April 19, 2021

Volume XI, Number 109

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April 16, 2021

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What the Heck is an NFT?

One of the biggest current trends in the world of digital and decentralized assets is the NFT, or non-fungible token.  In the past month, Grimes sold nearly $6 million of NFTs and Kings of Leon has pledged to come out with the first ever full rock album as an NFT.  So…what the heck is an NFT?

As indicated by the name, the two most prominent aspects of an NFT are that they are non-fungible and that they are blockchain-enabled smart contracts otherwise known as tokens. The first key aspect is that it’s non-fungible. This doesn’t mean that the subject of the NFT cannot be reproduced or replaced. Rather, it means that the NFT itself cannot be replicated. In some ways this is like a certificate of authenticity. Because of the immutable and open source nature of blockchain, everyone is able to see exactly who the owner is and the entire chain of title since the inception of the NFT. While many blockchain-enabled tokens are designed to be anonymous, NFTs typically have some level of attribution so the world can know the creator and the owner. But it’s not really a certificate of authenticity…so what the heck is an NFT?

The other aspect is that it is a smart contract, permanently on blockchain, always able to be tracked. The most common use cases for NFTs have been artwork, music or classes of “art” we didn’t really know could be art until they were assigned outside value, such as Crypto Kitties or CryptoPunks. If an NFT is associated with a digital image, the owner of that NFT is the true owner of the image, even if the ability to view that image is completely open source. For example, the French Republic itself is the owner of the Mona Lisa, but it has loaned the artwork to The Louvre where the entire world can view it, and anyone can look at an image of the Mona Lisa with a simple Google search.  That said, the Mona Lisa itself is probably one of the most valuable pieces of artwork in the world, even though anyone can see it for free. Similarly, a 1/100 print of a signed Dali will be worth a lot more than a copy of the same painting you printed out yourself. And the NFT typically isn’t created without the consent and ownership of the underlying owner of the property, making it somewhat like an autograph. But it’s not really an autograph…so what the heck is an NFT?

While this isn’t the only use case for NFTs, at their most basic they are a digital representation of a real, unique asset. Thus far NFTs have mostly caught on as means of selling art, music, films, etc., and that probably will be the most popular use case for a while. That said, the true value of an NFT is proof of title. One of the original proposed use cases for blockchain was to eliminate intermediaries and to be able to establish trustless transactions. While this can prove that one owns art (and create a circumstance where a single person “owns” the art while others merely enjoy it in a way that was never previously possible), the potential for proof of ownership via NFT goes well beyond their current use. NFTs could be used to establish an absolute chain of title for parcels of real property. They could be used to create REITs. They could be used for corporate transfers of goodwill and automatic contractual amortization on the sale of a company. Already a number of NFTs have irrevocably changed into a completely different asset based on contingencies.   So…what the heck is an NFT?

Who the heck knows. We’ve only scratched the surface. Dismiss at one’s own peril this technology as solely being a manner of commercializing art.  This could be a means of tying all real assets – literally the entire physical world – to the blockchain and thereby creating a permanent, immutable record of who owns anything ever.

In the meantime, we get to see a number of experiments with NFTs which may have regulatory uncertainty with a chilling effect on the ability to use NFTs in manners that could solve for problems we have been trying to solve for centuries, such as proving chain of title.

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© Polsinelli PC, Polsinelli LLP in CaliforniaNational Law Review, Volume XI, Number 67
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About this Author

Daniel L. McAvoy Shareholder Investment Funds Securities & Corporate Finance Mergers, Acquisitions and Divestitures Corporate and Transactional Joint Ventures and Strategic Alliances
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Dan McAvoy focuses his practice on private closed-end investment funds, corporate finance and M&A with a focus on private investment fund transactions, including complex GP-led restructurings and secondary transactions. Dan is a trusted adviser to numerous investment advisers, fund sponsors and investors, and has represented a range of companies, from startups to Fortune 500 companies. Dan has also represented portfolio companies and sponsors through all parts of the corporate life cycle, including formation, venture financings, add-ons, stock sales, asset sales, private and...

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