Launching an NFT Project – The Essential Legal Elements Part 3 – Smart Contracts
In this Part 3 of our series on the essential legal elements of an NFT project, we’ll be looking at Smart Contracts – what are they and why they are important.
Smart Contracts - Defined
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained within the contract exist across a distributed, decentralized blockchain network. The code controls the contract’s execution and with an NFT, it governs the interplay between the underlying asset and the NFT.
A smart contract will define the thing the NFT represents so for example, an artist might decide that they want to tokenise their physical sculpture and also transfer the actual sculpture to the token holder. The smart contract will stipulate the terms for this transfer.
The smart contract must detail the rights being transferred or owed to other parties – for example: a licence for personal use only of a digital artwork or royalty payable to the creator.
As we have seen, smart contracts are self-executing, and so when it comes to the transfer of the NFT, the smart contract will, much like a domino effect, provide for an ‘executing event’ – such as the payment of cryptocurrency into the NFT holder’s crypto wallet, prompting the smart contract to carry out the transaction and move the NFT to another crypto wallet, nearly instantaneously without any further human intervention.
It was established in the leading case of AA v Persons Unknown, that smart contracts are legally enforceable contracts under the laws of England and Wales.
Liability and Risk
Many ‘standard-form’ smart contracts fail to adequately provide for, or set out sufficiently a provision for, IP rights, and they can be overlooked. If there is any ambiguity or lack of clarity in the rights accompanying the NFT, it can lead to dispute.
If an NFT is misrepresented, you also risk falling foul of advertising and other ‘sale of goods’ regulations.
Our Recommendation – Reduce Risk
It is recommended therefore that there is a careful consideration and legal advice obtained in respect of the terms included in the NFT smart contract. Whilst a programmer will code the NFT metadata, underlying the NFT is a contract for sale of the NFT asset to the purchaser, and so it is recommended that legal advice is obtained.
In Part 4 of this series, we will consider the Corporate Structure element of an NFT project, why it’s important to carefully consider jurisdiction (where you’re setting up the company) and the nature of the structure with regard to limiting liability and enabling easier funding investment.