In the last few years, there has been much talk about the development of the “alternative investment” space. At one level, alternative investments have been touted as new tools for wealth structuring and, at a basic level, the “democratisation” of investment products with the offer of greater choice for the average investor. Indeed, in the last year much attention has been focused on a specific “alternative investment”: non-fungible tokens (NFTs).
Alternative investments in the digital space can mainly be understood in two ways. An investor could be purchasing or selling a conventional asset through less conventional alternative platforms, or an investor could also be purchasing or selling a recently created alternative asset that is unconventional to begin with.[i] The emergence of popular alternative platforms and assets increases accessibility to more diverse investment and financing options for investors. In this article, we will focus on NFTs, a form of newly created alternative asset.
Fundamentally, NFTs are blockchain-based digital tokens, the majority of which currently reside on the Ethereum blockchain.[ii] The distinguishing characteristic of an NFT is that each NFT possesses a unique identifier, thereby providing it the characteristic of non-fungibility. A common mechanism of achieving such non-fungibility is to feed unique data through a cryptographic algorithm which in turn generates a unique identifier, such that any alteration of such unique data would generate a different identifier.
The key advantages of NFTs, arising from their non-fungible nature, include:
Flexibility — almost any data can be encrypted in the form of an NFT; accordingly, an NFT may be attributable to anything, whether tangible or intangible property, or items not conventionally considered property at all, such as collectible “moments” or tweets.[iii]
Guarantee of Title — NFTs can serve as unique digital representations attributable to property (whether tangible or intangible). In other words, the holder of an NFT attributable to property X would have title, at least prima facie, to property X or a part thereof.[iv] Such representation of purported title cannot be replicated[v].
Resistance to fraud — as the verification of each transaction would take place on the blockchain through multiple nodes, records kept on the blockchain would generally be resistant to tampering and fraud. This includes records of ownership of the NFT and records of the originator of the NFT.[vi]
Market efficiency — transacting on the blockchain would also remove the need for intermediaries to verify the authenticity of the transaction, the involvement of which may otherwise be expensive and time-consuming.
Extensibility — conceptually, it would be possible to combine one NFT with another to “breed” a third, unique NFT.[vii]
The key drawbacks of NFTs include —
Dependence on the hosting blockchain — the integrity of the use case of an NFT depends largely on the ability of each NFT to guarantee its token-holder’s title to the underlying item. As a practical matter, this would depend to an extent on the blockchain which hosts the NFT. Although certain popular NFTs are also found on more “permissioned” blockchains (i.e. more centralised blockchains), David Z Morris, writing for Fortune.com, notes that “the downside is that more centralized chains may be more vulnerable to decay in the long run, and in very broad terms may provide a weaker guarantee of digital ownership”.[viii] Generally speaking, therefore, the more centralised the blockchain which hosts the NFT, the weaker the characteristic of non-fungibility.
Lack of certainty on legal position — it remains unclear how different jurisdictions will regulate NFTs and how an NFT’s purported guarantee of title will be recognised (if at all).
Guarantees of title to artwork, real property, etc.
NFTs may be attributable to high-value property, such as artwork and real property. Specifically, the use cases of NFTs in relation to such high-value property seek to capitalise on two advantages which arise out of the characteristic of non-fungibility — (1) retention of value; and (2) removal of intermediaries.
Retention of value
We would note that, although the guarantee of title may be in respect of both tangible and intangible property, the NFT’s use case in respect of intangible property, specifically digital property which can be replicated and disseminated with ease, appears to be more valuable. Where the use case of the NFT is related to digitally-disseminated creative property, it would appear that the characteristic of non-fungibility is integral to the maintenance of the value of the underlying property itself. In other words, the dissemination of a digital asset by way of an NFT prevents the dilution of the value of such an asset, which would otherwise take place by digital distribution.
In particular, we note the following examples of how value of underlying digital assets are retained by use of an NFT —
(i) Although the album itself is slated for distribution on conventional channels—such as Spotify, iTunes, Apple Music, Amazon—specific NFTs corresponding to unique digital assets will be issued accompanying the release of the album.
(ii) One specific example of the digital assets to which such NFTs would be attributable are “18 unique-looking ‘golden tickets’ […] Out of the 18, the band will auction six and vault the other 12 like a painter would do with a rare piece from a series of art. […] Each [‘golden ticket’] is a unique NFT with the most incredible Kings of Leon art you’ve ever seen”.
