NFTs, Contracts, and Smart Contracts
As my prior post explained, a non-fungible token, or “NFT,” is an indivisible unit of data containing a computerized code verifying it as the only asset with that specific digital identity. In the cyber world, NFTs are described as containing “smart contracts,” which does not mean what attorneys think of when we think of a “contract.” A smart contract is not an offer, acceptance, and consideration, but a collection of code and data at a specific address on the Ethereum blockchain.[1] This confluence of contract law and coding opens up interesting possibilities for the future of NFTs.
For example, a NFT seller can include within the NFT’s smart contract a provision paying the seller a royalty whenever the NFT changes hands. However, because NFTs become less trackable -- or impossible to track -- once moved off the original marketplace, a buyer may be able to defeat the royalty provision merely by moving the NFT to a secondary marketplace site after purchase.
If the buyer moves the NFT off the original marketplace, resells it on a secondary marketplace, and does not pay the royalty to the NFT creator, does that resale violate the NFT “smart contract”? If so, is that “smart contract” enforceable in court? If the NFT is considered art, that favors the buyer, as an art buyer can generally resell purchased art in the United States. If the NFT is considered software, and the smart contract is considered a valid end user license agreement (“EULA”), that favors the NFT author, as a EULA can validly restrict resale. Courts have not yet grappled with this issue, but they may soon. Until the law settles, any cybersecurity attorney handling NFT transfers needs to ensure that there exists an old-fashioned contract governing the sale.
Aside from the enforceability of “smart contracts,” the idea of NFTs as actual contracts is gaining ground. Recently, a San Francisco landlord announced the sale of apartment leases as NFTs that would entitle the buyer to rent a room for $1/month, with a starting price of $300,000.[2] The idea has arisen of an insurance company using a blockchain insurance platform that would store the identity and the necessary permissions to access a policy for its customers in a NFT. In these and other cases, a potential advantage may be the verifiable transferability of the NFT.
A landlord could verifiably transfer a property/casualty policy to a tenant, or a rental car company could transfer an auto policy to a driver. Less charitably, a scammer might be able to illegally obtain the NFT, steal or destroy the insured asset, then collect on the policy.
A NFT coder probably lacks sufficient legal expertise to encode, say, an integration clause or a conflict of laws provision into the NFT’s Ethereum account, which calls into question how enforceable the contract may be. Even assuming legal expertise on the part of the coder, a NFT buyer might not be able to comprehend the code containing the contract’s terms, which calls into question the extent to which the buyer can be bound by a contract that was not comprehensible. All this is to say that, for the foreseeable future, a NFT “smart contract” may add some functionality to old-fashioned contract, but NFT buyers and sellers should not rely on them exclusively.
[1] Ethereum is an open-source, block-chain based, decentralized software platform used for its own cryptocurrency, called ether. See https://www.investopedia.com/terms/e/ethereum.asp. (“Ether” resembles bitcoin, in the same way a euro is like a dollar. https://www.coindesk.com/learn/ethereum-101/ethereum-mining-works.)
[2] https://www.sfgate.com/bayarea/article/05-2021-SF-apartment-leases-nfts-crypto-auction-16147945.php