Introduction
In October 2021, the digital image of an ape with a wearied and uninterested expression – known as Bored Ape #8817 – sold for an astounding $3.4 million in an online auction by Sotheby’s.Footnote 1 Actually, it was not really the digital ape that was sold. Rather, the auction was for a token representing the graphic. Although noteworthy for its price, this bored ape non-fungible token (NFT) was just the latest in the tokenization craze – the idea of creating a unique digital representation (a token) of a particular asset, which proponents assert will upend government and property law as we know it.Footnote 2
This chapter gets to the heart of the real question: What does it really mean to tokenize something under the law? In other words, what property rights does the owner of the bored ape token receive? Ownership? Some other kind of property entitlement? If the right is a property right, is it a property right in just a token, or is it some right in the Bored Ape image? Perhaps the owner receives a contract right. Maybe the owner receives only bragging rights. The answers to these questions have tremendous implications for just how revolutionary tokenization can really be.
To be sure, the market for NFTs has grown at an impressive rate.Footnote 3 Aside from Bored Ape #8817 and its multi-million-dollar bounty (and the many other NFTs in the bored apes series that have sold for millions of dollarsFootnote 4), the NFT for a JPG produced by digital artist Beeple sold for $69.3 million in March 2021.Footnote 5 That same month, Jack Dorsey, the former CEO of Twitter, sold an NFT of his first tweet ever for a whopping $2.9 million,Footnote 6 and a New York Times reporter sold an NFT related to a news story (on NFTs!) for $560,000.Footnote 7 Indeed, these sales prices in the millions have continued into 2022.Footnote 8 So while the idea of NFTs has existed since the mid-2010s,Footnote 9 the market only caught fire in 2021 and has continued into the early part of 2022.Footnote 10
There has also been quite a bit of forward-looking excitement around the potential uses of NFTs. Millionaire Mark Cuban said that anything digital can be an NFT and opined that the NBA Mavericks, which he owns, could use NFTs to “sell virtual Mavs gear, sneakers, art, pictures, videos, experiences, anything our imagination can come up with we can sell.”Footnote 11 There is even a move to tokenize real world assets.Footnote 12 Mainstream corporate giants such as BNY MellonFootnote 13 and DeloitteFootnote 14 have concluded that tokenization has the potential to “disrupt” everything from securities tradingFootnote 15 to real estate markets.Footnote 16 Sotheby’s, Vanguard, and Microsoft all have NFT projects in the works for industrial assets, real estate, and securities transactions.Footnote 17 The financial giant State Street announced in the summer of 2021 its plan to move “hundreds of its staff” members to a new unit specializing in, among other things, “support for ‘tokenized’ assets.”Footnote 18
The idea behind the tokenization of a tangible or intangible asset is that the owner of the asset creates a digital item (essentially, an entry in a blockchain ledger) identifiable with the asset itself. The creation of this digital entry is called minting, and, as the foregoing suggests, the entry itself is called a token.Footnote 19 After its minting, the token is sold, often through an auction facilitated by the same online platform that performed the minting service, to willing buyers.Footnote 20 Typically, buyers pay using some form of cryptocurrency – Ethereum’s ether being particularly popular.Footnote 21 The purchaser of the token then ostensibly also owns the underlying asset, or at least that is the whole idea behind tokenization: that the owner of the token acquires authentic title to the reference asset.Footnote 22
Commentators note that tokenization has tremendous potential to change everyday transactions. They note that tokens can easily “be traded on a secondary market of the issuer’s choice.”Footnote 23 That transactions involving tokens happen on the blockchain and through smart contracts,Footnote 24 promoters proclaim, means that there are few “administrative burden[s] involved in buying and selling,” which, in turn, leads “to not only faster deal execution, but also lower transaction fees.”Footnote 25
But what is most interesting for purposes of this chapter are the developments surrounding tokens and property rights. Crypto-enthusiasts proclaim that NFTs are the “future of digital property.”Footnote 26 Tokens herald a day when “government will lose its unique power to mint currency and protect property.”Footnote 27 Self-proclaimed experts on YouTube state that tokens convey ownership,Footnote 28 constitute “intellectual property,”Footnote 29 and contain “historical ownership data” related to an underlying thing.Footnote 30 And while the assertions of social media influencers with no particular expertise may not seem noteworthy on the surface, their observations are, in practice, quite important. A recent study by LendingTree’s MagnifyMoney unit revealed that 41 percent of Gen Z investors and 15 percent of Millennials sought financial and investment advice from personalities on the social media platform TikTok.Footnote 31 Even some lawyers claim that “nonfungible tokens can be used to represent ownership of all sorts of original digital items.”Footnote 32
More concretely, industry proponents assert that tokenization does not only add “transparency to transactions,” but also allows for the holder’s “rights and legal responsibilities [to be] embedded directly onto the token” alongside “an immutable record of ownership.”Footnote 33 In that vein, the promise includes the notion that because tokens are “highly divisible” and have a direct connection to ownership of a tethered thing, individuals can purchase fractional interests in an underlying asset,Footnote 34 the entirety of which they may not be able to afford.Footnote 35 In this way, tokenization is said to open up investment opportunities, democratizing finance.Footnote 36
Due to the tokenization craze,Footnote 37 the significant funds being deployed to support the NFT market,Footnote 38 and the many assertions (from a variety of directions) about what rights a token holder actually acquires in the underlying thing,Footnote 39 it is inevitable that issues about tokenization and property rights will end up before courts.Footnote 40 With this prospect, this chapter endeavors to take a more sober look at the tokenization phenomenon and, in doing so, to describe what exactly it means for property rights. What can a purchaser of a token expect? How is a token connected (or, as we say, tethered) to the underlying asset, if at all? What does the law – not the hype – have to say about it? These are the issues this chapter explores. This chapter also discusses how the recent revisions to the Uniform Commercial Code, which the American Law Institute and Uniform Law Commission promulgated in 2022Footnote 41 to address emerged and emerging technologies, will impact NFT transactions.
