The legal future of NFTs: A conversation with lawyer Mercedes Turnstall

Recent headlines suggest that mainstream brands, digital artists and even Kevin Smith are digging into the world of non-fungible tokens or NFTs.

NFTs are, simply put, unique pieces of data tied to some kind of digital thing, be it a piece of art, a work of music, or, as in the case of Smith, the exclusive right to distribute and stream a movie. 

Indeed, a few months ago, it felt nearly impossible to avoid the topic of NFTs, and recent weeks have seen venture capital firms across the crypto space make investments in some of the services built up around them. But now it appears that while the initial hype activity around digital collectibles has begun to show signs of slowing down, the conversation around NFTs has shifted to a new area: their legal repercussions, not just for creators but also buyers and the marketplaces through which NFTs are sold. 

So what comes next? What entities should be held responsible for regulating the creation and trade of these collectibles? Another pertinent question: is the NFT boom a fad, or are they here to stay? 

The Block spoke with Mercedes Turnstall, a former Federal Trade Commission lawyer and current partner at law firm Loeb & Loeb, to provide some potential answers to these questions. 

What are some of the big unanswered legal questions hanging over the NFT space today?

One of the biggest questions in the NFT space is how it should be regulated and by what kind of regulator. As long as NFTs are being sold or auctioned as collectibles and items, and not as a means to raise money, the FTC is the federal regulator that would have jurisdiction over NFT marketplaces. 

But, NFTs today often have the potential to be worth a good amount of money and typically can only be accessed or sold, auctioned, or traded through NFT marketplaces and NFT wallets. This raises the question as to how to ensure that sellers and purchasers are who they say there are, as well as whether there is a need to make sure that the sellers and purchasers are not engaged in money laundering or terrorist financing by way of transacting with NFTs. These concerns are generally addressed through proper online identity verification and are regulated today by the federal banking regulators and the Financial Crime Enforcement Network (FinCEN) pursuant to the Bank Secrecy Act. 

However, NFTs are not financial instruments – they really are digital products – so, the BSA probably does not apply to the NFT marketplaces where the transactions take place and the federal banking regulators would not have jurisdiction over them, and the FTC does not have presently have authority to compel NFT marketplaces to put into place the kind of customer due diligence and know your customer practices and controls that seem to be called for in the NFT space.

Why are big marketing agencies exploring building their own NFT platforms? 

Advertising agencies are very interested in providing the best protection possible for the brands of their corporate clients, which includes helping them to police their intellectual property (IP).

Most of the generic NFT marketplaces out there provide a basic amount of IP protection that often is not as protective as companies interested in controlling their trademarks and copyrights would prefer. In addition, often the basic amount of IP protection mostly just applies to the initial purchaser of the NFT and not necessarily subsequent purchasers of the NFT.

Some advertising agencies are considering developing custom NFT marketplaces that would provide the optimal amount of protection and control for brands, simply because the agency can then dictate the terms and even go so far as restricting the ability of the NFTs offered on their custom marketplaces from being sold on any other NFT marketplace. This high level of control and IP protection is one of the reasons why certain sports-based NFT marketplaces have been created.

Why is it important for brands to build more contingencies into their smart contracts for NFTs?

Smart contracts are an integral part of minted NFTs and provide the technological means for restricting the copying of NFTs, essentially ensuring that the NFT remains non-fungible. So, at a minimum, every NFT has a smart contract that restricts copies of NFTs to be made by purchasers. 

But, smart contracts can include a whole variety of additional technological functions such as ensuring that a percentage of every purchase flows back to the NFT creator, causing written disclosures to appear to a purchaser when they access the content in the NFT, or even allowing special perks for only certain purchasers of NFTs such as concert tickets to accompany the NFT content. As such, a major brand is often looking to have better protection for its IP than offered by the generic smart contracts the general NFT marketplaces offer during the minting process and will want to put into place stronger smart contracts. 

What legal questions are big brands asking you?

I am often asked about what the worst-case scenario is if everything goes wrong with an NFT. At present, if everything goes wrong with an NFT for a content creator, then potentially the content creator loses control over a portion of their intellectual property rights and must redress violations through legal means. If everything goes wrong with an NFT for a purchaser or seller, then it will mean that the NFT and its related value have been lost somehow. 

I am also asked questions about the underlying connection between NFTs and cryptocurrency and whether there are pitfalls therein. Because NFTs are built on top of cryptocurrencies, this usually means that big brands have to enter into the cryptocurrency market for the first time, either for themselves or by way of someone acting on their behalf. Accordingly, I talk to the brands regarding concerns they have about the fluctuations in the value of cryptocurrency and perceived reputational risks regarding being involved with cryptocurrencies.  

In addition, the big brands are concerned about emerging “best practices” in the NFT selling space – how to make sure that they describe the NFTs appropriately in the initial listing on the NFT marketplace, and what steps they can take to ensure that the NFT is either described properly by subsequent sellers or it is made clear to the purchaser of the NFT that the NFT is being re-sold, thus severing the tie between the representations made regarding the NFT and the brand. And, of course, I have spent a lot of time recently going through the terms and conditions of the various marketplaces, reviewing the generic smart contracts and the applicable privacy policies to help the big brands understand exactly what they are getting themselves into, should they list their NFTs on the relevant marketplace.

Do you think NFTs are here to stay or are they just a fad? 

Right now, NFTs are definitely trending up as something new and exciting for people to acquire and trade. However, the buzz around NFTs is mostly unrelated to the real value NFTs bring to the marketplace.

In other words, right now NFTs are hot and fun, regardless of the benefits they represent. What are those benefits? Basically, for the first time since the internet started to be used commercially, NFTs give content creators (artists, musicians, authors) the ability to absolutely control the ownership of their works and to receive payment for their works each time an NFT is sold. This is because NFTs cannot be copied or shared without the transfer of the ability to access the digital content it holds. In other words, when someone purchases an NFT, they are given a private key that allows them to access the digital content of the NFT. When they sell the NFT, a new private key is created and given to the new purchaser to access the digital content in the NFT, and the previous private key no longer works. Of course, if the NFT contains music or video, the holder of the NFT could “bootleg” the content by recording it and distributing it outside of the NFT, but there are still strong laws on the book that criminalize that behavior.

So, even should the novelty of NFTs die down, I fully expect that content creators will be using NFTs to distribute their works more and more in the future.