NFTs derive their name from the concept of fungibility because, unlike cryptocurrencies, they are not fungible. NFTs are completely unique and cannot be changed, removed, or destroyed because, similar to Bitcoin, the data of an NFT is stored in blockchain, an immutable and decentralized digital ledger used to record transactions on a peer-to-peer network. The technology behind NFTs offers a very valuable asset as an asset, the verification of authenticity. Each NFT contains data that distinguishes it from other NFTs, and such data cannot be replicated. Hence, replicating NFTs is unsuccessful as each NFT can be traced back to the original issuer using the blockchain. The ability to trace an NFT back to the original creator eliminates the need for third-party verification, increasing efficiency and reducing overall costs.
The vast majority of NFTs are based on Ethereum, the decentralized open source platform that uses blockchain technology to create and run decentralized digital applications (DApps) that can be used to create smart contracts. Ethereum enables the use of token standards, a form of blueprint that developers can use to create NFTs while ensuring that the NFTs are compatible with platforms, exchanges, and wallet services currently in the blockchain ecosystem. However, other platforms like Neo and Tron have published their own NFT token standards that developers can use to create and host NFTs on their blockchains.
The adoption of NFTs
NFTs are being introduced in many industries, but the most popular introduction is in the entertainment industry. In cooperation with the blockchain company Dapper Labs 2019, the NBA launched NBA Top Shot, an NFT marketplace for NBA highlight roles. NBA Top Shot allows individuals to buy and sell NBA highlight reels or other moments. Since its inception, Top Shot has had sales of more than $ 300 million. A single video clip of a LeBron James Dunk sold for over $ 200,000. This bold move by the NBA could be the catalyst for other sports leagues. We’ll likely see similar marketplaces for the NFL, MLB, and more. Similar marketplaces could also be adopted by other entertainment companies like Disney, which has a wealth of intellectual property that it could use in such a market.
Artists also rely heavily on NFTs. NFTs provide the ability to sell works of art in reviewable digital form directly to consumers worldwide without the need for an auction house or gallery. By removing such intermediaries, artists can retain a greater percentage of the profits from a sale. Claire Boucher, a musician and artist also known as “Grimes,” recently sold her collection of digital works of art for $ 5.8 million in NFTs on a virtual NFT marketplace called Nifty Gateway. Digital artist Mike Winkelmann, better known as Beeple, recently sold his NFT digital art collage “Everydays: The First 5,000 Days” for over $ 69 million at auction. Although this sale was facilitated by an auction held by Christie’s, a traditional broker, Christie’s involvement could be a pivotal moment in validating NFTs. Another reason artists are drawn to NFTs is the impact they have on royalties received. Typically, artists do not earn royalties on future sales of their work. However, NFTs can be programmed so that the creator receives a set license fee every time their digital artwork is sold to a new owner. For example, Mike Winkelmann receives a 10% royalty every time his NFT is sold after that first sale.
The music industry is also adopting the technology. The band Kings of Leon recently released an album in the form of an NFT on OpenSea, a marketplace for NFTs similar to Nifty Gateway. Steve Aoki, 3lau, Ozuna, and others like the Kings of Leon all capitalize on the technological innovation that NFTs bring to the industry.
- Potential intellectual property law issues are likely to arise as NFTs gain popularity. Typically, when a person purchases an NFT, that person is granted the right to use the copyrighted work (ie, image, video, or other form of media) displayed by the NFT for personal consumption. The person generally does not expect to use the NFT and the works presented for any commercial purpose other than reselling the NFT. However, it is important for NFT marketplaces to design and present their terms and conditions in such a way that this is legally sufficient.
- Selling NFTs has income tax consequences. Both NFTs and cryptocurrency are treated as taxable property. For example, if a person buys an NFT using Ether, the cryptocurrency that Ethereum runs on, that person will have a tax liability on any capital gains on the Ether (whether short-term or long-term) since the IRS will tax cryptocurrency as property. The same person also has a similar tax liability on capital gains from the sale of the NFT itself (whether short term or long term). In addition, NFT versus NFT exchanges would be chargeable events. There is a separate tax bracket for “collectibles” which has a higher maximum capital gain rate than other assets (28% versus 20%) that might apply to the sale of certain NFTs. It is always advisable to seek advice from a tax advisor on NFT transactions.
- NFTs can have significant value and are increasingly becoming an inheritance. The lack of a legal structure and existing rules for NFTs requires the inclusion of specific provisions and instructions in estate planning documents. NFTs add a complex twist to estate planning in terms of understanding where and how NFTs are stored, and how they can be legally transferred from one person to another by a will, trust, or other legal instrument.
- NFT companies must be wary of the risks of being treated as a money transmitter as money transmitters are subject to anti-money laundering laws and assessments. The Financial Crimes Enforcement Network (FinCEN) has provided guidelines that a company can be considered a money transmitter when it accepts or transfers convertible virtual currency, or when it sells or buys convertible virtual currency.
- NFTs could potentially be subject to scrutiny by the Office of Foreign Assets Control (OFAC) and the US Sanctions Act, preventing US citizens and citizens from doing business with individuals or organizations from sanctioned countries.
Some are wary of NFTs and delve into the speculative nature of this technology, but there is no denying that the trend of decentralization has put this technology in the spotlight and opened up a new avenue for participants in various industries to pursue untapped markets. This disruptive technology will be preserved and will grow immensely with mass acceptance.