1.1 Tokenization in the Law
Before one can understand what NFTs are – in other words, what these contemporary tokenizations are really doing – one must understand tokenization as a legal concept. Having a background in how the law conceptualizes tokenizing something, in turn, helps to see what NFTs can and cannot be under existing property law and related frameworks.
There is already law around the idea of tokenization.Footnote 42 While not always referred to by this name, doctrinal tokenization has been happening for many centuries. Specifically, legal concepts have developed to recognize that a single thing can be configured to represent rights, such as property rights, in something else. The following furnishes the bedrock examples of doctrinal tokenization: the law of negotiable instruments, the law of securities, the law of deeds, and the law of bills of lading. These examples illustrate bodies of law that recognize the fact that possession or control of one thing, usually a piece of paper, may convey certain exclusive or relative rights in something else, which may be either an intangible right or a tangible asset.
1.1.1 Negotiable Instruments
Negotiable instruments law is first because it is perhaps the most famous example of tokenization. This body of law provides that pieces of paper that satisfy listed requirements as to formFootnote 43 confer different rights from those conferred by an ordinary contract written on paper. The paper not only evidences a debt owed, but also an easily transferrable and highly liquid debt.Footnote 44 Article 3 of the Uniform Commercial Code (UCC) reifies payment rights in such paper, providing that a person who possesses the paper has the right to enforce the payment right evidenced by that instrument.Footnote 45
As with all tokenized property, the tokenization of debts in negotiable instruments satisfied a commercial need. The idea of using a tangible item of little worth to represent monetary value dates to ancient times. Importantly, this representation solved a practical problem. Ancient coins were heavy, and it was not safe to transport large amounts of them, so traders accepted skins, leather, silks, and other textiles as currency.Footnote 46
Negotiable bills of exchange, the precursors to today’s checks, emerged in the fourteenth century.Footnote 47 The early bill of exchange was a letter addressed from one party to another directing the addressee to pay a third person a sum of money.Footnote 48 These instruments addressed a problem created by counterfeiting. To lessen the reach of counterfeiting, some countries, such as England, limited the exportation of their currency.Footnote 49 The need to assign debts as payment was particularly acute in commercial transactions involving parties from such countries. In countries such as England, the negotiable bill of exchange thus facilitated trade transactions that crossed national borders.Footnote 50
The industrial revolution served as the catalyst for developing the negotiable instrument principles that remain in effect today. The money supply at the time was insufficient to allow for cash payments in the growing number of commercial transactions spawned by industrialization.Footnote 51 As a result, parties in commerce invented their own paper currency substitute based on the bill of exchange.Footnote 52 This money substitute came in the form of a draft in which the seller would order a buyer to pay a specified sum of money to a third person.Footnote 53 This paper, which could pass from hand to hand to pay such debts, supplemented the inadequate money supply.Footnote 54
The large-scale problem that had to be solved to give instruments value as money substitutes was assignability.Footnote 55 Ancient systems of law did not allow one person to represent another before a tribunal, nor did they allow creditors to assign their rights against their debtor to another person.Footnote 56 Since these creditor rights (called choses in actionFootnote 57) were not assignable at common law, the primary goal of early English negotiable instruments law may have been to make debts assignable.Footnote 58 The law’s development of a method of assignment, which ensured the right to payment to any person presenting the instrument for payment, supports this notion.Footnote 59
To substitute for currency, the paper had to satisfy a number of requirements that now form the basis of negotiable instrument law. In passing from person to person in a worldwide market, these instruments ended up in the possession of a person who had no knowledge of the transaction that created the instrument.Footnote 60 The negotiable instrument principles that endure today ensure that the ultimate holder, the one who wants to exchange the instrument for government-backed money, will receive a sum ascertainable from the face of the instrument.
For paper to serve as a medium of exchange, it must be easy to determine the value of that paper. The paper itself would not be acceptable as payment if its value was not easily ascertainable.Footnote 61 The paper payment devices developed over the centuries could not effectively serve as payment for goods and services without meeting what we now recognize as the requisites of negotiability.Footnote 62 To qualify as a negotiable instrument in American law today, the paper must show that the right to payment is unconditional, for a fixed amount, due on demand or at a definite time, and payable either to the bearer or to a named person.Footnote 63
After resolving the assignment problem, determining priority between obligees became important. Since a right to payment is intangible, the law had to develop a way to determine who had the prior right to payment if the obligee assigned the payment right twice (the double-dealing problem). Tokenization, or reification,Footnote 64 solved this problem. Once the payment right was reified in the paper, the person holding the token, in this case the paper, had a better right to payment than anyone else.Footnote 65
An important concept of negotiable instrument law is holder in due course status. When a person takes a negotiable instrument for value, in good faith, and without notice of any forgery or claims to the instrument, that person takes the instrument free of any defenses of the person obligated to pay the instrument.Footnote 66 This status gives value to the token; a person can buy a payment right and know the value of that right by looking at the token instrument.
1.1.2 Securities
The tokenization of securities also has a long history, and, like negotiable instruments, developed to address a particular economic problem. This form of tokenization dates back to the small, but often very wealthy, city-states of the Italian peninsula and other nearby commercial centers in the 1100s and 1200s.Footnote 67 For example, the French Société des Moulins de Bazacle, a mill system association in Toulouse owned by the citizens of the town, issued shares in the form of certificates.Footnote 68 Those certificates indicated on their face that the bearer of the certificate held the share rights in the association; in other words, whoever possessed the certificate had the rights of an association member and could participate in mill decision-making.Footnote 69 The certificate was a kind of token for rights in the association. Then, in the early 1600s, the Dutch East India Company issued, for supposedly the first time ever, true equity shares to the public.Footnote 70 The shares did not come in the form of actual certificates like the Bazacle shares,Footnote 71 but the use of certificate-like receipts called “deeds of bargain and sale” – used in connection with the company’s official share ledger – became integral in facilitating the exchange of Dutch East India Company shares.Footnote 72 The buyer would pay for the shares and the seller would furnish a deed of bargain and sale.Footnote 73 The buyer would then bring the deed to the company’s corporate office and have the transfer formally consummated.Footnote 74
In the late 1800s, commercial parties recognized the need for legal reform in securities law and set about bringing corporate tokenization into effect.Footnote 75 To facilitate numerous and quick transactions involving the transfer of corporate stock, the legal rules changed so that it was no longer necessary to bring a certificate to the corporation’s office and have the owner’s name changed in the official records.Footnote 76 Instead, there would be true tokenization – reification to a degree that would provide easy assignability of the security from one party to another.Footnote 77 Thus, only the holder of the certificate held the relevant rights in the referenced thing – in this case, the corporation – and that holder could easily transfer the token and thereby effect a transfer of the corporate rights.Footnote 78
Today, the UCC again provides the framework for these tokenized securities – known as certificated securities, namely stock and bonds evidenced by a piece of paper.Footnote 79 The law allows for denominating such certificated securities as either bearer securities or registered securities.Footnote 80 If in bearer form,Footnote 81 then the person who “acquires possession”Footnote 82 of the certificate acquires the rights in the security.Footnote 83 If in registered form, then the certificate will indicate its holder’s name.Footnote 84 To transfer the rights in it to another person, the certificate must be indorsed (typically signed) by the holder and then delivered into the possession of the new holder.Footnote 85 Regardless of its form, the certificated security remains a tangible token. Becoming the holder of the physical token gives the person rights to the underlying asset: the security. Tokenization solved the problem of high-volume assignability. Tokens could pass from hand to hand and the corporate rights followed.
