Although digital currencies have been the hottest topic in the blockchain area for several years, investors are increasingly turning their attention to a digital asset that is valuable for the item it represents rather than for its potential use as a currency. Non-fungible tokens (“NFTs”) are digital versions of artwork, music, trading cards, autographs, and other collectibles that are secured on a blockchain and purchased using a recognized cryptocurrency, such as Ethereum or Bitcoin. (Robyn Conti and John Schmidt, Forbes Advisor). However, unlike cryptocurrencies, every NFT has its own digital signature, which makes them impossible to copy and thus significantly enhances their value. Id.

Browsing the website of an NFT marketplace, such as OpenSea, is an easy way to familiarize yourself with the diversity of these digital assets. (OpenSea). All sorts of digital collectibles can be purchased through this website but only by using a cryptocurrency. Id. Although there is a lot of enthusiasm about this market from both the public and content-creators, there is also significant legal uncertainty concerning the ownership of digital assets, which adds substantial risk to NFT transactions. Particular risks include whether a partial owner of a physical asset has the right to sell the asset as an NFT; whether NFTs will be subject to federal anti-money laundering laws or SEC regulation as securities; and the extent of legal duties owed by NFT marketplaces to consumers of the digital assets. (Jones Day).

 The lawsuit between music artist Jay-Z and Damon Dash, co-founder of the Roc-A-Fella Records label along with Jay-Z, is one recent example of the legal risks associated with NFT-ownership (Chris Dolmetsch, Bloomberg Law News). The June 2021 complaint alleges that Dash is attempting to auction off the rights to Jay-Z’s debut album, Reasonable Doubt, as an NFT, but Jay-Z’s record company argues that Dash holds no ownership interest in the album’s copyright and therefore, Dash cannot sell it. (Complaint, Roc-A-Fella Records, Inc. v. Dash (S.D.N.Y. 2021)). Although Dash is a significant shareholder in Roc-A-Fella Records, the complaint asserts that the record company owns the copyright to the album in its entirety and that Dash is attempting to sell an asset which he does not own. (Complaint, RAF, Inc. v. Dash). Dash argues that he is trying to transfer his future royalties as a shareholder in the record company to someone else, and he is not attempting to sell the copyright rights to the album. (Chris Dolmetsch, Bloomberg Law News). As illustrated by this lawsuit, NFTs often aggravate ownership disputes of assets split among multiple parties. This is due in part because of NFTs’ digital nature, but also because blockchain and cryptocurrencies are, by and large, not well understood.

Whether NFTs are subject to federal anti-money laundering laws, such as the Bank Secrecy Act of 1970, is one particular area of legal uncertainty. (Jones Day). If NFTs are considered “substitutes for currency,” then the Financial Crimes Enforcement Network of the Department of Treasury may subject them to the agency’s regulations. Id. Specifically, the transfer of an NFT between persons could be considered a money transmission, and businesses which use NFTs would be subject to compliance program and record-keeping requirements under the Bank Secrecy Act. (Jamie Boucher et al., Skadden). Another risk is the threat of cybercriminals targeting high-value NFTs, such as autographed trading cards or award-winning music albums. (Jones Day). Id. If a criminal obtains the private key associated with each NFT, they could access and sell the NFT without the knowledge of the true owner. Id. Especially given the relative recency of NFT marketplaces, this area is particularly vulnerable to cyberattacks. Id.

 Another issue is whether the Securities and Exchange Commission (“SEC”) will consider NFTs securities, and subject them to the extensive set of registration requirements under the Securities Act of 1933. (SEC, Investor.gov). It is unknown at this point whether the SEC will categorize all NFTs as securities, but it has provided public guidance on how it will examine NFTs going forward, and it would be prudent for private and institutional investors to carefully review this guidance before engaging in NFT transactions (King & Spalding). Additionally, to protect themselves from consumer protection liability, NFT marketplaces should ensure that purchasers of NFTs are sufficiently informed of the attached intellectual property and ownership rights, or risk accusations of insufficient consumer protection. Id. Furthermore, NFTs are taxable property, and any person buying or selling them must report sales, taxes, profits, and losses to the Internal Revenue Service. (Catherine Zhu, Mondaq).

Similar to cryptocurrencies, the potential applications of NFTs are numerous but so are the legal and security risks with marketplace transactions. For this reason, it is recommended that casual investors read the terms of service of an NFT marketplace before undertaking transactions. Institutional investors should consider consulting an attorney for a complete understanding of the risks and value of NFT investments. For the OpenSea marketplace, interested parties should carefully read the sections regarding user conduct, indemnification, assumption of the risk, and limitation of liability. (Terms of Service, OpenSea). Knowledge is power, and the more investors avail themselves of information about the risks of digital assets, the more likely that those investors can avoid potentially adverse consequences.