The Curious Case of Non-Fungible Tokens

Sports, music, gaming, and other industries driven by increasing digitisation and higher internet usage are recognizing the emergence of non-fungible tokens (“NFTs”) as a mushrooming revenue stream.¹ Twitter CEO Jack Dorsey sold his first tweet for $2.5 million in a charity auction using NFTs.² Closer to home, Indian cryptocurrency exchange, WazirX has launched a NFT marketplace for Indian artists and creators. Indian artists can place their digital assets including art pieces, audio files, videos, and even tweets, for auction over the blockchain-based NFT marketplace to earn royalty thereafter. Wazir X claims it to be India’s first NFT marketplace and has declared that it will not charge its customers for creating and listing NFTs on the platform. It has added that it is working to eliminate the fees paid to miners in respective currencies to verify transactions.³

WHAT ARE NON-FUNGIBLE TOKENS?

1. Understanding (non) fungibility
   “Non-fungible” means that each token is unique and therefore cannot be a unit of exchange as it is not replaceable. On the contrary, currency such as legal tender is fungible i.e., mutually interchangeable. If you trade it for a different NFT, you would have something completely different. This is the distinguishing feature of an NFT.
2. NFT & Blockchain
   NFTs work on blockchain technology where digital records of all owners and transactions related to it are maintained in a ledger. These are coded to have a unique identification and other metadata that no other token can replicate. Therefore, the ownership can be tracked and verified.⁴
3. NFTs vis-a-vis digital content
   Rapid reproducibility of digital content and media makes identification of the original owner extremely difficult. Replication has the disadvantage of the devaluation of the original piece of content. Even if the original owner is identified, the proof of such ownership is dependent on centralized institutions or intermediaries that maintain such records.⁵NFTs offer solution to these problems as summarised in the following flowchart. Unlike most digital items which can be endlessly reproduced, each NFT has a unique digital signature which makes identification easy.⁶

   The technology has been proposed so that digital artists can ensure that the value of the art that they produce is maintained during its sale, while also ensuring that they are able to track future sales and collect any royalties that they may be owed.⁷

   A NFT acts as proof of ownership over a piece of digital content or a digital asset from art pieces to music files to books.⁸ NFTs are unique digital tokens that represent specific digital assets that can be bought, sold and traded between individuals.⁹

WHERE DOES THE LAW STAND?

Classification of NFTs under the law is still unclear. There is no law that directly deals or regulates the usage of the NFT in India yet.¹⁰

1. NFTs as derivatives
   Derivatives are a contract between two or more parties that obtains its value from fluctuations in the underlying asset such as insurance policies wherein insurance companies make educated bets on the value and cost a policy holder will pass on to them.¹¹Conceptually, therefore NFTs are similar to derivatives as defined under Securities Contract Regulation Act,1956.¹² The Act defines derivatives “includes a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities.¹³ Legally one can only trade derivatives on authorized exchanges such as for stocks or commodities. However, as of now, there is no legal framework for a derivative value for a non-financial asset.¹⁴
2. Cross border investments and NFT
   Cross border exchanges in NFTs would also invoke provisions of Foreign Exchange Management Act, 1991 (“FEMA”), the frequency of which is expected to be more in the intial stages until there is clarity under the Indian law about the position of NFT. However, even under FEMA, the classification of NFTs remain a problem.¹⁵ Recognising it as an intellectual property raises more questions than answers.
3. IPR of NFTs
   Although both NFT and IPR bestow right on an intangible asset, the rights provided by an NFT are not similar to those under an IPR. Under NFT the rights for an item gives an ownership right, but the owner has no right to reproduce it. The exclusivity under IPR is not provided under NFTs. Further despite have a right under NFTs, the copy of the original can still be sold. Therefore, in terms of copyright, it is a weak protection.¹⁶
4. NFTs as cryptocurrency?
   The classification of NFTs as cryptocurrency depends on how cryptocurrencies are defined by a jurisdiction. The Cryptocurrency Bill, 2021 in India does not specifically deal or mention NFTs. It defines ‘cryptocurrency’¹⁷ as having a “digital representation of a value and has utility in a business activity or act as a store of value of unit of account”. Although NFTs are exchanged using cryptocurrencies, however they lack any inherent value as it derives its value from an underlying asset. The characteristic of fungibility of cryptocurrency is absent in case of NFTs. Additionally, since NFTs are traded mostly using cryptocurrencies, the latter’s legality is closely attached to that of NFTs.¹⁸

CONCLUSION
It is definitely a possibility that the enthusiasm around NFTs might have more to do with novelty than resolving a real-life issue in the digital space. It needs to be seen whether NFTs are able to retain their relevance in the long run. The ambiguity surrounding its legality must serve as a caution of those planning to invest in it. The regulatory authorities must be mindful of its benefits and attached costs before framing a policy for NFTs.