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Everything you need to know about NFT

NFTs stands for non-fungible tokens. They have taken the digital world by storm. We have seen artists and organizations, from Kings of Leon to the NBA, announcing their dive into the world of NFTs. But what exactly are they?

What are NFTs?

To understand what a non-fungible token is, we need to draw a comparison with fungible tokens. Most cryptocurrencies, such as Bitcoin, Ether, Ripple, Ethereum, and Tether classify as fungible tokens, meaning that each token may be replaced or exchanged with another token since every token is the same and capable of mutual substitution. Fungible tokens are also divisible.

On the other hand, whilst NFTs like most fungible tokens are a digital store of value, they shift the crypto paradigm by each being a unique representation of an asset as well as indivisible, meaning they cannot be divided into parts. NFTs cannot be substituted by the same amount of tokens of the same kind. They are unique and each NFT may hold different characteristics and functionalities. The value of an NFT lies in the authentic asset which it represents, making the NFT as rare as the asset itself.

Although the whole NFT concept relies on blockchain technology, the idea of titling an asset has long been present, such as holding a title deed to a house or holding a license to a software. The concept of NFTs is therefore migration of such titles and representation of assets to the blockchain, to facilitate the transfer thereof.

What can be tokenized as an NFT?

Generally speaking, NFTs can either represent a thing or be the thing. Currently, the use of NFTs is mostly being seen in the digital art world where the NFT itself becomes a digital collectible. A digital asset that is being issued as an NFT includes images, videos, sounds, and text. And whilst copies of such content may be downloaded, the authentic content remains that which is encoded in the NFT. One can think of the NFT as an autographed football card. Copies may be printed of it but there will only be that one card which the footballer has signed, and that trading card is what will hold the most value. The value proposition of an NFT, therefore, lies in its authentic uniqueness and scarcity. Before the current hype, these types of NFTs were already being widely used on gaming platforms where the NFT would represent an in-game asset such as a piece of digital land or an in-game weapon. The value of NFTs can therefore range from minimal amounts to selling for millions – think of Beeple’s Everydays: The First 5000 Days NFT which was sold at a whopping $69.3 million.

On the other hand, NFT’s may be used to represent a right in an underlying asset including those in the real-world. The use-cases of NFTs for digital rights management are endless starting with land ownership, tangible artwork, securities, software licenses, and trademarks. Here, we see a link between the NFT and the underlying asset, meaning that what is being represented by the NFT is the right to such asset – it refers to the process of asset tokenization. The aim is to enhance NFT market efficiency, the creation of new forms of investment, and remove intermediaries. At the moment, these types of NFTs are mostly still in a legal limbo especially from a practical point of view.

How are NFTs classified and regulated?

The legal classification of NFTs is not a one-size-fits-all approach. As already noted, there are different types of NFTs ranging from those which are the assets themselves, to those which represent a right in an underlying asset, as well as hybrids thereof. The legal classification of a specific NFT would therefore necessitate an analysis of what that token represents, its characteristics, and what rights are given to the token holder. In general terms, an NFT may be classified purely as an asset itself and possibly also as security.

Subsequently, the regulation of NFT’s will vary depending on the classification thereof as well as the respective jurisdiction where such NFT is being issued from or traded-in. Different jurisdictions may treat the same classes of tokens differently and may also have different classification criteria altogether. It is therefore extremely important for artists, brands, and investors to understand what the regulatory implications are by seeking legal advice in their specific jurisdiction.

What are the regulatory concerns and challenges?

  • Copyright and intellectual property: There are questions on how NFTs can fit in existing IP and copyright laws. The buyer’s perception of what they are buying may not match the legal reality. On the other hand, from a seller’s perspective, it’s doubtful whether every seller is aware if the NFT he is selling is a copyrighted version or the master itself.
  • Formalities for the transfer of ownership and the concept of ownership: In the traditional legal realm, the transfer of ownership in certain assets necessitates formalities in the absence of which, such transfer would be null and void. Therefore, unless existing laws (long-standing ones) are amended to embrace such technological developments, there will still be the need to mirror the trading of NFTs with transfers of ownership in the traditional sense. This raises the question of what efficiency is being achieved in such instances. Moreover, jurisdictional laws distinguish between ownership and possession of a thing. Whilst the two terms are often confused, they both have different legal meanings and effects, which may become more blurred in the NFT world.
  • Consumer Protection: Consumer protection is another impending challenge as many buyers may not know what they are buying and what their rights are. The same goes for the sellers and how far they are aware of their obligations vis-à-vis the consumers. The buy and sell NFT marketplace is becoming increasingly popular with a less-sophisticated audience which makes it essential to have adequate and clear consumer protection laws targeting this new market.
  • Counterfeiting: NFTs linked to a real-world asset may raise the possibility of having the authenticity link between the non-fungible token and the asset is broken. How would the holder of the NFT know that the underlying asset is or will remain the authentic asset that the seller claims it to be?
  • Tax Laws: The tax treatment on the trading of NFTs will also vary on the type of NFT and the tax jurisdictions involved. Whether income tax, capital gains tax, or otherwise is to be charged will therefore rest on a case-by-case analysis.

Should I invest in non-fungible token cryptocurrency?

Non-fungible tokens have become an attractive revenue stream for artists and brands who are jumping on the NFT bandwagon. As with everything, the hype is inflating prices and ridiculous amounts of money are being paid for simple GIFs. This calls for some sensibility on the investor’s side. Whilst, blockchain technology and its applications (including NFTs) are deemed to be here to stay, it’s also wise to note that you may have millions worth of investments in non-fungible tokens which at the end of the day may be lost with a simple mindless act of losing a password. So, whilst this concept is opening doors for great opportunities in both the digital and real-world, as with any new hype, investors should be mindful and seek advice before diving in.

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