Money is fungible. NFTs are not. | Insight
“Fungible” is an adjective that describes something that is easily capable of mutual substitution, so that one part or quantity can be exchanged for another equal part or quantity. Money is fungible. It is designed to be fully fungible: one dollar is always equal to another dollar. Cryptocurrencies are also fungible and designed to function similarly to fiat currencies. NFTs, on the other hand, are not.
NFTs are non-fungible tokens, so they are explicitly designed to be unique assets that are irreplaceable and non-fungible. An NFT is a token built on a blockchain and “minted” using the same technology as cryptocurrencies, but they represent a distinctive underlying asset, making them non-fungible in nature.
Each NFT basically has an identifier, metadata and a smart contract. Beyond the very basic parameters, the possible applications of NFTs vary widely. They are differentiated by aesthetics and arrangement. Conceptually, you should think of an NFT as a deed that uses the blockchain to track a real-world value, but the stylistic aspect of NFTs, like art, is virtually limitless.
Purpose and execution of NFTs
NFTs were created as a better means of tracking the chain of title, and they achieve this goal exceptionally well. The immutable nature of blockchain means that title is more securely and reliably recorded than with other existing methods.
As a deed, an NFT tracks ownership, but for most people the real question is: ownership of what? The simplest answer is: a digital collectible embodied in an electronic file. The general consensus is that NFTs (associated with art) should acquire some collectible or cultural value over time.
Identify what you own
An NFT is a digital asset in its own right, but it is fundamental to recognize that NFTs are distinct from the underlying artwork or other assets. Rather, an NFT is representative of the asset. Just as nothing prevents an artist from creating and distributing reproductions of an original work of art, they do not prevent minting many NFTs of that work of art.
Minting an NFT fundamentally requires an identifier and coding. NFTs can only exist on blockchains with an NFT standard, such as Ethereum, which is a blockchain that can be programmed with a smart contract. Ethereum is considered the NFT standard and it is the most popular blockchain for NFTs. The underlying asset is disconnected from the NFT. The following elements have been characterized in NFTs:
- music
- graphic arts
- photography
- digital art and GIFs
- shoe
- videos and sports highlights
- collectibles
- tweets
- virtual assets, such as avatars, skins and video game assets
- metaverse or virtual property
An NFT ledger can be programmed to credit the original artist/creator, indicate copyright ownership or contract for commissions or royalties. Copyright and copyright licenses can also be incorporated into smart contract aspects of the NFT ledger. Whether an NFT buyer obtains anything other than the right to use/display the NFT depends on the details of the NFT sale. If you intend to purchase copyright or enter into a license related to an NFT, you should consult an intellectual property attorney with knowledge of NFT.
Identify your NFTs in your estate plan
Ownership mechanics of NFTs work similarly to cryptocurrency ownership. NFT transactions mostly take place within NFT marketplaces that are specifically designed for the sale and purchase of NFTs. NFTs are purchased with cryptocurrency, held in a wallet and programmed on the blockchain.
If you own an NFT, be sure to tell your estate planner, and conversely, estate planners should ask about NFT ownership upon intake and when updating estate plans. Because NFT ownership is recorded on the blockchain, there are special considerations and provisions that must be made to guarantee that they pass to intended heirs. Simply giving an intended heir an electronic NFT file without more would be akin to giving keys to a house without more – ie without a deed. It is not sufficient to transfer ownership. A change in NFT ownership must be entered as a transaction on the blockchain. Sophisticated planners can ensure that the correct transfer takes place.
Appreciate your NFTs
The value of an NFT is demand-based. In terms of value, you can think of an NFT like a baseball card. Some are very valuable and some are not. Instead of holding a baseball card in hand, an NFT owner has a digital file. Like baseball cards and works of art, rarity or uniqueness is directly related to desirability, demand and value.
Other issues with the valuation of NFTs and their eventual taxation include: 1) The NFT’s fundamental tie to the blockchain it is programmed on – for example, if it is programmed on Ethereum, the value of Ether is tied to the NFT and will itself be subject to possible profit taxation; 2) the potential status of some NFTs as collectibles, which would subject NFTs to the higher 28 percent long-term gain treatment; and 3) domicile of an NFT, which is not yet defined and thus can be transferred to other tax jurisdictions, etc.
Additional NFT applications
While the intended use of NFTs is deed replacement, the creative world has embraced NFTs. Some practitioners think of NFTs as a new genre of copyright that recognizes the value of symbolic rights in copyrighted works.
New uses of NFTs include linking an NFT to original artwork and its creator by including authorship credit, reserving moral rights, automating royalties on future sales, and offering additional services or subscriptions, etc. in the smart contract. For example, a musical artist can sell an NFT that comes with a subscription to all music content generated by that artist in the future. Copyright owners who imprint NFTs of their own artwork may include the assignment or transfer of all or part of the associated copyrights along with the NFT purchase. NFTs have also been used as indicators of membership or to provide access to an exclusive club. These are just a few creative uses of NFTs, and there is no consensus on the intended future use of NFTs at this time.
The information in this notice is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not replace legal advice, which relies on a specific factual analysis. Also, the laws in each jurisdiction are different and are constantly changing. This information is not intended to create, and its receipt does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we encourage you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.