Until the second half of the twentieth century, securities remained in certificated form.Footnote 86 Eventually, however, the continued and widespread use of paper, or paper tokens, went out of vogue. It became extremely cumbersome and inefficient to actually deliver the certificates to many individuals at great distances throughout a trading day.Footnote 87 In fact, the late 1960s and 1970s saw a so-called paperwork crisis that necessitated shortening trading days to give time for trading staff to catch up; transfer and recording errors abounded during this period.Footnote 88 The answer was for the law to also allow for the creation of intangible tokens, now known in the Uniform Commercial Code as uncertificated securities.Footnote 89
Transfers of such tokens occur by having the name of the owner changed in the official records of the company, rather than by a change in physical possession.Footnote 90 In essence, this dynamic created a precursor to digital possession, which is largely referred to as control. Rather than possessing the token (and thereby acquiring referenced rights), one would control the token by having it associated with them in an official ledger.Footnote 91 The controller of the token acquired the legal rights in it. Having the legal rights in the token gave the holder rights in the corporation.
Control over securities developed even more in the second half of the twentieth century with the indirect holding of these tokens.Footnote 92 In 1973, the Depository Trust Company came into existence to accept deposits of certificated securities issued by publicly traded companies.Footnote 93 Although designated as the owner of the securities, this depository company merely held them for others – specifically, on behalf of other intermediary parties (such as banks and broker-dealer firms).Footnote 94 In turn, individual investors had so-called brokerage accounts with these one-step-removed intermediaries, such as Charles Schwab, Vanguard, and the like.Footnote 95 The UCC, through Article 8’s rules on securities entitlements, memorializes this ownership concept,Footnote 96 which dominates public securities trading to this day.Footnote 97
In sum, despite the desire to move away from tangible tokens, there remained a need to maintain the token itself as an authoritative object, even if rights in it could be acquired through new, indirect means. The holder of the securities entitlement – a token itself – holds the rights in the shares of the corporation – yet another token – and, in turn, has rights in the corporation – the underlying thing. Although holding the token evolved so that it now includes control of an intangible thing, the existence and continued recognition of tokens persist in securities law because they still serve a useful economic purpose.
1.1.3 Deeds of Real Property
Deeds of real property provide yet another instance of tokenization under the law. In Anglo-American law, the transfer of an interest in real property could happen without a writing through a ceremony-laden process known as feoffment with livery of seisin.Footnote 98 This transfer took place, as first year property law students know all too well, through the formal delivery of possession of the land from the grantor to the grantee.Footnote 99 The grantor at the ceremony needed only say as little as “I enfeoff thee and thy heirs forever of black acre” to consummate the transaction.Footnote 100
Over time, however, there was a recognition that these transactions needed evidence of their occurrence. English courts generally suffered from a certain level of deception in their proceedings, with perjury and the use of so-called professional witnesses (individuals who hung around the court house waiting to swear to anything for a price) being all too common.Footnote 101 For this reason and others related to it, the result was that some individuals began executing a document – often called a deed or charter of feoffment – that did not replace the ceremony and oral transfer, but instead served as after-the-fact evidence of it, using language in the past tense.Footnote 102
The need-for-a-token problem in land transactions, however, eventually became a problem of public administration. English revenue officials needed a better way to determine when property had changed hands and triggered tax implications.Footnote 103 So, in 1536, the English statute of enrolmentsFootnote 104 came into effect, which required so-called bargain and saleFootnote 105 transactions of freehold interests in real property to occur in writing under seal, with the document thereafter recorded in a land records registry.Footnote 106 From this point onward, a transfer of this particular type of legal interest in land – although not as prevalent as other types of transfer at the time, such as leaseholdsFootnote 107 – required a written document to memorialize the transaction.Footnote 108 Indeed, a token was required.
Finally, in 1677, the English Parliament passed the famous Statute of Frauds.Footnote 109 It, like the statutes of frauds later passed in the various jurisdictions that now comprise the United States,Footnote 110 provided that the transfer of any interest in land required a written instrument.Footnote 111 The purpose of the law, as the name so aptly suggests, was to prevent “frauds and perjuries by requiring in many cases written evidence of a contract.”Footnote 112 The token, or rather, a deed, served that purpose.
To be sure, deeds are not tokens in an absolute sense. It was and is possible to acquire title to real property without a deed. For example, one may become the owner of real property through intestate inheritance, the rights of a spouse, or adverse possession for the required period of time.Footnote 113 However, deeds created an efficient way of establishing the relative rights of parties in voluntary land transactions. Aside from the exceptions, a deed was necessary to convey real property interests, doing so efficiently through notice rules. The original common law rule simply provided that one who acquired real property through a deed had superior title to any subsequent party who also purported to acquire title to that same property via a deed.Footnote 114 Over time, this general rule underwent modifications through the introduction of recording system statutes that incentivized grantees to make their deeds known, typically by recording them in a public registry of land transfers.Footnote 115 The token, the deed, showed that the transaction had actually occurred and served as the foundation for a property recording system inspectable by the public – essentially, a public repository of land tokens. Today, the holder of the token, the deed, is the holder of the rights in the real property relative to others also claiming title through a deed. The token embodies rights in the land and, with notice rules, works to moderate land title disputes.
