What brands need to know before experimenting with NFTs

There are numerous legal, practical and PR issues that brands need to consider before launching any NFT project, writes advertising lawyer Nick Breen.

Whether it’s a pair of digital trainers from Jimmy Choo or a limited-edition digital sandwich from McDonald’s, most people will get their first ever NFT from a recognized brand. This presents a significant opportunity for brands, but brings with it an educational burden. It’s easy to forget that NFTs are a 2021 phenomenon, and many consumers are still very much in the dark as to what NFTs actually are. This leaves brands in an important position of responsibility, and they will need to do some handholding to guide their customers through the journey of NFT ‘ownership.’

The branding dilemma

NFT is Collin’s Dictionary’s word of the year, yet ask your average person what they are and they will likely struggle to explain.

A cartoon image of a cat, a virtual pair of shoes, a real-world diamond, a music album, a ticket to a sports event, a piece of digital art and a virtual plot of land are all examples of items that have been sold as NFTs. NFTs are simply a tool that harnesses the power of blockchain technology, in a similar way to how a website is a tool to harness the internet. The use case, content and application for a website is almost endless, in the same way that just about anything can be tokenized as an NFT.

No NFT project is the same, which only adds to the difficulty of explaining how they work. Yet, with many people buying their first NFT from a brand, brands now have a burden of responsibility to outline exactly what NFT ownership entails and must take particular care in how they describe and market them.

Addressing misconceptions

The most common misconception surrounding NFTs is ownership. The overwhelming majority of NFT projects do not give purchasers ownership in the associated work (eg the underlying image, music).

When you buy a collectible figurine from a shop, you own the physical item and can do what you like with it. You would not acquire any intellectual property rights to the figurine, nor would you expect to. However, when you buy a skin for a character in a video game, you will be granted a limited licence to use that skin in that particular game only, in accordance with a set of licence terms. There is no separate property that you obtain in the skin that is equivalent to the physical property in the figurine.

NFTs are being used to address this distinction between the physical and the digital world by relying on the blockchain to invent an artificial, digital equivalent to physical ownership. This establishes a technological imitation of ownership, but importantly this has no legal basis (for now).

Going back to the digital skin example, if you bought an NFT that tokenized the skin, your right to use that skin has not changed; it will still be determined by a set of licence terms. The difference is that your name (or wallet address) is forever attached to that particular version of the skin in a public, decentralized database, in a manner that emulates ‘ownership.’

Brands that are launching NFTs need to make sure that there is no ambiguity over what is being sold and what rights are being granted to the purchaser. It is particularly prudent to prepare clear, accessible terms of use for the purchase of NFTs and ensure that they are prominently presented to consumers before the purchase. Similarly, when selling to consumers, consumer protection laws will apply, which require brands to avoid unenforceable disclaimers and broad limitations of liability, prepare terms that can be easily understood, provide applicable pre-contract information and consider whether cancelation rights may apply.

Equally importantly, brands will need to carefully choose the terminology used for describing the NFT sale in their marketing materials and in the descriptions given on the NFT platform. In particular, brands should take care not to unintentionally imply that extensive or exclusive usage rights are being acquired in the tokenized work, or that the NFT is one-of-a-kind if subsequent substantially similar editions will later be sold.

Consumer protection and advertising laws require brands to be transparent in their marketing and to avoid misleading consumers. Given the growing number of NFT projects that are launching, it is inevitable that the regulators and watchdogs will start receiving consumer complaints over mis-sold NFTs, and prominent brands will need to pay particular attention to avoid the regulators’ crosshairs.

Uncharted territory

The buck doesn’t stop at ownership. There are numerous legal, practical and PR issues that brands need to consider before launching any NFT project. For example, brands will need to ensure that all intellectual property rights within the underlying asset have been appropriately cleared for the purpose of the NFT, and that the sale of the NFT is accompanied with a prominent set of T&Cs that clearly define the usage rights.

To avoid misleading consumers, brands will need to take care in describing NFTs in marketing materials, and, going even further, they should also consider which layer one or layer two blockchain solution is best for the NFT, as this will feed into the transaction costs for consumers and environmental impact.

Where the utility for the NFT goes beyond being a simple collectible item or piece of digital art, brands should take advice to ensure that the NFT could not unintentionally be classified as an investment product or security. What’s more, if the NFT is being used in connection with a prize promotion, brands should take care not to fall foul of applicable gambling law where the purchase of an NFT could be considered a payment to enter.

The use of NFTs may seem daunting at first, especially given it was only this year that the world was introduced to the new blockchain technology. However, there can be no doubt that in 2022 we will see brands start to explore the vast opportunities that the technology facilitates. This is why getting to grips with the legal issues early is vital and puts brands in the best position to take advantage of these booming developments.

Nick Breen is a partner in Reed Smith’s Entertainment and Media Industry Group, with a particular focus on digital media, music, advertising and video games.