Non-fungible tokens (NFTs) are part of the Ethereum blockchain. Ethereum is a cryptocurrency (like Bitcoin), but in addition to supporting the market value of the currency, NFTs have been designed also to store their own totally unique digital information. Although this information could take almost any form – designs, music, serious collectables – by far the greatest application of NFTs so far has been within the art world.

NFTs have enjoyed enormous publicity over the last few months. However, the limelight has quickly turned to notoriety in the wake of several high-profile art scams.

A famous example of NFT art is the Nyan Cat which recently sold for 300 ether (a cryptocurrency) – worth over $500,000 at the time of sale.

NFTs and the art world

There are, generally speaking, three reasons NFTs are proving so popular with artists and collectors:

• the ownership cannot be disputed;
• they can be traded freely on specialist markets; and
• they reduce the likelihood of fraud as the underlying blockchain can recognise counterfeiting.

These benefits are seemingly irresistible to the art world. Not only has historic auction house Christie’s auctioned their first NFT (for an eye-watering $69m), Anthony Pompliano, respected co-founder of Morgan Creek Digital, has also gone on record to say he thinks digital art is already on track to eclipse the physical art market.

There are also benefits for the artist.

They are able to reclaim a lifetime commission from their work rather than just the commission on the initial sale. For example, on the Asynchronous Art platform an artist is paid a 10 per cent commission the first time their work is sold but would then earn a further 20 per cent the second time it is sold. As this is written into the software, it is impossible for the artist to lose out because of oversight or unprincipled practices.

Moreover, thanks to the process of “layer” selling (creating derivative works with different colours or a different perspective), NFTs can offer artists an almost limitless future revenue stream.

And the timing couldn’t be better for digital art.  

The Coronavirus pandemic has meant people can’t go to galleries or museums in person. This means the ability to share works of art digitally whilst being able to track and prove the true provenance of each piece was welcomed immediately. Arriving just in time, NFTs appeared to provide the perfect solution.

NFT fraud

However, where there’s opportunity, there is always threat. The huge sums of money being reported have already captured the attention of highly sophisticated digital scammers.

In March 2021 The Daily Telegraph published an article about David Drayton, the German designer who paid around £43 in cryptocurrency for the ownership of a digital image of a Grecian statue. He quickly found out the artwork had actually been stolen and resold without the knowledge of its creator, Hedi Xandt.

Meanwhile, artist Derek Laufman received several emails and direct messages from fans and contacts asking if he’d started selling NFTs. As he hadn’t, he immediately became suspicious.  It didn’t take long to find someone had set up a fake profile to sell his art on Rarible, a well-known NFT trading site. Even though the site took down the profile upon his request, they weren’t able to remove it before devotees had bought pieces of his work.

While this type of art fraud has rocked the art world, it is certainly nothing new.

In 2018 Terence Eden, a British coder, registered himself as the creator of the Mona Lisa via the blockchain start-up Verisart. Although Verisart viewed this as nothing more than a stunt, it appears to have opened the floodgates for scammers.

There are two distinct types of victims in NFT scams: the artist who is cheated out of their livelihood and the buyer who purchases a piece of art in good faith but under false pretences. What both have in common is the apparent ease with which they can be targeted.

The main problem is any digital object can become an NFT once it has been put – or “minted” – on the blockchain.  As it is very easy to steal images from the internet or social media, it is not difficult for criminals to create their own tokens.  Added to that, verifying identity on trading platforms is hardly a stringent process. This means that as long as you have a wallet and can cover the cost of your first transaction, it is fairly easy to sell any NFT you create.

Despite the speed at which scammers have been able to infiltrate NFT trading, the trading platforms themselves have been slow to react.  

Their security remains lax and the market has repeatedly called for them to take decisive action to provide the security required to convince artists and buyers this way of trading has a future. The outcry for greater security has been compounded by the fact an increasing number of artists have moved away from using NFTs saying they won’t return until the level of accountability and transparency improves.

However, while improved protection will improve market confidence, there is also concern that criminals are already adapting some of the more traditional frauds to NFTs.  

For example, fake wallets are being used to trick the users of several of the leading NFT exchanges into giving up their personal information. This approach has been a mainstay of digital fraud since cryptocurrency became popular but the scammers’ ability to update their tactics to meet the NFT craze unfortunately shows that where there is a will to profit, an illegal way to profit will be found.

Regulation of NFTs

From a legal perspective this is very much a developing marketplace. As such, there is currently little in terms of law or regulation to protect participants.

Some countries like Malta and France are taking steps to implement new laws but in most jurisdictions the picture is much less sure. Some protection may be afforded by existing laws, most notably copyright, but copyright law has never been straightforward.  

In this context, it could be argued that copyright protection was originally designed to be fungible or as copyright experts would describe it, non-rivalrous. There is a non-fungible element to every copyrighted work as each starts life unique, but throughout its lifetime a work of art could be copied, licensed and reproduced in a number of guises even though the original still exists somewhere.

With that in mind, from a copyright perspective can an NFT be considered to be totally original work? Or is it a digitally signed version of the work rather than the work itself? And is there anything currently stopping Ethereum’s smart contracts creating even more unique versions for sale?

These are very much rhetorical questions and at time of writing the answers are still very unclear. Therefore, when NFTs are involved, my advice would be that relying solely on the protection of copyright is probably not a wise strategy.

With regards to contract law, there is a strong possibility the contract law governing the terms and conditions under which a trade is made and/or the website is run will originate from jurisdictions in which it is difficult to challenge the terms.  This challenge will not be made any easier by the fact the terms and conditions themselves have probably been drafted to be complex if not contradictory.

This picture is complicated further by the fact all the information the contract and the terms and conditions pertain to is being held in the Ethereum blockchain. This means the lawyers involved will need to understand both blockchain technology and the differences between a contract and a smart contract. 

Again, this is an area that is still very much in the development stage, particularly given the added complexities introduced by GDPR and the increasingly stringent focus authorities are placing on data protection, not to mention the changes being forced by the continual introduction of new technologies.

Finally, local tax laws should be considered, possibly including taking advice from a local lawyer. After all, if you’ve just purchased an incredibly expensive piece of art, you don’t want to find out you owe a significant amount of sales tax in the wake of the transaction.  

Avoiding NFT pitfalls: practical steps

Until NFTs are governed by a stricter legal and regulatory framework we would always urge our clients to find ways to protect themselves ahead of entering into a transaction.

There are several ways for an artist to protect their work. They can watermark their work, increase the security on their social media accounts and, most importantly, take sole control of the sale of any tokens holding their work.

Traders and collectors should:

1. Always approach NFT transactions with caution and perform as many online checks as possible including reverse image searching the piece on Google. This is not infallible, but it will provide a first warning if a scam isn’t hugely sophisticated.

2. Only use established and well-regarded marketplaces rather than DIY minting platforms that allow anyone to mint their own NFTs. 

3. Do Your Research. You will be safer collecting proven pieces or proven artists. This doesn’t mean you can’t take a chance on something new; it just means you need to do more thorough homework before you do.

4. Be prepared for failure. This is a very new technology so there needs to be an awareness that certain NFT projects will fall through. This won’t be because of the technology or demand, it’s simply because a high risk/high reward opportunity is always a gamble.

Richard Howlett is a founder at Selachii, a fintech, bitcoin and commercial litigation law firm. His specialities include blockchain, digital currencies and smart contracts. Email info@selachii.com. Twitter @Selachii_Legal.

Image NFT mania is here by Marco Verch cc by-sa.