1.1.4 Bills of Lading
Yet another example of tokens in the law is the bill of lading, a document that a carrier of goods issues upon receipt of goods set for shipment.Footnote 116 The document contains certain information about the goods, the parties, the destination of the goods, and any special terms about the delivery.Footnote 117 If the bill of lading indicates to whom the goods should be delivered when they reach their destination (called a straight bill of lading because it is nonnegotiable), then the carrier may only deliver the goods to that person.Footnote 118 However, if the bill of lading is negotiable, then the carrier must deliver the goods to whomever possesses the document and is indicated on its face.Footnote 119
In this way, the bill of lading controls who receives possession of the goods. Specifically, a bill of lading is a type of document of title.Footnote 120 Hence, it controls ownership of the goods while in transit.Footnote 121 The bill of lading is a token for the goods. The law gives legal recognition to the bill of lading’s role through Article 7 of the UCC and under the Federal Bill of Lading Act.Footnote 122
Like with the other examples of legal tokenization, the bill of lading emerged to solve a very specific problem relationship between distant parties in a commercial sales transaction.Footnote 123 For example, the buyer of goods desires to purchase them from a commercial seller, but the two parties are unfamiliar with each other.Footnote 124 The seller is uncertain of the buyer’s ability to pay for the goods, which the buyer will not pay for until they actually receive and inspect them.Footnote 125 The seller, of course, is hesitant to ship goods without receiving some form of payment.Footnote 126 So, to solve this issue, the seller ships the goods to the buyer through a commercial carrier.Footnote 127 At the time of shipment, the carrier issues a bill of lading, which can be made out, for example, to the seller or its agent.Footnote 128 The goods are shipped and, at the same time, the seller sends the bill of lading ahead to his own agent who awaits delivery at the destination location.Footnote 129 Upon taking delivery of the goods, the seller’s agent meets with the buyer to negotiate over the bill of lading in exchange for payment.Footnote 130 This way, the seller maintains legal control of the goods until payment.Footnote 131 With the bill of lading now in hand, the buyer can direct the carrier to deliver the goods.Footnote 132
In essence, the chief function of the bill of lading is to serve as “a legal embodiment of the rights to the goods described therein.”Footnote 133 It is a true token – it embodies the legal rights in the goods shipped.Footnote 134 The carrier will only deliver the goods to the person designated in the document.Footnote 135 The bill of lading is the token and the holder of it has the exclusive rights in the goods.
* * * *
1.2 NFTs and Tokenization’s Mismatch
Each of the tokenization examples described in Part I arose from a commercial need. This Chapter acknowledges that the use of the internet in commercial transactions has created a need for digital uniqueness because copyright-protected works can be copied perfectly online.Footnote 136 Although digital uniqueness is a noble goal, this Part will show that NFTs, at least as currently structured, do not provide that uniqueness for the underlying asset. The key to a true token is that the transfer system for the token provides a method of transferring the intangible rights embodied in the token.Footnote 137 This Part also explains that current law does not give NFTs tethering effects – specifically, that the current system of property and commercial law does not provide the legal tethering of the NFT to another asset. Of course, just because current law does not provide tethering effects does not mean that it could not. Indeed, as noted in Part I, all the current forms of legal tokens stem from commercial practices that the law eventually recognized. For example, the trading of paper notes as a substitute for currency was a commercial activity that worked in practice among merchants, and so eventually received legal effect by the courts.Footnote 138 But as currently constituted in the marketplace, the theoretical justifications for doing the same with NFTs are dim.Footnote 139
1.2.1 NFTs are Not Tethering
First, NFTs do not actually embody property rights in a reference asset. As this Chapter notes, promoters of these tokens say that they can establish “an immutable record of ownership” and will allow for the purchase of fractional rights in an underlying asset.Footnote 140 In other words, ownership of the token conveys ownership of something else. But NFTs, as currently constituted, do no such thing. They are not tethering – they do not embody property rights in a reference thing.
The many kinds of legal tokens discussed in Part I actually serve a tethering function.Footnote 141 The deed has a legal connection to the land it describes.Footnote 142 It serves as the vehicle to convey property rights in the land (the underlying/reference asset).Footnote 143 And, when proper notice is given of such a conveyance, the deed actually creates superior property rights relative to certain other classes of persons claiming rights in the same land.Footnote 144 Negotiable instruments have a similar tethering function.Footnote 145 The party that enjoys the status of holder of the instrument, which includes having possession of it, acquires a particular set of rights in the underlying debt – specifically, the ability to enforce it against the debtor under the instrument and to avoid most defenses that the debtor can raise.Footnote 146
But in the case of NFTs, there is no tethering. Creating an NFT of another thing – whether tangible or intangible – creates no legal link as is created with the examples in Part I. The creation of an NFT and its purchase by a third person, without more, conveys no actual rights in the digital painting.