(iii) It has also been stated that such “golden tickets” would also unlock —
(a) an actual concert ticket, guaranteeing four front-row seats to any Kings of Leon concert during each tour for life;
(b) a VIP experience that includes a personal driver, a concierge at the show to take care of their needs, a hangout with the band before the show, and exclusive lounge access; and
(c) four bags filled with every item from the merchandise booth.[xi]
(iv) While it appears to be the case that there may be more than one NFT issued in respect of similarly packaged digital assets (i.e. there are 18 ‘golden tickets’ of the manner described above to be issued), it would appear that the characteristic of general non-fungibility is retained, to the extent that the distribution of such “equivalent” NFTs remains exclusive. In addition, the records of ownership and origination, which are a consequence of NFTs being transacted on a blockchain, permit the issuer of the NFT to programme, via smart contract, the dissemination of proceeds from the resale of NFTs to the issuer of the NFT (i.e. the artist), or even a charity.[xii]
Removal of intermediaries
NFTs may also assist in keeping costs of such transactions down by removing the need for various intermediaries who would otherwise be interposed in the transaction of the underlying asset.
In specific relation to artwork, whether physical or digital, transaction by NFTs would likely remove the necessity for intermediaries which would otherwise play a role in advertising, or otherwise publicising such artwork, as well as determining the authenticity and origin of such artwork. While intermediaries such as art consultants may still be valuable in assisting their clients with the decision to purchase the NFT associated with the artwork in the first place, the cost of the NFT is not affected by factors external to the intrinsic value of the artwork, such as art appraisal.
In specific relation to real property, transaction by NFTs would likely remove the necessity for intermediaries which would otherwise play a role in determining good root of title or conducting inspections in relation to and legal requisitions on the property. Owing to the flexibility of the data which can possibly be included in NFTs as mentioned above, it would be possible for data concerning the minute details of real property to be included in the NFT by cryptographic hash.
NFTs may be attributable to specific products for the purposes of tracking their movement through the supply chain and assisting actors throughout the supply chain in interacting and transacting with it. LaVis, one of the largest Italian wine producers, has worked with EY Ops Chain to produce an NFT which captures data “during each stage of the wine making process, using a mix of manual records and automated tools like drones and Internet of Things (IoT) technology, and recorded into a blockchain. Furthermore each time the bottle moves – between producers, brokers, importers, wholesalers, distributors and retailers – the status of the bottle is also updated on the blockchain.”[xv]
Increasing liquidity for investment
Where multiple NFTs are issued in respect of a single underlying property, particularly property which would otherwise be relatively illiquid (such as real estate and artwork), such NFTs could serve the function of increasing liquidity for investment in such assets.
A key characteristic of NFTs is their extensibility, i.e. the ability to integrate different NFTs together and tokenising assets which would otherwise be separable.
A primary use case for such extensibility is video-game development. Third-party developers may build NFT assets which may be integrated with other developers’ assets on the blockchain. Such NFT assets could include, for example, video-game weapons, apparel, or characters, which may be stored in NFT wallets and used in games hosted on the blockchain (e.g. CheezeWizards[xvi] and Cryptokitties[xvii]).
Financing in relation to multiple underlying items of property
The key advantages of NFTs may also permit the integration of NFTs, representing different property, for the purposes of a financing transaction. The value in such a use case derives from simplifying the process of the authentication and verification of the documentation associated with a financing transaction by integrating NFTs associated with each contract or asset (as the case may be) into a single token which may be easily bought, sold, assigned, novated, and so forth, depending on the nature of the specific transaction.[xviii]
While the use cases for NFTs are promising, it remains to be seen whether NFTs will catch the imagination of the wider public and how the legal regulatory treatment of NFTs in different jurisdictions will develop.
[i] Claudia Chong, “New ways to make money: The alternative alternative assets” Business Times, dated 31 October 2020, accessed 17 March 2021 at https://www.businesstimes.com.sg/brunch/new-ways-to-make-money-the-alternative-alternative-assets.
[ii] David Morris, “Are your NFTs on the wrong blockchain?” Fortune.com, dated 10 March 2021, accessed 12 March 2021 at https://fortune.com/2021/03/10/are-your-nfts-on-the-wrong-blockchain/.
[iv] The phrase “a part thereof” references the possibility of one NFT representing a fractionalised unit of property which would otherwise be indivisible; e.g. person A could hold 1 NFT, entitling him to 10 per cent of the Mona Lisa.
