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Introduction to NFTs
One of the latest trends being built on the blockchain ecosystem are non-fungible tokens (“NFTs”). NFT is a digital token or a certificate having the following broad characteristics:
- represents a digital asset (digital version of artworks, photos, music, videos etc.), which can be transferred from one person to another based on a smart contract (based on the ERC-721 or ERC-1155 (Ethereum Request for Comments 721 or 1155) standard); [i]
- certifies the digital asset to be unique (attributable to underlying metadata), and therefore renders such digital asset to be not interchangeable (unlike a currency which is interchangeable); and
- created on blockchain just like virtual currencies – BTC, ETH, etc., (more commonly on Ethereum using ERC-721 standard) which is a distributed ledger system, rendering the ownership of NFT immutable and thus a more authentic way of representation of ownership.
NFTs as Crypto Assets
NFTs are created on the blockchain technology, akin to other virtual currencies and crypto assets. The popularity of blockchain technology and dealing in crypto assets has grown manifold in recent times. India too has witnessed a heightened interest in this sector, especially from the new age entrepreneurs and investors after the Supreme Court invalidated Reserve Bank of India’s (“RBI”) circular dated April 6, 2018 (“2018 Circular”)[ii] which prohibited banking entities from dealing with or providing services to any person dealing in virtual currencies.[iii] On May 31, 2021, RBI further acknowledged the Supreme Court’s decision and instructed banking entities to no longer cite the 2018 Circular while cautioning their customers against dealing in virtual currencies. Currently there is no law which prohibits dealing in crypto assets. This has emboldened crypto and blockchain enthusiasts to further invest in this sector.
Legal & Regulatory Framework in India
NFTs: Why the Craze?
Since NFTs represent the digital artform which can be uniquely owned and traded later for consideration, one may view NFT as a ‘collector’s item’, the ownership of which is recorded on a blockchain like virtual currencies. However, unlike virtual currencies, NFTs are non-fungible. Since NFTs cannot be duplicated, it makes them rare and unique by design. Buying of NFTs is akin to buying artwork in an auction process, with an indisputable proof of ownership or provenance of the digital artwork.
Popularity of NFT has seen rapid growth in the Indian market during the last few months. An Indian cryptocurrency exchange – WazirX has launched India’s first NFT marketplace. In the absence of a regulatory framework to govern crypto assets in India, legal intricacies surrounding NFTs is a topic of deliberation. This article proposes to draw attention to the legal intricacies and aspects in relation to trading and dealing with NFTs in India.
Legal Affirmation to Crypto Assets
According to the Competition Commission of India, one of the prime reasons for growing enthusiasm around blockchain technology is the impact it can have on currencies, record keeping, sharing of information, contracting and verifying identities.[iv] Despite the mounting interest in this sector, no legislative affirmation is available at present to govern the aspects of dealing in crypto assets such as NFTs or virtual currencies.
It is pertinent to note that the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019 (“2019 Bill”), which proposes to ban mining, generation, holding, selling, dealing, issuing, transfer, disposal or use of private cryptocurrency regardless of its nature creates an exemption for usage of blockchain technology in certain situations.[v] Accordingly, the 2019 Bill carves out an exemption for the use of blockchain technology (distributed ledger technology) for creating a network for delivery of any financial or other services or for creating value, without involving any use of cryptocurrency, in any form whatsoever, for making or receiving payment.[vi] Thus, it can be contended that NFTs may possibly be exempted from the apparent prohibitions proposed under the 2019 Bill, if and when it is enacted. However, this will primarily depend on NFTs not falling under the ambit of the term “cryptocurrency”[vii] as defined under the 2019 Bill. That said, the 2019 Bill may not even see light of the day as there is a new Cryptocurrency and Regulation of Official Digital Currency Bill of 2021 (“2021 Bill”) which has been included by the lower house of the Parliament in its agenda.[viii] Much like the 2019 Bill, the 2021 Bill seeks to allow for certain exceptions to promote the underlying blockchain technology of cryptocurrency and its uses. While we hope that the 2021 Bill resolves certain deep-rooted regulatory uncertainties around the use of crypto assets, it may be too soon to comment on the treatment of NFTs under the 2021 Bill.
From a fundamental aspect and based on the nature of the underlying asset which NFT represents, legalities around the intellectual property rights (particularly the copyright laws) and information technology laws cannot be ignored for analysis of legal rights and entitlements which NFT may carry. Another concern of the Indian authorities is that like other crypto assets NFTs too are traded on exchanges and platforms, which are not recognised under any legal framework. In India, recognized securities[ix] like stocks and commodities are only allowed to be traded on authorized and recognized exchanges and all trading is carried out in accordance with the provisions of the Security Contract (Regulation) Act, 1956. However, NFTs are not classified or recognized as ‘securities’ under Indian law and there is no governmental body or authority that regulates or recognizes the trading platforms on which NFTs are traded.
Copyright law & NFTs
NFT may exist in the form of an independent and unique version of art (like a photo, music or a video in digital form) existing only on the blockchain as a token which merely represents one of the many copies of the underlying artwork, but may not necessarily ascribe ownership of such tokenised asset. For example, an artist who has composed a musical work may create a unique NFT representing such musical work and sell such NFT to another individual. However, such sale does not de facto grant the copyright ownership on the musical work to the NFT holder. That is, by mere ownership of the NFT representing the musical work on the blockchain an NFT holder does not own the rights to publish or distribute or earn royalties from such musical work unless the artist explicitly grants copyright in such work to the NFT holder through a contractual arrangement. Only an owner or a licensee of the artwork is entitled to exercise the statutory bundle of exclusive rights under the Indian Copyright Act, 1957 (“Copyright Law”), which includes the right to reproduce in any form, issue copies, create derivate work, and transfer/assign[x] the ownership of such copyright work.