Despite this legal reality, the NFT minting and auctioning platforms suggest that the owner of an NFT owns not only the NFT but the reference asset. Sometimes these platforms make representations on their websites inconsistent with their well-hidden terms of service. One example is the Rarible platform. On Rarible’s “What is an NFT?” page, it explains that NFTs prove ownership of a digital asset, such as digital artwork, and that before the development of NFTs, digital assets “were like photocopies.”Footnote 147 The Terms and Conditions tell a more complicated story, however. The terms refer to the minting of “Collectibles,” defined as the creator’s content, such as artwork, and the NFT.Footnote 148 However, after this definition, the terms regularly describe the two as separate assets. Most importantly, the terms subsequently define “Collectible Image” as the image file associated with the Collectible, and place the Collectible Image within the category of “Collectible Metadata.”Footnote 149 After the terms define the components of the NFT, they disclaim any tether between the NFT and the underlying creative work by stating that:
In the absence of an express legal agreement between the creator of any Collectibles and purchasers of Collectibles, there cannot be any guarantee or assurance that the purchase or holding of Collectibles confers any license to or ownership of the Collectible Metadata or other intellectual property associated with Collectibles or any other right or entitlement, notwithstanding that you may rightfully own or possess the Collectible.Footnote 150
One can find another example of the confusion created by NFT terms in the Terms and Conditions for the Bored Ape Yacht Club.Footnote 151 Bored Apes, as mentioned in the Introduction, made headlines several times in 2022. In May, actor Seth Green “was robbed of” several Bored Apes that he had planned to use in an upcoming animated series,Footnote 152 and in August, rappers Snoop Dogg and Eminem performed as their Bored Ape avatars at the Video Music Awards.Footnote 153 The Terms and Conditions provide a confusing and nonsensical mash of license and ownership rights to the holder of a Bored Ape NFT.
The Bored Ape Terms and Conditions are short and written in clear language. Clarity stops there, however. The first paragraph of the “Ownership” section tells the buyer of a Bored Ape NFT that “you own the underlying Bored Ape, the Art, completely.”Footnote 154 The second and third paragraphs, governing personal use and commercial use of the Bored Apes, appear to take away some of that “complete” ownership by stating that the developer, Yuga Labs, grants the buyer an “unlimited, worldwide license to use, copy, and display the Art” for a variety of purposes.Footnote 155 If viewed as Yuga Labs transferring ownership of the Art completely, it is hard to understand how it retains rights sufficient to license the Art. It is possible that Yuga Labs means to distinguish between the Art as “thing,” or the NFT, and the intellectual property rights in the Art, much in the same way that the purchaser of a painting does not receive intellectual property rights in that painting, but may, under copyright’s first sale doctrine, transfer the painting to another person.Footnote 156 But an owner of a tangible work of art has the right to exclude others from enjoying that art. An owner of a Bored Ape NFT has no ability to exclude others from enjoying the Bored Ape, as anyone can see it by clicking on the provenance link for any Bored Ape on the Bored Ape Yacht Club website.Footnote 157
The terms of service themselves hardly make clear what the company otherwise promises the users. If it is true that the token establishes ownership of an external asset, then one can only reach this conclusion through a very creative reading of the contract text. Moreover – unlike the examples of tokenization in Part I – there is no actual, current law that would give an NFT such a tethering effect. In all the examples of legal tokenization, there was an underlying law. With negotiable instruments, it is Article 3 of the UCC.Footnote 158 With securities, it is state corporate law and Article 8 of the UCC.Footnote 159 With deeds, it is the common law of property and subsequently specialized state statutes.Footnote 160 The tethering that occurs under bills of lading is also due to state and federal law.Footnote 161 No tethering is occurring merely because a contract says so – although it is again noted that while many of these platform websites say tethering occurs, the terms of service conflict or confuse the issue entirely.Footnote 162 In any event, legal recognition is needed and there is none when it comes to NFTs.
To that point, there is reason to be skeptical that legal recognition is forthcoming. Throughout history, legal rules developed when markets matured. New technologies give rise to individualism. The development of cyberspace in the late twentieth century is a memorable example of this phenomenon; internet entrepreneurs often claimed that cyberspace meant the end of rules by national governments.Footnote 163 The same sentiment permeates the words of those who promote cryptocurrenciesFootnote 164 and NFTs.Footnote 165 These entrepreneurs come back to governments for rules because governments can protect their property rights and “keep the pirates at bay.”Footnote 166 The problem with NFTs, however, is that the only property right to protect is in the token itself, not the underlying asset.Footnote 167
1.2.2 The Problem: Non-rivalrousness. The Solution: Not an NFT
Non-rivalrousness poses challenges to creators of artistic works. Unlike a tangible asset, such as a chair, and some intangible assets, such as internet domain names, creative works, such as music, can be enjoyed by many people at once. If one person listens to a song, another person can listen to it at the same time without diminishing the quality of the song.Footnote 168 If one person views digital art on their computer, another person can view the same piece on their computer. Since many people can enjoy and copy creative works, creators can be hindered from earning money from their work.Footnote 169 The non-rivalrousness of creative works is one justification for copyright protection, which gives creators control over the use of their creations.Footnote 170
Pre-internet, a copy of a work was likely an imperfect copy. The internet exacerbated the need to protect copyrighted musical recordings, as its emergence presented great problems in the music community, particularly the unauthorized distribution of perfect copies.Footnote 171
Creators of visual works, however, never relied much on copyright to protect the value of their works. Broadly speaking, a painting consists of two sets of property elements: the intellectual property rights embodied in the work protected by copyright and traditional property rights represented by the physical manifestation of the piece. A purchaser of a painting obtains the latter rights, while the creator retains the former.Footnote 172 And indeed, some maintain that visual artists do not even need copyright to protect their works because the value in tangible visual art rests in their uniqueness or in limited editions.Footnote 173
Enter the internet. As with music, it is possible to make a perfect copy of a digital work of art. More importantly, there is no such thing as a unique copy of a digital file. Thus, because the visual art market thrives on scarcity, and there is no scarcity when the art is digital, there is a concern that visual artists who work only in a digital format will have difficulty monetizing their works.Footnote 174 This concern presents the problem that NFTs purportedly solve, raising the question of whether they, in fact, solve the problem.
Digital visual art lacks rivalrousness, as it can be viewed on many computers at once. One way that digital artists can monetize their work is by presenting the work in a way that ensures rivalrousness. One such method is by embedding that work in a unique physical manifestation. The hip-hop group Wu-Tang Clan did exactly that in 2015, producing one copy of its album “Once Upon a Time in Shaolin” and selling it in an ornate hand-carved box that contained the album, a leather-bound book of the lyrics, and a history of each of the album’s 31 songs.Footnote 175
The art world has solved rivalrousness problems before without resorting to new technologies. Conceptual art is an art form that consists of the creator’s idea combined with instructions about how to present the work.Footnote 176 Museums and collectors have bought conceptual art for millions of dollars.Footnote 177 That anyone would pay that much for an idea executable by almost anyone seems absurd, but the art market has found a way to make such works of art effectively rivalrous. Participants in the art market do so by agreements under which only one person or entity can display the work at a time.Footnote 178 Since everyone in the art market respects these agreements, the presentation of a conceptual artwork is rivalrous, and collectors will pay large amounts of money to have the right to present.Footnote 179
If the scarcity provided by rivalrousness is the goal, NFTs do not achieve it. Here, it is useful to discuss protecting the rights of both the creator of the digital artwork and the purchaser of the artwork. The former’s rights are intellectual property rights, including the right to control reproduction of the work and its distribution. The latter’s rights are economic and traditionally tied to the ability to claim ownership of a unique work.