[v] The immutability of the NFT itself and its mechanics is not in question – however, it is the link to the actual content of the property itself that is of current debate. In other words, the holder of an NFT attributable to property X is entitled to property X as it is represented by the digital metadata on the blockchain (separate from the NFT itself); however anyone that has access to property X (physically) or the metadata that represents property X to which the NFT gives purported title to, may be able to alter property X itself.
[vi] An NFT of Guernica, for example, would contain a record of its originator, Pablo Picasso.
[vii] Investopedia, https://www.investopedia.com/non-fungible-tokens-nft-5115211; although rather technical, see also https://dl.acm.org/doi/10.1145/3366611.3368142.
[ix] Palumbo, “First NFT artwork at auction sells for staggering $69 million” CNN, dated 12 March 2021, accessed 12 March 2021 at https://edition.cnn.com/style/article/beeple-first-nft-artwork-at-auction-sale-result/index.html.
[x] The tokens may be purchased on https://www.yellowheart.io/; Hissong, “Kings of Leon Will Be the First Band to Release an Album as an NFT”, Rollingstone.com, dated 3 March 2021, accessed 12 March 2021 at https://www.rollingstone.com/pro/news/kings-of-leon-when-you-see-yourself-album-nft-crypto-1135192/. See also https://www.wsj.com/articles/nfts-explained-whats-driving-prices-for-lebron-james-and-kings-of-leon-digital-collectibles-11615205133.
[xii] This latter option is explicitly canvassed by Samantha Hissong (n 8) in conversation with Josh Katz, CEO and Founder of Yellowheart.io, the blockchain which hosts the Kings of Leon NFTs.
[xiv] The Verge, “Jack Dorsey’s first tweet may fetched US$2.9 million, and he’ll donate the NFTy proceeds to charity”, Theverge.com, dated 9 March 2021, accessed 12 March 2021 at https://www.theverge.com/2021/3/9/22321464/jack-dorsey-nft-tweet-auction-bitcoin-donate-charity.
[xv] EY, “Restoring trust in the wine industry, from grape to glass” EY.com, accessed 12 March 2021 at https://www.ey.com/en_za/global-review/2018/restoring-trust-in-the-wine-industry.
[xviii] Medium, “Business NFTs — Financial Business Documents As Tokens On Decentralized Networks”, Medium.com, dated 18 July 2018, accessed 12 March 2021 at https://medium.com/centrifuge/introducing-business-nfts-financial-business-documents-as-tokens-on-decentralized-networks-ec4b773f7ec5.
Adrian is Co-Head of Allen & Gledhill’s FinTech Practice, and Co-Head of Allen & Gledhill’s Public Policy Practice. Adrian has been active in the FinTech sphere, contributing to policy formation and enactment of FinTech-related legislation. He has advised on a variety of FinTech models including payment services such as e-wallet providers, merchant acquirers, equity and debt crowdfunding platform, transfer systems, online payment system providers, robo-advisers, initial coin offering structures, security token exchanges and digital payment token exchanges. Adrian is recommended as a key practitioner in several leading publications including Chambers Global, Chambers Asia-Pacific, Chambers FinTech, The Legal 500 and Who’s Who Legal.
Alexander Yi Fong
Alexander is a Practice Trainee in the Fintech and Financial Regulatory Practice at Allen & Gledhill LLP, which advises clients ranging from established financial institutions to small-and-medium sized enterprises on financial regulatory matters, including licensing and prospectus registration considerations, as well as regulatory implications surrounding the provision of payment services, the distribution of financial products, fund management activities, outsourcing arrangements and conduct of business requirements applicable to regulated entities. Alexander has published articles for the Cambridge Law Review relating to the law and regulation of digital tokens, covering issues relating to the adoption of standard taxonomy in the regulation of digital tokens, as well as rights of property in digital tokens.
Melody Hoay Hong Leng
Melody is an Associate in the Fintech and Financial Regulatory Practice at Allen & Gledhill LLP. Her areas of practice encompass capital markets, banking, financial advisory and payments work in Singapore. She has experience in advising traditional financial institutions, international organisations, technology conglomerates and start-ups on regulatory and compliance matters in respect of their business models, conduct of business requirements, regulatory filings and corporate acquisitions. In particular, Melody has advised on a variety of FinTech payments and fundraising models, and cryptocurrency trading and exchange businesses.