This is the first in a two-part series on the current status of NFTs. The second Insight in the series will discuss the issue of whether NFTs are securities subject U.S. securities laws.
In 2021 Art Basel Miami Beach attracted more than 250 international galleries across 36 countries and territories and showcased artworks across all media – including digital works. Thousands of NFT and cryptocurrency enthusiasts waited in long lines to attend gallery shows, interactive experiences, concerts and parties. Despite the hype and close to $2.9 billion in art related NFT sales in 2021, sales dropped an astonishing 98% at Art Basel Miami 2022. However, it would be premature to sound the death knell for this novel vehicle. While NFT sales are trending steadily downward, transaction levels are increasing, with 10.8 million transactions in June 2023 and 10.4 million transactions in July 2023, the highest levels since February 2022. Lower price barriers are making NFTs accessible to general audiences. This trend suggests NFTs are alive and well, with more clarity as to their potential applications and value in the art market. Meanwhile, high-profile lawsuits are pointing to unresolved legal issues surrounding NFTs.
Yuga Labs and the Bored Ape Yacht Club
The sensationalism and controversy accompanying the meteoric rise of NFTs in 2021 was driven in large part by the Bored Ape Yacht Club (“BAYC”), a collection of algorithm-generated works of digital art featuring profile pictures of animated apes with bored expressions on the Ethereum blockchain. Limited edition licenses to mint 10,000 of these digital artworks were sold within one week in April 2021, yielding the owners more than a billion dollars. In May 2022, BAYC had a value of approximately $2.04 billion. NFT collections made the cover of Rolling Stone magazine and appeared in other high-profile media. After two years, prices for the BAYC NFTs have hit an all-time low. As of October 3, 2023, there are a total of 9,998 BAYC NFTs minted, held by 5,567 unique owners, with a total market cap of $435,362,768.
In December 2022, a class action lawsuit was filed in federal district court in Los Angeles against Yuga Labs, the parent company of BAYC; a host of A-list celebrities, including Madonna, Paris Hilton, Jimmy Fallon, Serena Williams, Diplo and Post Malone, as well as certain intermediaries. The plaintiff, Adonis Real, subsequently added Sotheby’s to the lawsuit, arguing that the auction house’s 2021 NFT auction helped legitimize Yuga Labs and mislead investors. The suit alleges that the defendants conspired to defraud potential investors, resulting in artificially inflated prices for Bored Ape’s NFTs. The complaint (at pages 3-4) states:
Yuga’s flagship NFT collection, the so-called Bored Ape Yacht Club (“BAYC”), and related brand rely heavily on the perception that “joining the club” (i.e., buying a BAYC NFT) brings investors status and provides them access to events, benefits, and other lucrative investment opportunities exclusive to BAYC holders. The exclusiveness of BAYC membership was entirely based on the inclusion and endorsements of highly influential celebrities. But this purported interest in, and endorsement of, the BAYC NFTs by high-profile taste makers was entirely manufactured ...
The complaint alleges that, had the plaintiffs known the celebrities/defendants were being paid by Yuga Labs to endorse the NFTs, they would not have purchased the BAYC NFTs. The plaintiffs brought actions based on California’s laws against unfair competition, deceptive business practices, conspiracy to misleadingly promote BAYC NFTs to artificially inflate the price and violations of federal securities law.
Meanwhile, in a separate lawsuit brought by Yuga Labs in the same court, the court ruled in its favor on a motion for summary judgment regarding its trademark infringement claims against visual artist and designer Ryder Ripps and others. The suit alleged that Ripps’s copycat NFT collection (which featured the original BAYC images and was called the Ryder Ripps Bored Ape Yacht Club or “RR/BAYC”) used the Bored Apes trademarks to mislead buyers and devalue its brand. The mark for BAYC was registered on May 30, 2023. As of October 24, 2023 the mark for BAYC plus design as well as a second intent to use application for BAYC are pending before the PTO, awaiting the filing of Statements of Use.
The defendants claimed that their NFTs were a satirical response to BAYC and filed a motion to dismiss and a California anti-SLAPP (Strategic Lawsuits Against Public Participation) motion based on a free speech argument under Rogers v. Grimaldi, 875 F.2d 994 (2d Cir. 1989). (The U.S. Supreme Court recently clarified the Rogers test in Jack Daniel’s Props. V. VIP Prods. LLC, 599 U.S. 140, 167 (2023) opining that even if a mark has other expressive content, i.e., because it conveys some message on top of the source, it is not automatically entitled to Rogers protection because the goals of the Lanham Act to protect consumers from confusion outweigh First Amendment concerns of free expression.) The Yuga Labs court rejected the Rogers argument and ruled that R/BAYC’s collection was not protected as artistic expression under the First Amendment and that Yuga Labs was allowed to protect their trademarked products. This ruling follows the precedent set by the Hermes and MetaBirkin case discussed below. Citing the “totality of the circumstances,” on October 25, 2023 the court awarded Yuga Labs nearly $1.6 million in damages.
Yuga Labs’s problems are not limited to the United States. A court in Singapore issued an injunction against the sale of a BYAC NFT in connection with a commercial dispute. The NFT had been used as collateral for a loan and, when the borrower defaulted, the lender, in violation of the loan agreement, transferred the NFT to its own Ethereum wallet and put it up for sale on OpenSea, a NFT marketplace where users can buy, sell, create or auction NFTs. It will be interesting to see if the courts of other countries are also willing to assert jurisdiction over an asset on a decentralized blockchain. Already crypto companies are looking to hire and invest outside the U.S., particularly in the UK, Europe and Singapore, where existing regulations address these transactions. Andreessen Horowitz, also known as “a16z,” a venture capital fund that invests in crypto and web3 (the third generation of the World Wide Web built on decentralized blockchains), recently announced their expansion to the UK, where policies and regulations are more favorable for crypto and digital asset innovation.
