United States: What Companies Need To Know About NFT And IP Rights Regulations

This article was originally written and published in a longer form by the American Bar Association on March 22, 2023.

Non-fungible tokens (NFTs) tethered to IP rights are an intriguing innovation that may usher in a new way to transact in and monetize IP.

But the ongoing uncertainty of their classification as a security, as well as their classification as an asset class in commercial finance transactions, will keep them from being aggressively adopted until the dust has settled on enactment of more uniform laws, which will bring needed clarity and certainty both in the U.S. and abroad.

In the short term, there may be value in issuing limited offerings that work in the current regulatory environment of a targeted market and generate earned media coverage as interest in new uses of NFTs remains high.

NFTs Generally Are Not Regulated at the Federal Level

Currently, an offer to sell one or more NFTs is not directly or explicitly regulated by the U.S. federal government, unless it is a "security" under the traditional Howey test, in which case the Securities and Exchange Commission (SEC) is likely to consider the NFT an "investment contract" and regulate it. That may be changing, though. Many are calling for greater guidance from the SEC, as well as additional federal legislation, clarifying the regulation of NFTs and other digital assets. In July 2022, after an invitation to do so by Senators Leahy (D-VT) and Tillis (R- NC), the U.S. Patent and Trademark Office and the U.S. Copyright Office confirmed they would undertake a joint study of IP issues related to NFTs.

Some States Are Beginning to Regulate NFT Sales

At the state level, the offering of NFTs (as opposed to virtual currencies) is largely regulated only pursuant to securities laws. Some states have given specific guidance for NFT offerings or adopted laws that apply directly to NFT offerings.

For instance, Colorado has enacted a law clarifying that certain digital tokens are exempt from the securities laws of that state if the digital tokens are for a "consumptive purpose," the tokens are registered, and the offeror complies with both statutory and agency rules in making the sales. Several other bills are pending across the states, and further regulation should be expected in the coming year and that regulation may come without uniformity.

Regulations Are Developing Outside the U.S.

The European Parliament Committee on Economic and Monetary Affairs recently passed the Regulation on Markets in Crypto-Assets (MiCA) to provide an EU-wide regulatory framework for certain crypto-assets, that regulation must still pass through the European Parliament and will not come into effect as crafted until 2024.

In addition, NFTs are not necessarily covered by MiCA, depending upon the facts and circumstances of the NFT itself.

The most daunting regulatory challenge is the complexity brought about by varying approaches to NFT regulation from one country to the next, given the competing objectives of NFTs to facilitate easier digital asset transactions in potentially global markets.

For instance, a security under the Howey test may or may not be a security in the European Union. The varied approaches to the underlying smart contract terms and conditions associated with a given NFT and the jurisdictions in which an NFT might be offered for sale will dictate an analysis of each NFT and its circumstances of sale to determine the extent to which investment contract, securities or other laws of a particular country could present a material risk to the seller or buyer.

What the Current Lack of Regulation Could Mean for Companies

Operating in an unregulated or lightly regulated industry can provide great opportunities, but it also comes with risk. As early adopters, companies may be able to operate without the expense of complying with onerous regulatory oversight. Upstanding companies may also be able to set a standard that both works for them and will eventually become adopted or even codified as the industry standard.

On the other hand, operating in currently unregulated spaces means that the concept may become illegal or unsustainably expensive as regulations develop. Additionally, unregulated spaces can be susceptible to scams and unscrupulous competitors. Those bad actors may damage a company's reputation simply because it operates in the space.

Please contact Drew Patty, Andrew Coffman or any member of the Phelps Intellectual Property team if you have questions or need advice or guidance.

Published in Landslide, Vol. 15, No. 3, March/April 2023, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.