How can companies use NFT tokenization to strengthen and streamline IP rights? – Trademark
This article was originally written and published in a longer form by American Bar Association
on March 22, 2023.
Non-fungible tokens (NFTs) are unlikely to revolutionize all forms of intellectual property (IP) marketing, but in some use cases they can improve the efficiency of licensing and provide monetization opportunities that would not otherwise be available.
As with any new technology, there are many uncertainties about how the NFT markets will develop. Currently, there are significant challenges to tokenizing IP, including how certain legal requirements, such as a signature requirement for transfers included in The Intellectual Property Act, can be harmonized with tokenized assets; how tokenization can be compatible with highly regulated industries such as franchising; and how tokens can be claimed by those with security interests or contractual rights that are violated.
Despite these roadblocks and uncertainties, any business that drives its revenue with IP should keep a close eye on blockchain developments to identify opportunities on the horizon.
What is tokenization?
“A”non-fungible token’ or ‘NFT’ is an encrypted unit of data on a digital ledger, typically a ‘blockchain’.” Once an NFT is minted, code embedded in a digital token is associated with an underlying asset using a smart contract that governs the token’s ownership, sale and transfer .
“Essentially an NFT a unique “digital object” that anyone can own, sell or buy.” They are non-fungible in the sense that each NFT is unique, has no identical counterparty and cannot be exchanged for another identical NFT. However, this does not mean that they cannot be exchanged or transferred. It just means that no two NFTs are identical.
Tokenization of IP is to attach certain IP rights to NFTs. NFTs can provide a tool to streamline transactions involving these IP rights. By “tokenizing” IP rights and embedding smart contracts, it may be possible to:
- Reduce transaction costs
- Expand the number of potential rights holders
- Provide more flexibility for start-up or small businesses
Smart contracts are agreements where execution is automated to ensure performance by eliminating the need for human interaction. The smart contract executes by itself at the time of transfer and enforces the terms without interaction between human parties.
These smart contracts can contain all kinds of restrictions related to the sale of NFTs. For example, should a right to franchise operations be sold through an NFT, all the duties and obligations of a franchisee must be included in the terms of sale of this token.
A particularly attractive feature of smart contracts in the tokenization of IP is royalty rights for resale. As discussed in more detail below, these resale royalty rights can encourage IP owners to allow a wider range of licenses and provide protection for businesses wishing to license IP.
Tokenization can reduce transaction costs
One of the biggest transaction costs when selling and licensing IP is the legal costs. By tokenizing certain IP rights, the need for negotiated agreements can be eliminated. The result is less friction in the system for IP utilization. Of course, on the other hand, the terms offered are take-it or leave-it terms, which may result in fewer completed transactions.
In addition, the unique legal requirements of IP transfers must be considered to create viable NFTs. For example, exclusive licenses and assignments of copyright must bear the actual signature of the assignor and must be in writing. This means that copyright tokenization of anything other than non-exclusive licenses must have a written signature. This currently poses an obstacle to the implementation of copyright transfers through a smart contract. Similar restrictions will also apply to patent transfers. These signature requirements add a layer of inefficiency to the typical NFT.
Trademarks present even more difficult problems, as the sale of a trademark usually requires the sale of goodwill associated with the use of the trademark. Furthermore, licensing trademarks can trigger both state and federal franchise laws.
With these limitations, finding the right IP to tokenize can allow for efficient transactions, including repetitive non-exclusive transactions. In situations where there is a market for repeated transactions, most of the transaction costs will be in minting the first token. Each subsequent token can simply follow the path created by the first smart contract. There is a huge opportunity to eliminate transaction costs for repetitively licensed IP rights.
Tokenization can expand the IP market
While some of the problems with tokenized IP rights can undermine its effectiveness, the take-it-or-leave-it nature of tokenized rights can boost the market for IP rights. By offering these non-negotiable terms, owners can advertise their IP widely without the worry of experiencing expensive marketing or legal costs for unqualified buyers. Such a system of take-it-or-leave-it rights can generate a marketplace.
Today, many IP rights are widely distributed. Open sea, the largest US NFT marketplace, is proof that an NFT marketplace can be viable. OpenSea allows individual users to create (create) NFTs and buy or sell NFTs either at a set price or through an auction system, and to embed smart contracts into these NFTs.
A similar system could allow those seeking IP rights to engage in one-stop shopping through a single marketplace where various NFTs related to IP rights and their embedded terms would compete with each other. One-stop shopping makes it easier for less sophisticated buyers to participate in the marketplace and may well expand the scope of potential licensees.
Imagine a marketplace that enables non-exclusive patent licensing without the need for each individual agreement to be negotiated or sold, and that allows smaller companies to license patents on transparent terms and prices. Such a marketplace could also be a way forward for some franchise models with each territory marketed by an NFT. In this case, whoever owned the NFT would have the right to operate a franchise in that market according to the terms of the smart contract. For franchising, this is probably a better fit where franchise success is based on business knowledge as opposed to strict brand standards. In theory, the market will decide which franchise models fit best into such a tokenized marketplace.
Whatever IP rights are offered, increasing the number of buyers and licensees will increase the value of IP rights and benefit creators. In this way, IP tokenization can be a blue-water model for creating completely new markets.
Tokenization can create more flexibility for small businesses
Most small businesses fail. This complicates licensing for small businesses from both the licensor’s and the licensee’s side. From the licensor’s perspective, the fact that a small business is likely to fail means that fewer royalties can be expected. From the rights holder’s perspective, this means that the risk of licensing expensive IP rights is high, because the business is unlikely to generate a significant return on investment. Some of this risk is exactly what it means to start a business. But NFTs and smart contracts can reduce some of this risk.
The value of NFTs is to some extent determined by how easily they are traded. This could allow licensees to pay a higher amount for tokenized IP rights, if the terms allow resale in case the new venture fails. Smart contracts can incentivize allowing the transfer of tokenized rights because a built-in resale royalty can be included in the self-executing smart contract.
Such a system could, for example, give buyers the ability to buy, sell or trade franchise rights with a smart contract that has a redistribution royalty rate baked in. This can increase the value of the first sale and ensure that any subsequent sales will generate at at least some payment to the IP’s ultimate owner.
The more flexibility that can be created in sales and licenses means more participation in the market and more opportunities to make money from various forms of IP.
The importance of tokenization for companies
In today’s economy, asserting IP rights is an important source of income for some industries. This applies to both practicing and non-practicing units. Assertion of IP is only the enforcement of IP owner’s rights. The US regulatory system provides for broad exclusive rights in most IP, but it is up to the owner to bear the costs of bringing a lawsuit or other administrative action.
For claim, proof of ownership is the very first step to any action. Tokenization of IP rights can ultimately provide definitive proof of ownership. If blockchain registries become the best proof of ownership, tokenization could be incredibly important for those who want to enforce their rights.
The content of this article is intended to provide a general guide to the subject. You should seek specialist advice about your specific circumstances.