Copyright and Trademark Issues
It is not surprising that copyright disputes are arising over the right to mint NFTs since contracts predating the emergence of NFTs are silent regarding such rights. This is an issue which has repeated itself with the introduction of new technologies, from the chromolithographs in Bleistein v. Donaldson Lithographing Co., 188 U.S. 239 (1903), to Sony's Betamax video tape recorders in Sony Corp. of Am. v. Universal City Studios, Inc., 464 U.S. 417 (1984). One such suit, instituted in November 2021, was brought by Miramax against filmmaker Quentin Tarantino, alleging that his plan to auction off exclusive scenes from Pulp Fiction as NFTs infringed Miramax’s copyright. Although Tarantino held certain “reserved rights” relating to derivative works under a pre-NFT agreement, Miramax claimed they were too narrow to encompass his plan. The case has since been settled.
It is worth underscoring that the purchase of an NFT does not transfer ownership of the copyright but merely a license to display or transfer the work. Not understanding this basic premise proved to be a costly and embarrassing mistake for the purchasers of a rare physical copy of a “bible” containing artwork and a storyboard based upon the science fiction book “Dune.” The purchasers intended to tokenize the book only to find that their $3 million purchase price did not include the rights to do so.
In the trademark arena, in February 2023 a jury in the U.S. District Court for the Southern District of New York returned a verdict in favor of Hermes, maker of the iconic “Birkin” handbag, in its lawsuit against digital artist Mason Rothschilds, who created and sold NFTs of “MetaBirkin” bags. The jury found that the creation and sale of the NFTs constituted trademark infringement, trademark dilution and cybersquatting. The jury also determined that Rothschild’s creation and sale of the MetaBirkins NFTs were not protected by the First Amendment. While the case suggests that brand owners can use traditional trademark law to protect against digital infringements of their products, the verdict hinged upon a very particular fact pattern and may not be applicable to other cases. Despite the defendant’s protests, the court refused to throw out the verdict or hold a new trial.
The Future of NFTs
The saga of the BAYC NFTs and other ongoing lawsuits, while headline-grabbing, obscures the more focused and promising trends in the NFT space. Below we discuss some of the emerging opportunities in the legal and creative landscape.
Customer Loyalty Programs
Some well-known brands have started offering exclusive privileges to their NFT customers. In an apparent attempt to attract and retain younger customers, these programs are often based on gaming in the metaverse. For example, Starbucks is testing a program called Starbucks Odyssey, which involves interactive, coffee or Starbucks-related games called “Journeys,” affording the opportunity to earn Stamps (NFTs) leading to digital and real-world experiences. Luxury fashion brand Louis Vuitton created and then updated Louis: The Game, in which users help an avatar named Vivienne through a virtual world in search of exclusive historical postcard NFTs. Louis Vuitton designed the NFTs to educate players about the brand’s 200-year history, and rewards players with raffles to win NFTs. As of April 2022, more than two million users had downloaded The Game. In the last year, Louis Vuitton has sold its “Treasure Trunks” NFT collection, in a limited release of only a few hundred digital products, for about $42,000 each. The success of these ventures will depend in large part on traditional marketing principles, such as their ability to resonate with both the existing, traditional customer base and the emerging generation of target customers.
Although they create bragging rights and speculation, links to a digital image alone have no transactional value. However, pairing NFTs with physical assets promises real utility. Because NFTs are not fungible (that is, not interchangeable), they can be used as proof of authenticity and ownership. In the world of luxury goods, linking NFTs to physical assets provides such a record, enhancing security to both consumers and companies and protecting against fakes. For example, luxury fashion line Loro Piana is pioneering a digital certification program. Pairing a traditional work of art with an NFT with a certificate of authenticity stored on the blockchain can track the provenance of the item, reducing the risk of theft or forgery. This hybrid approach could have practical benefits for more modest art collectors as well; for example, to inventory their art for insurance and as a record for the heirs.
Royalties to Artists
In the U.S., repeated legislative efforts to provide resale royalties to artists, such as exist in European countries under a “droit de suite,” have been unsuccessful. “Smart contracts,” or programming within the blockchain, are promising attempts to rectify this inequity by securing a future income stream to artists. Such contracts provide that a transfer of the NFT triggers the automatic payment of a percentage of the profit as a royalty to the artist. The royalties are fixed during the minting of the NFT. These payments are intended to be triggered automatically. However, platforms like OpenSea have abandoned mandatory creator royalties in response to competition from other platforms that have also reduced or eliminated creator fees. In response, Yuga Labs has blacklisted the most popular NFT platforms, like OpenSea and Blur, from trading its new NFT collection in an effort to enforce royalties. Some commentators suggest that these uses of NFTs will change the dynamic in the art world:
The current convergence of digital art, crypto money and blockchain technology will bring about a profound structural shift in the art ecosystem: Collectors won't buy if a work is not registered on the blockchain; artists will exert more control over their work and earn royalties from resales; more collectors will populate a transparent market and the art market will become more regulated, for the better."The Art World Underestimates the Power of NFTs," Coindesk, 9/28/23
Although the promise of astronomical financial return from the sale of NFTs may be in the rear-view mirror, a more balanced and functional approach to exploiting the technology appears to be evolving, as both the legal issues and market demands become clearer. Lutzker & Lutzker will continue to track these developments.