NFTs do nothing to address the artist’s intellectual property rights. As discussed earlier in this Article, most contracts governing NFTs leave the creator’s intellectual property rights intact. The creator retains the right to control copying and distribution of the creative work, just as the creator could before minting the NFT. Blockchain may have a role in protecting creators’ intellectual property rights; at least some commentators posit that a blockchain-based copyright registry would more reliably provide information about the ownership of copyrights than the existing system maintained by the United States Copyright Office.Footnote 180
An owner’s rights in a physical artwork receive protection from ordinary property concepts. Scarcity gives value. But NFTs do not mimic these property concepts and, as a result, do not provide the real or artificial scarcity on which the art market thrives. The contracts to which NFT creators and buyers agree do not give the holder of the NFT any right to control the underlying asset.Footnote 181 At best, and only when digital assets are endogenous to the NFT, the use of computer code can show some degree of provenance.Footnote 182 “Endogenous to the NFT” means, in this case, those instances (such as with our digital painting) where the underlying digital asset and the NFT are integrated on the ledger such that the association between a given person (through their cryptographic key) and the digital asset is embedded in the metadata. Therefore, even if someone else made a perfect digital replica of the painting, the code of that image file would not have the chain of title imprint embedded within.Footnote 183
But, more broadly, many of the works transformed into NFTs are freely available for download by anyone with a computer – including the authors’ own digital image of the bovine oil painting referenced above. In another instance, a New York Times technology columnist turned a column about creating an NFT into an NFT.Footnote 184 NFTs created a market for internet memes, items that are, by definition, spread widely online.Footnote 185
Tokens evolved to solve practical problems related to the transfer and ownership of assets. Although NFTs emerged in the digital art world, they do not solve any of the most decried problems related to digital art. If the problem for digital artists is an inability to profit from their works because of a lack of scarcity, tokenization is not the answer. The NFT craze has enabled artists to profit from their works, but there is reason to be skeptical that this will last when participants in the NFT market realize that their NFTs give them no rights in the underlying creative works.
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1.3 NFT Transactions and Policy Implications
This chapter endeavors, as noted in the Introduction, to not only orient readers to the world of NFTs and commercial transactions, but also to assist courts and private parties as they deal with transactions involving NFTs in the marketplace. This final Part III places NFTs within the context of commercial law and then turns to the 2022 amendments to the UCC to show how recent changes in this body of law impact NFTs – as well as how they do not.
1.3.1 NFT Markets and Legal Effects
This section sets forth two example transactions involving NFTs that parties have and are predicted to enter (and which courts will have to deal with). In doing so, this Section shows how the law should treat these deals and what the outcomes would be. Recall that, as described in Part I, legal tokens entail that the holder has rights in some kind of underlying thing. The transfer of a negotiable instrument enables the new holder the right to enforce the instrument against the obligee.Footnote 186 The transfer of a security enables the new holder the economic and governance rights in the corporate entity to which the security relates.Footnote 187 The transfer of a bill of lading allows the transferee the right to possess the goods – essentially, ownership of them.Footnote 188 The list goes on – the transferee of a true, legal token gets something. However, the transferee of an NFT gets nothing in terms of a tethered asset. And indeed, sometimes it is not certain that the transferee even gets the NFT.Footnote 189
1.3.1.1 Sales and NFTs
The first example transaction is perhaps no surprise considering that this is the dominant type of NFT transaction in today’s market – the sale. The auction process on NFT sites like Mintable, Foundation, and others is all about a buyer purchasing an NFT with cryptocurrency. The idea, as noted in Part I, is that the person who purchases the NFT acquires two things: (i) the NFT itself and (ii) the reference asset. This writing does not address the sale of only the NFT. In a recent article, Professor Joshua Fairfield addresses the issues around such sales – specifically whether the sale of an NFT should be treated as the transfer of contract rightsFootnote 190 or the transfer of a right in personal property.Footnote 191 In contrast, this Section focuses on the arguably more lauded aspect of NFT transfers – the acquisition of rights in the reference thing by virtue of acquisition of the NFT.
Imagine that a seller owns a sculpture (a tangible asset). Seller then mints a digital token in connection with this sculpture, intending, as the minting platform provides,Footnote 192 for the digital token to embody ownership in the sculpture. The NFT’s auction page includes a picture of the sculpture, and the item description gives the name and medium of the work. Seller then conveys the NFT to Buyer 1 through the platform’s auction process. After the transaction is complete, but before Buyer 1 obtains delivery of the sculpture, Seller sells the sculpture to Buyer 2, who takes delivery of it at the time of sale. The question then becomes: between Buyer 1 and Buyer 2, who has superior rights in the sculpture? Is it Buyer 1 who purchased the NFT and did so first in time, or is it Buyer 2 who purchased the sculpture directly, although second in time?
The answer is clearly that Buyer 2 wins. The sale of the NFT did not transfer anything to Buyer 1 (except for the NFT itself). The reason for this is that there is nothing tethering about the NFT that would create a legal connection between it and the sculpture. Merely uploading a picture of the sculpture alongside the NFT does not change this, despite what the minting platform may say. The law does not give legal effect to the NFT as a true token. Thus, a transfer of the token transfers nothing else.
