United States: Legal Considerations for Launching A Non-Fungible Token (NFT) Marketplace

Westlaw Today | Catherine Zhu and Louis Lehot of Foley & Lardner LLP | March 19, 2021

Want to launch a new NFT marketplace? Here’s what you need to know.

 
While the initial coin offering (“ICO”) craze of 2017-2018 fizzled out in the face of government enforcement actions, a new resurgence in the global market for bitcoin and a new category of non-fungible tokens (“NFTs”) are fueling a recent boom in digital assets. This post will attempt to sketch out a legal guide to NFT’s and legal tips for launching an NFT marketplace.
 

What are NFT’s and how are they different from other blockchain-based assets?

 
NFT is an acronym for “non-fungible token.” Using blockchain technology, an NFT can be “minted” to document digital ownership of an underlying physical or digital asset and constitutes a unique certificate of authenticity.
The blockchain provides the protection and transferability enabled by distributed ledger technology. Representing anything from tweets to real estate — NFTs are ultimately digital collectibles. NFT’s are different from other blockchain-based assets like Bitcoin, Ether, and stablecoins that are identical, interchangeable, and ultimately fungible. This is because NFT’s represent non-fungible, divisible, and transferable pieces of ownership in distinct assets.
 
While many NFT’s are issued on the Ethereum blockchain, new NFT-focused protocols are being launched independently of more extensive networks. NFT marketplaces are mushrooming to process purchases and sales of these assets and to enable peer-to-peer transactions.

What is fueling the boom in NFT marketplaces?

Lately, we have seen a spike in the popularity of NFTs as mainstream interest increases. In fact, in just 48 hours last month, internet celebrity Logan Paul made over $5 million selling NFTs, while musician Post Malone invited fans to play beer pong with him if they bought an NFT. And recently, Christie’s became the very first major auction house to offer a fully digital work.
 
A few days ago, it sold1 a Beeple piece, “Everyday: The First 5000 Days,” for a record-breaking $69 million, making the creator of the work one of the top 3 most valuable living artists. Finally, the 10x increase in the price of Bitcoin over the past year has aficionados of the digital currency looking for new ways to diversify their holdings.

Essential legal documentation needed for launching an NFT marketplace
This article will cover some common legal considerations when launching an NFT marketplace, including documentation you need, intellectual property and other legal considerations, as well as overarching legal implications of this new technology.
 
Company formation. If you are launching an NFT marketplace, it’s highly recommended that you form a corporate entity first. Having a corporate entity will offer the strongest liability protection for business owners and shield your assets from business obligations. Having a corporate entity will also give you greater ability and credibility to seek financing from external sources and more flexibility to accommodate growth. To avail yourself of these benefits, your company must be correctly formed and registered.
 
Terms of service. Your terms of service (also known as terms of use, terms, conditions, etc.) are essential legal documents and serve as the governing legal contract between you and your users. A well-drafted set of terms of service will protect the company from liability with respect to your users and will include provisions such as disclaiming any warranties towards users, limiting the company’s overall liability, setting up an indemnification framework to cover your company, and implementing an arbitration process in the event of any disputes.
Putting these protections in place is especially important for NFT marketplaces. In contrast to SaaS or other digital products, where the company directly provides a service to its users, NFT marketplaces typically consist heavily of content created by users and interactions and transactions between users.
Therefore, there is a higher likelihood where misconduct by one user negatively impacts another user. In that situation, it’s easy to blame the company or the marketplace for anything that goes wrong.
 
Community standards. Given the predominance of user-generated content and user transactions in NFT marketplaces, it’s recommended that most NFT marketplaces include an additional layer of legal restrictions in the form of community standards (also known as code of conduct) to govern interactions on your platform.
Community standards are also helpful to have for other reasons. It can help you define the values and ethos governing your marketplace. It can also help build trust among your users, which is crucial if you cultivate a user base and community within your platform.
 
Privacy policy. Privacy policies are mandatory by law. Legally your company is required to disclose its data collection and use practices, among other legally required disclosures. Generally, privacy policies are intended to provide transparency to users in what you are doing with their data. Moreover, depending on the privacy law framework applicable to your business (e.g., CCPA, GDPR, HIPAA, etc.), you may need to make additional disclosures and provide other optionality to your users.
Beyond fulfilling legal requirements, privacy policies can also be a helpful instrument to build trust among your user community. A well-written privacy policy can also signal to the public, the media, investors, and other outside parties that your company operates at a certain level of maturity and sophistication. In contrast, a poorly written privacy policy may undermine user trust and raise red flags about your data practices to outside parties.
 
Other policies. Given the unique legal challenges posed by NFT marketplaces (covered below in more detail), it may also help to have other documented policies, both internal and external. External policies can expand on your company’s position concerning specific actions and behaviors. Internal policies can help you implement and standardize response and enforcement of your compliance obligations, external policies, and other legal obligations within your organization.

IP considerations

When creating an NFT marketplace, it’s vital to ensure that you appropriately allocate intellectual property rights between the creators/artists, purchasers/collectors, and any other involved parties effectively and fairly. Without an effective allocation of intellectual property rights in place, you run the risk of undermining the legitimacy of your entire marketplace.
 
Owning an NFT will not automatically grant you ownership of the original work. The ownership of the original work is copyright ownership that vests in the creator of the original work.
 
When an NFT is minted and subsequently sold, the purchaser or collector will receive (as part of owning the NFT) a set of intellectual property rights from the creator.
At the same time, your company will also need to utilize the original work for the marketplace and promotional activities, such as digital galleries, promotions and events, potential compilations, and other displays of the original work.
 
You will need to ensure sufficient allocation of intellectual property rights from the creator to the company for any such business purposes.
 
When considering the appropriate intellectual property rights allocation from the creator to collectors, the company, and any other involved parties, it’s essential to set a fair percentage of intellectual property rights.
 
If you are overly aggressive in transferring rights from the creator, this may turn away artists and other creators from participating in your marketplace. In contrast, if you do not allocate sufficient IP rights to collectors, the company, etc., these involved parties will not have the right to carry out their role or function in the marketplace.

Global Fintech Ecosystems

Subscribe to NCFA's Newsletter

[directiqwp 2]