current NFT craze may have longer-term reverberations in the art market.
First, as a general matter, the last few months seem to signal that NFTs and cryptocurrency have reached the mainstream of the art world. The first major exhibition of NFT art is happening in Beijing later this month. Beeple himself recently predicted that, while there may be individual projects that are overhyped and creating a “bubble,” the overall concept is sound and not likely to go anywhere. With these developments come a host of questions for the art market. For example, as discussed above, while NFTs may feel novel to some of us, there is already an established market for them, complete with various intermediaries and marketplaces providing the infrastructure for these sales, whether that means companies that focus on minting NFTs, platforms for buying and selling NFTs, or companies that provide services related to cryptocurrency, like digital wallets and cryptocurrency exchanges. The traditional art market will increasingly have decisions to make about how much to interact with, and compete with, those ecosystems. Will auction houses and dealers begin regularly accepting cryptocurrency, with all the complexity that entails, from volatility to tax implications? (While Christie’s accepted Ether for the Beeple sale, it has not indicated it plans to accept cryptocurrency in future sales generally.) As known artists begin to work in new digital mediums, will they turn to traditional galleries and auction houses, or move to other venues, including the thriving online marketplaces for NFTs? The potential implications for collectibles markets are also significant; see, for example, Nike’s recent plans for CryptoKicks, which contemplates using blockchain to link an NFT to the physical product of a collectible sneaker, or a project linking an authenticated Rolex watch to an NFT.
Second, artists will be considering the opportunities and perils of this technology. At least some “traditional” artists (or their estates) will begin considering how NFTs might be useful in relation to existing, tangible artworks, for which blockchain technology can create a clean and reliable record that may help avoid title, provenance, and authenticity disputes down the road. At the same time, artists of all stripes will need to also protect their copyrights in their existing works, given the clear risk that unscrupulous actors may seek to create unauthorized NFTs for artwork created by others.
Third, NFTs will likely raise the profile, importance, and value of digital art. By nature, digital art is easily copied, and the copies are essentially undistinguishable from the “original.” But NFTs, through the use of blockchain, solve the problem of how to make a digital asset “scarce.” Thus, NFTs have the potential to shape the market for digital art by ensuring scarcity of a work. NFTs also can potentially change the market for artworks that are sometimes ephemeral, such as performance art and street art; a video of a performance or a photograph of a street mural can be immortalized (and owned) via a unique NFT even after the performance is over or the street art whitewashed away. And as digital art becomes more important, it will be interesting to observe how people interact with and experience it. With digital art, some collectors may be more likely to buy an item if they can enjoy it themselves or even show it off to others, whether in a virtual or a real-life space. For example, in an earlier release of some of his NFTs, buyers received a frame that displayed the art. In another example, last month, artist Andres Reisinger sold ten of his digital furniture designs, verified by NFTs. Five will eventually also be manufactured in real life and sent to the buyer, while the other five exist only digitally. In all ten sales, buyers received the NFT “along with a 3D model in GLB/GLTF—the file format described as the ‘JPEG for 3D’—compatible with any virtual reality app.” Of course, some digital art may be simply collected and resold, with minimal aesthetic experience involved. But the same is true of more traditional forms of art; consider the difference between a collector who hangs their beloved art on the wall of their home, ponders it, and enjoys the aesthetic experience, versus a collector who parks their art in a crate in a specialized warehouse or freeport where no one sees it until it’s time to sell it.
Fourth, we anticipate that NFTs could change the conversation around longstanding challenges for the art market, from resale royalties to fraud prevention, from due diligence to anti-money-laundering. (See here for one thoughtful look at NFTs’ potential to influence some of the major problems faced by the traditional art market.) There are also important conversations already happening regarding issues such as diversity in the NFT space (see here) as well as the environmental impact of NFTs (see here). There’s no doubt that NFTs could be applied in ways that allow for some creative legal problem-solving.
Overall, putting the hype aside, NFTs offer a myriad array of pitfalls and opportunities, and we look forward to watching and being part of those conversations.
Art Law Blog