Assignment of right in NFTs
If NFT represents an underlying original work[xi] of an artist, the artist may assign the copyright in such work either wholly, partially, generally and/ or subject to certain limitations, for a fixed or perpetual term to the NFT holder. Only upon such assignment, the NFT holder would be entitled to the rights related to such original work and accordingly, would be treated as the owner of copyright to the extent of the rights assigned. The Copyright Law requires the assignment of copyright to be in written form and to specify the contractual arrangement between the copyright owner and the assignee.
Licensing of NFTs
A license allows a third person to simply use the work of an artist without any transfer of ownership. Grant of a limited NFT license is more common than NFT assignments due to the flexibility offered in terms of commercialisation of the copyright work tokenised into NFT. The NFT license defines rights and obligations of both – the owner of the NFT as well as the artist(s)/ and creator(s) working on the NFTs. It is common for NFT issuers to grant to the NFT holders a non-sublicensable and non-exclusive license with limited usage rights.
Given that the most important aspect while licensing NFT is the contractual terms of the license, NFTs are usually associated with an underlying smart contract which is again operated and implemented on blockchain. The primary advantage of using a smart contract for NFT is that it allows the parties linked to the NFT (inter alia purchaser, seller, licensee) to enforce the terms and limits the use of copyrights in the NFT, including, proving ownership, providing automatic royalties in case of resale transactions, tracking further purchases, etc.
Under Indian law, an attempt to define Smart Contract has made by the Telecom Regulatory Authority of India as “a functionality of intelligent and programmable code which can execute pre-determined commands or business rules set to pre-check regulatory compliance without further human intervention and suitable for DLT system to create a digital agreement, with cryptographic certainty that the agreement has been honored in the ledgers, databases or accounts of all parties to the agreement”[xii]. Unlike traditional contracts, smart contracts are secure self-executing computer programs. However, akin to e-contracts, the provisions of the Indian Contract Act, 1872 and the Information Technology Act, 2000 will govern their execution and validity in India.
Concerns of copyright infringement
The first assumption while discussing assignment and licensing requirements in relation to NFTs is that the NFT which represents an underlying work product has been created by the owner of the work. However, this assumption may be completely misplaced. NFT of an artwork can practically be created by anyone on the blockchain. This raises serious copyright infringement concerns and accordingly, statutory remedies available under Copyright Law would need to be regarded in such cases.
Section 51 of Copyright Law lays down specific instances under which a copyright in an artwork is deemed to be infringed. Creation or minting of NFT without the due license or permission granted by the copyright owner would certainly lead to infringement under Copyright Law in India, and the owner of such copyright shall be entitled to all civil remedies including by way of injunction, damages and accounts as are conferred by law for the infringement of his/ her right.[xiii]
The adoption of NFT is still awaiting acceptance by masses and in the absence of the same tokening digital art forms and dealing in it is at most a speculative way of making investment by enthusiasts wanting to make quick and early adoption gains. While NFTs may open-up new possibilities and doors to commercialise creations by artists in the exponentially increasing digital economy, especially in the time of Covid-19 pandemic, a lot would depend on acceptance of NFT and digital artforms in the mainstream art and media industry, and actual demand to fetch value of NFT in the longer run. Moreover, since most trades in NFTs as on date are being made by way of bartering virtual currencies being BTC, ETH, etc., (which are yet to receive formal acknowledgement by most jurisdictions (if not all)) by early adopters’ and buyers of such virtual currencies at lower valuations in their inception days, the probability of success of NFTs will be determinable once NFTs will be transacted by exchange of fiat-currencies or upon virtual currencies becoming a formal tender.
From a legal standpoint, it is undeniable that creators and artists are looking to jump on the NFT bandwagon mainly to capitalise on their creations and by exploiting their exclusive right under the Copyright Laws. In addition to the concerns on the aspect of copyright infringement mentioned above, the sale and licensing of tokenised artwork in the form of NFT opens-up for discussion, multiple other legal challenges around its life cycle, including: (a) liability of platform, creator and holder, (b) enforcement of rights of the copyright holder and NFT holder, (c) exhaustion of rights of copyright holder post the first sale, (d) applicability of other laws on taxation, foreign exchange and money laundering.
Mr. Rishi Anand, Partner, DSK Legal
Mr. Nakul Batra, Associate Partner, DSK Legal
[v] Section 3(1) Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019
[vi] Section 3(3) Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019
[vii] The 2019 Bill defines the term Cryptocurrency as – Cryptocurrency, by whatever name called, means any information or code or number or token not being part of any Official Digital Currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes.
[ix] Section 2(h), Securities Contracts (Regulation) Act, 1956. Securities include:
- shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
- units or any other instrument issued by any collective investment scheme to the investors in such schemes;
- security receipt as defined in clause (zg) of section 2 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
- units or any other such instrument issued to the investors under any mutual fund scheme;
- Government securities
- such other instruments as may be declared by the Central Government to be securities;
- rights or interest in securities.
[x] Section 18 of the Copyright Act, 1957.
[xi] Section 2(y) of the Copyright Act, 1957 defines “work” as any of the following works, namely:— (i) a literary, dramatic, musical or artistic work; (ii) a cinematograph film; (iii) sound recording.
[xii] Regulation 2 (bk) of the Telecom Commercial Communications Customer Preference Regulations, 2018
[xiii] Section 55 of the Copyright Act, 1957.