Non-fungible tokens – or NFTs – have well and truly made their mark on the fashion industry. While these unique digital assets have existed since 2012 and experienced popularity among the gaming community for a number of years, they have only relatively recently intersected with mainstream fashion thanks to an array of efforts by no shortage of brands, ranging from Gucci and Louis Vuitton to Dolce & Gabbana and digital fashion brand RTFKT. Put simply, NFTs are digital tokens that store information and are linked to an (often digital) asset, and managed on a blockchain, which acts as an immutable digital ledger recording details of transactions. NFTs are akin to a certificate of title to the asset.
At first, many NFTs minted by fashion brands were linked to digital assets that were generally considered to be pieces of art with otherwise limited utility. For example, take the short film “Aria” sold by Gucci in June as an NFT. But there is both the appetite and scope for NFTs to take broader forms more than this. Digital-only fashion houses, such as The Fabricant, for instance, are emerging, and Burberry is designing an exclusive line of digital accessories for Mythical Games Inc.’s new video game “Blankos Block Party.”
With the value that younger consumers are increasingly placing on their digital personas and the enduring interest of fashion brands to engage with consumers in this way, it may not be long before our avatars are gliding through the parallel digital universe – aka the metaverse – in otherwise largely-inaccessible haute couture.
But in the rush to be at the forefront of innovation and embrace the opportunities that NFTs present for fashion, global brands and fashion houses may be exposing themselves to ill-advised legal risks. At the outset, any brand foraying into the world of NFTs must consider whether it is even entitled to “sell” the digital asset in question via an NFT. In particular, the intellectual property rights of those who created the asset must be considered. Depending on the nature of the asset, there may be various contributors – from designers to coders to musicians – whose rights in their contribution need to be assigned or licenced before the asset can form part of a legally-above-board NFT sale.
The next stage is determining the terms upon which an NFT sale will take place and precisely which rights are to be granted to the buyer. In reality, most brands will want the NFT to grant a bespoke licence under which the buyer can use the digital asset for personal purposes, but will prohibit the commercial exploitation of the asset. Beyond that, brands may aim to reserve royalties for themselves in the event of subsequent sales of the NFT, while also ensuring that no copyright in the asset is transferred.
Given that NFTs are – at their core – “smart contracts” that are collections of code and data that effectively act as self-executing programs, an advantage for brands is that they can provide for the automatic payment of royalties to the original seller upon the NFT being resold (providing it is resold on the same platform). However, it is often advisable that in addition to setting out the contractual framework in the code, itself, brands also include a complementary natural language contract in order to ensure that there is clarity on the rights and obligations of those involved, as well as the applicable law and jurisdiction.
Contract and intellectual property issues are not the only ones that brands may stumble upon in furtherance of their efforts to bank on the appeal of NFTs; as TFL previously noted, there has been debate about whether NFTs are compatible with data protection legislation, such as the General Data Protection Regulation. There is, for instance, a potential tension between the immutability of the blockchain on the one hand, and a data subject’s right to data rectification and erasure, on the other hand. When creating NFTs, brands should ensure that they obtain advice on how best to achieve maximum data protection compliance through both contractual terms and technical solutions, the latter of which are constantly improving.
Finally, there is also the potential to get caught up in financial regulation. In the United Kingdom, an NFT could, depending on its characteristics, constitute an e-money token or a security token, meaning that authorization by the Financial Conduct Authority or other requirements may apply. It may also be deemed “a cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and can be transferred, stored or traded electronically,” which could lead to registration obligations under UK Money Laundering Regulations. In order to assess the regulatory burden, the attributes of each individual NFT and the related activities need careful analysis.
Aside from some of the legal issues at play, brands must not forget to consider the tax implications of selling NFTs for their businesses when they are planning their NFT strategy. (While there is little guidance to date about how NFTs should be treated from a tax perspective, they very well may be considered a taxable asset for capital gains and inheritance purposes.) And still yet, brands are encouraged to consider the potential for negative reputational impacts in light of rising attention to the fact that minting and selling NFTs on certain platforms may have a negative environmental impact.
While blockchain may have been developed based on an anti-regulatory ideology, as outlined above, NFTs are not immune to risks and regulation. Fashion houses must navigate NFTs with care to ensure that they do not find themselves entangled in issues that reflect poorly on their brand.
Lizzie Williams is a Senior Associate at Harbottle & Lewis. She is a member of the firm’s Dispute Resolution Group, specializing in litigation, digital, technology, retail and fashion.