Even when the facts are changed to be slightly more favorable to Buyer 1, the result is likely the same. As part of the marketing of the NFT, Seller actually represents in the item description that whoever wins the auction for the NFT will become the owner of the sculpture. Here, the promise related to the sale of the sculpture is express, rather than implied. Assume that when Buyer 1 wins the NFT, this (combined with Seller’s representation) creates a separate contract of sale of the sculpture (a sale by e-contractFootnote 193 and not by virtue of merely acquiring the NFT). Yet again, if Buyer 2 takes possession of the sculpture before Buyer 1, Buyer 2 still wins.
This is because, absent true tokenization, the sale of tangible personal property (the sculpture) can only be completed by delivery.Footnote 194 Until such time, although the sale may be effective between the seller and the buyer, it will have no effect as to anyone else.Footnote 195 The issue can then arise that a seller conveys personal property to one person, who does not yet take delivery, and then conveys that same property to someone else, who does take possession. The rule, long articulated by U.S. courts, is that “[a]s between two bona fide purchasers of the same chattels,” the one “who first obtains delivery and possession of them has the better title against the other.”Footnote 196 This is true “notwithstanding the contract of sale of the [second buyer] with the vendor may have been prior in point of time to that of the [first buyer].”Footnote 197
Applying this rule, Buyer 2 will typically win. All Buyer 2 must do is receive possession first and be a bona fide purchaser.Footnote 198 To be such a purchaser (often also called a good-faith purchaser), one must typically give value to the seller with the belief that the seller possesses the authority to convey the thing, as well as acquire the thing under facts and circumstances that would not make the buyer inquire about the seller’s title or right to sell.Footnote 199
In typical arms-length transactions involving strangers, Buyer 2 will easily meet these requirements. Buyer 2 will reasonably assume that Seller owns the sculpture if Seller possesses it, and, absent clues to suggest otherwise, Buyer 2 is under no obligation to inquire about Seller’s title.Footnote 200 Even the requirement of giving value is construed to be rather nominal.Footnote 201 Assuming that Buyer 2 does not know about the transaction with Buyer 1, then Buyer 2, who takes possession of the sculpture first, will prevail over Buyer 1. Now, of course, this does not mean that Buyer 1 is without a remedy. Buyer 1 will have a breach-of-contract claim against Seller,Footnote 202 but Buyer 1 will not be able to receive the remedy Buyer 1 really wants – ownership of the sculpture. And the primary reason for this is, once again, that the NFT is not a true token. Transfer of the token does not transfer rights to anything else.
1.3.1.2 Secured Credit and NFTs
The non-tethering nature of NFTs also poses a problem for secured creditors. A person with an NFT might want to borrow against it, and the transaction in which an NFT would serve as collateral for a loan would be governed under Article 9 of the UCC.Footnote 203 In 2019, the sponsoring entities of the UCC, the American Law Institute, and the Uniform Law Commission, appointed a committee to draft amendments to the UCC to accommodate emerging and emerged technologies.Footnote 204 The 2022 amendments to the UCC clarify the rules governing the creation and perfection of security interests in digital assets, including but not limited to cryptocurrencies and NFTs.Footnote 205 Until those amendments are enacted by states, the existing version of Article 9 will govern lending transactions involving NFTs.
Under the current version of Article 9, an NFT is a general intangible. “General intangible” is a catch-all term under the UCC; it encompasses all assets that do not fall into any other Article 9 definition.Footnote 206 Because an NFT is neither a good, a payment right, a security, nor any other type of Article 9 collateral, it is a general intangible. As a result, a secured party can perfect its interest in the NFT only by filing a financing statement in the applicable government office in the state in which the NFT’s owner is located.Footnote 207
Such a perfected security interest, however, would not likely be satisfactory to a secured creditor for two reasons. The first is that it would not convey any right in the reference asset. The second is that there is no easy way to enforce the security interest in the NFT.
Part I of this chapter discussed other tokens. The law recognizes that each of these tokens grants rights in something else to the person in possession of the token. Article 9 of the UCC respects the non-UCC classification of rights. This respect for general property principles is implicit in the UCC definitions and in the general requisites for creating a security interest. The UCC defines “[s]ecurity interest” as “an interest in personal property … which secures payment or performance of an obligation.”Footnote 208 Article 9 defines “[c]ollateral” as “the property subject to a security interest.”Footnote 209 One of the requirements for creation of a security interest is that the debtor have “rights in the collateral.”Footnote 210 Under all of those definitions, the collateral would be the token itself.
Article 9 also respects “linked” collateral. For example, for a promissory note secured by a property interest in an asset, the creation of a security interest in the note also creates a security interest in the lien.Footnote 211 This arrangement is a codification of the long-standing principle that the mortgage follows the note.Footnote 212 There is a practical reason that the property interests in the mortgage and note are inextricably linked: without the note that evidences the obligation to pay, the mortgage is ineffective, and without the mortgage that secures the note, the note is unsecured.Footnote 213 Because the creation of a security interest conveys the property rights in collateral recognized by other law, the UCC thus provides that a security interest in a mortgage is a security interest in the note secured by that mortgage. One right follows the other.
Another example of linked, or tokenized, collateral is when goods are in the possession of a bailee that has issued a document of title covering those goods. Part I discussed bills of lading as tokens.Footnote 214 As discussed in that Part, a person to whom a document of title, such as a bill of lading, is negotiated obtains title to both the document and the goods covered by the document.Footnote 215 Because title to the goods is embodied in the document, the UCC provides that the perfection of a security interest in a negotiable document of title perfects the creditor’s security interest in the covered goods.Footnote 216
As illustrated throughout this chapter, there is no property link between an NFT and its reference asset. All an NFT does is refer to the underlying asset; it gives no rights, including priority rights, in that asset. As a result, a security interest in an NFT will give the lender a lien only on the token itself, not on any related asset (and, in most cases, it is the related asset that has the real value that the lender really wants).
