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Launching an NFT Project – The Essential Legal Elements – Part 1

New NFT projects are incredibly popular, and supply is struggling to keep up with demand.

However, an increasing number of NFT project creators are being caught out by failing to undertake the basic due diligence at the outset of project planning. Common problems include NFTs that infringe existing intellectual property rights, fall foul of financial regulations, or are mis-sold.

If you fail to treat the launch of an NFT project like the launch of any other business (obtaining necessary legal advice and undertaking due diligence) you could easily expose yourself to unnecessary risk, which could result in not only the failure of the project but also in personal liability.

Elements to an NFT Project

The primary focus of an artistic NFT launch is the artwork; the perceived (and potential) value of the artwork the subject of the NFT acts as the primary attractive force driving the promotion of a project launch (particularly with a well-known artist).

However, the artwork is only one element of an NFT project, and the launch can be quite complex, typically involving multiple parties and various practical and legal considerations. The initial launch is invariably often only the start of an ongoing project, with the building of a brand through multiple NFT drops.

An NFT project is a commercial activity (the sale of NFTs to consumers) pursued to generate revenue and profit: it is therefore a business. With any business comes risk, however there are ways in which to manage risk and limit liability.

There are several basic essential legal elements to an NFT project:

  1. Regulation
  2. Intellectual Property
  3. Smart Contracts
  4. Corporate Structure
  5. Terms of Business
  6. Branding

In the first part of our series on the elements of an NFT project, we consider Regulation, below.

Regulation

Although NFTs are not (yet) specifically regulated, if they exhibit characteristics of other regulated investments, they may trigger legal obligations around their promotion, marketing and sale.

For example, where an NFT grants entitlement to commission on resale, this can be construed as a 'right akin to a secured investment' meaning that it may be subject to regulation. Further, if an NFT is a ‘security token’, it be a specified investment for the purpose of the Financial Services and Market Act 2000 (Regulated Activities) Order 2001. Alternatively, if the NFT can be classified as e-money, it will be subject to the Electronic Money Regulations 2011.

It’s important to assess whether the NFTs sold in the project can be classed as regulated investments, securities or payment instruments. Further, it should be considered whether the offer for sale, or the provision of related services, such as an exchange platform, constitutes a regulated activity for the purposes of financial regulation.

NFTs commonly contain provisions for enhanced rights, rights to future remuneration, guarantees as to value, connections with tangible goods etc. and these can influence an NFT’s classification.

There are also anti-money laundering regulations to consider, as determined by the Financial Conduct Authority (FCA).

Liability for compliance will sit with the regulated entity and is difficult to pass on. As well as any financial penalties, the reputational risk of non-compliance can be severe.

Therefore, it is recommended that a detailed analysis is undertaken of the project NFTs at the outset, and legal advice is obtained from counsel experienced in this area of regulation before any NFTs are marketed, promoted or sold.

If you would like to discuss this further, please contact our Head of Intellectual Property, Will Charlesworth.

In Part 2 of this series, we will consider the Intellectual Property legal element of an NFT project, how such rights may arise, be addressed and protected.

 

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