Assuming that a secure creditor will be satisfied by a lien on the token, that creditor will face hurdles in enforcing that lien. A secured party can take possession of collateral upon the debtor’s default,Footnote 217 but NFTs, as intangible assets, are not possessable collateral.Footnote 218 Another UCC Article 9 enforcement section allows a secured party to notify “an account debtor or other person obligated on collateral” to pay or otherwise perform for the creditor upon default.Footnote 219 While this provision could arguably apply to NFT collateral because the definition of account debtor includes a person obligated on a general intangible,Footnote 220 there are several stumbling blocks. The first is that the collection remedy has no teeth when the collateral is a general intangible. Article 9 permits an account debtor to continue to pay the debtor until it receives notification from the secured party that the secured party should receive payment instead.Footnote 221 If the account debtor pays the debtor after that notification, its obligation to pay will not be discharged.Footnote 222 The term “pay” is used deliberately; the remedy given to a secured party with a security interest in intangibles only has teeth when the collateral is a payment right.Footnote 223
Even assuming that the existing enforcement provision could be effective, there is a second hurdle. As explained in the description of the terms of service governing NFTs, it is not clear who the account debtor is. The NFT minting platforms all deny that they have any control over the NFTs, although they reserve the right to deny the NFT owner access to the token for various breaches of the terms of service.Footnote 224 Even if the platforms can deny access to the token owner, it is unlikely that they can transfer the tokens, which exist on the Ethereum blockchain. This dynamic raises a further question: who would receive notification of the default, and how would that entity turn the token over to the secured party?
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1.3.2 Article 12 and the 2022 UCC Amendments
In 2022 the UCC amendments described above were promulgated effect and, as of this writing, available to all states for enactment. The amendments added a twelfth article to the UCC, which governs the transfer of “controllable electronic records.” The amendments also revise Article 9 to accommodate financing secured by controllable electronic records.Footnote 225
The Study Committee on the Uniform Commercial Code and Emerging Technologies formed in 2019 to study the entire UCC to recommend amendments to accommodate technological developments that emerged since the last major revision to the UCC, namely the Article 9 amendments that became effective in 2001. Finding that charge too broad, the committee focused on a subset of digital assets that the committee named “controllable electronic records.”Footnote 226 Although the committee intended to use this term in a technologically neutral way, one of the driving forces behind the UCC amendments was the aspiration in some states, led by Wyoming and fueled by lobbying by the crypto industry, to enact laws to clarify property rights in cryptocurrencies.Footnote 227 States wanted to attract cryptocurrency businesses by enacting laws intended to clarify the transfer and use of cryptocurrencies as collateral for loans.Footnote 228 There were two consequences of crypto-specific commercial laws enacted by individual states – laws that rendered the Uniform Commercial Code non-uniform, and questions regarding the law that a court would choose in a dispute over cryptocurrency. The 2022 Amendments to the UCC solve both of those problems.
Participants in businesses that transact in digital, or crypto, assets expressed a desire that those assets be as negotiable as negotiable instruments. To achieve that goal, the 2022 Amendments had to: provide a mechanism by which a person, be it a buyer or a lender, could “possess” the asset, and provide a rule that a good faith transferee of that asset for value could take that asset free from competing property claims if it took such possession of that asset.
The UCC Amendments do both in a new Article 12. Article 12 uses the term “control” to provide an electronic analogue to possession, an approach consistent with Articles 8 and 9 of the UCC. To have control of a controllable electronic record (CER), the CER, a record attached to the CER, or a CER recording system must give the person: i) the power to enjoy “substantially all of the benefit of the CER,” ii) the “exclusive power to prevent others” from enjoying the benefits of the CER, and iii) the ability to “transfer control of the CER” to another person.Footnote 229 Recognizing that the transfer of CERs may be governed by a “multi-sig” arrangement, Article 12 provides that control may be shared among persons.Footnote 230
The Article 12 control and negotiability provisions are designed to resemble the possession and negotiability provisions that apply to negotiable instruments in Article 3 of the UCC. For example, under Article 3, a person can possess a negotiable instrument on behalf of another person. Article 12 has a parallel rule: a person can have control of a CER on behalf of another person.Footnote 231
To facilitate negotiability, Article 12 contains take-free rules. A purchaser who takes control of a CER “for value, in good faith, and without notice” of a property claim in the CER takes that CER free from competing property claims.Footnote 232 Again, this rule mirrors the rule applicable to negotiable instruments – a purchaser who takes possession of a negotiable instrument takes that instrument free from competing property claims. In both cases, a filed financing statement is not notice of a competing property claim.
Although a qualifying purchaser takes the CER free from competing property claims, the UCC amendments are silent with respect to property rights that might transfer with the CER. The drafting committee wisely left that decision to other law, and as a result, the only rights that travel with a CER for take-free purposes are payment rights embodied in two new types of collateral: the controllable account and controllable payment intangible. These two new types of collateral categories reflect the historical tokenization of payment rights in paper tokens and provide parallel rules for electronic tokens.
If the law develops to recognize tethering of referenced property rights to an NFT, the new Article 12 will facilitate the transfer of those rights with the NFT. At the time of this writing, however, all the transferee of an NFT gets is the electronic token, not any other referenced asset.
Conclusion
The NFT hype promises a new way of giving value to intangible assets. As legal tokens, however, NFTs fail. All legal tokens evolved to solve problems. Negotiable instruments and certificated securities developed to give certainty to the transfer of intangible rights. Deeds of real property developed to prove the transfer of land, an asset that cannot be physically transferred. Bills of lading developed to facilitate transfers of goods in transit. Other “token-like” items such as automobile certificates of title and bailment tickets provide evidence of ownership.
NFTs, however, are a solution in search of a problem. They do not provide any link to an underlying asset, and, therefore, do not facilitate the transfer of any asset. A blockchain, like a recording system, provides a record of ownership, but in the case of NFTs, all it provides is a record of who owns the NFT, not of who owns any reference asset. Representations to the contrary by crypto enthusiasts and financial engineers fail to recognize the role of private law – in this case, property law – in the tethering function. As Professor Danielle D’Onfro has observed in her work on bailments and cloud storage: “any law of technology that skirts the core principles of private law is the law of suckers.”Footnote 233
As policymakers grapple with new assets, particularly digital assets, it is important for them to know what those new assets are, and what rights they embody. This Chapter has not only given a more concrete and sober picture of NFTs, but it has also illustrated areas of uncertainty and areas where the law – particularly property and commercial law – remains unchanged despite recent updates.
