The Ethereum “Merge” is being touted as one of the most important events in the history of crypto, with the blockchain-based software platform describing it as “a truly exciting step in realizing the Ethereum vision – more scalability, security, and sustainability.” At its core, the highly-anticipated event, which went live on Thursday, acts as a significant software upgrade for Ethereum, bringing a new Beacon Chain proof-of-stake system into the equation in furtherance of a move to shift Ethereum’s security mechanism away from a proof-of-work method. In doing so, the Merge is expected to reduce Ethereum’s energy consumption by roughly 99.95 percent by removing the need for energy-intensive mining operations.
Looking beyond the sustainability elements that come into play with the Merge and the potential for more security and “future scaling upgrades,” there are likely to be impacts for token holders in the event that there is a post-merge hard fork (i.e., a blockchain split) that enables Ethereum miners to continue operating a proof-of-work chain. “If the Ethereum Merge results in the blockchain getting split into two chains, duplicate NFTs will exist due to the ETH proof-of-work (‘ETHPOW’) chain and other potential forks,” alongside the ETH proof-of-stake (“ETHPOS”), per Outlook, which notes that there is “likely to be some level of confusion, including around which assets are ‘official’ or ‘authentic,’” among other things.
“For many fungible ‘store of value’ tokens, hard forks have a relatively straightforward impact,” Latham & Watkins’ Jenny Cieplak, Adam Fovent, Ghaith Mahmood, Justin Tzeng, Yvette Valdez, and Stephen Wink state in a recent note. “Each chain ends up with a different version of the token, but each set of tokens is still used in a similar fashion on its respective, newly forked chain.”
The results for non-fungible tokens (“NFTs”), specifically, ones that are tied to content and thus, give holders certain usage rights in connection with the underlying artwork, are likely to be muddier. For these types of tokens, the Latham & Watkins attorneys say that “a hard fork may present challenges because it takes a single record commonly presumed to be unique and splits it in two, creating potential confusion as to how rights might be administered post-fork across the two sets of tokens.”
Such a scenario raises an array of questions, according to DLA Piper’s Mark Radcliffe, Michael Fluhr, Tom Ara and Spencer Hodson, such as, “which [of the post-fork] NFTs holds the license to the artwork that was granted to the purchaser when they bought the NFT from the creator? Does the license exist on the ETHPOW blockchain or the ETHPOS blockchain? And who decides?” Beyond that, what if the NFT holder sells the NFT to a buyer on the ETHPOW blockchain, but continues to hold the NFT on the ETHPOS blockchain, “does the license remain with the holder or transfer to the new purchaser?”
These potential issues are intensified by the importance of the licenses attached to NFTs (both in terms of copyrights and trademarks) and the frequency with which the terms of such licenses can vary – quite widely – from one project to another.
“In the absence of clear guidance from license agreements, the ownership of the license may be ambiguous, and disputes may arise between the parties,” according to the DLA Piper attorneys, who claim that as a matter of best practice, “NFT issuers” – and NFT-trading platforms, as well – “should provide clear guidelines on how they will deal with forks in their license agreement” – or for platforms, in their terms of service – in order “to avoid disputes later on.”
There are examples of projects providing such guidance, they note, including the CryptoPunks License Agreement from Yuga Labs, which “expressly permits Yuga Labs to ‘designate’ which NFT on which chain holds the license agreement,” an approach that has since been adopted by the a16z Can’t Be Evil template licenses.
Chances are, most NFT creators will “only seek to grant rights to holders of tokens on the most widely adopted, ‘mainstream’ version of the chain post-fork,” per Cieplak, Fovent, Mahmood, Tzeng, Valdez, and Wink, as granting rights to all versions of the tokens across forked chains “could reduce the uniqueness and corresponding value of such rights, or simply make it untenable for the project to allow redemptions of a single off-chain asset for duplicate tokens.” Concerns on this front are particularly pronounced for tokens that can be redeemed for items of value, such as the USDC stablecoin, thereby, prompting fintech firm Circle, for instance, to announce pre-Merge that the USD Coin “can only exist as a single valid ‘version’ and … our sole plan is to fully support the upgraded ETHPOS chain.”
Such concerns can extend to content-linked NFTs, especially in the event that such tokens come with robust usage rights, and as such, Cieplak, Fovent, Mahmood, Tzeng, Valdez, and Wink assert that creators would benefit from making similar clarifications. “If any holder of an NFT on ‘an Ethereum chain’ could sell merchandise using the underlying NFT art,” they hypothesize, “the value of such a commercial right could be significantly diminished if two sets of tokens now hold the same rights to the same artwork.” As such, limiting rights to the most widely adopted chain could not only “preserve such uniqueness,” but could also “provide assurance to partners that might be sensitive to the degree of influence they can exert over tokens featuring their IP.”
In order to actually implement this, they contend that “projects could state that rights associated with a particular token will only be granted to owners as recorded on the Mainnet recognized as the legitimate successor of the original chain.”
As for platforms, Radcliffe, Fluhr, Ara, and Hodson point to precedent that allows blockchain service providers to establish their responsibilities in the event of a fork. “In Archer v. Coinbase, a California appellate court affirmed summary judgment in favor of [the Defendant] cryptocurrency exchange against a user who had claimed that the exchange was obligated to provide him access to all forked versions of the Bitcoin he had in his exchange account.” Siding with Coinbase, the court determined that its user agreement “contained no term obligating [it] to support all forks.” Following Archer, they note that “blockchain asset trading platforms (including NFT trading platforms) often expressly provide in their terms of service that they retain the right to determine which of any blockchain forks they may support.”
But even still, the results will of a hard fork will inevitably vary. While OpenSea, for instance, says that it will be “solely supporting NFTs on the upgraded [ETHPOS] chain,” Rarible’s Standard Collectibles Sale and License Agreement specifically states that in the event of an “Ethereum Persistent Fork” that it will recognize the authenticity of copies of NFTs created in the same wallet address when they were held on Ethereum. The likely purpose of this approach, according to Cieplak, Fovent, Mahmood, Tzeng, Valdez, and Wink? It “may be beneficial to reduce consumer confusion, promote an open and inclusive ethos, and avoid forcing the project to take a stance on a contentious issue regarding what is the ‘true’ blockchain upon a fork.”
While hard forks are not without precedent in the mark, it is, nonetheless, “impossible to predict what the actual outcome will be,” Rarible’s chief strategy officer and co-founder Alex Salnikov said in a statement to Forkcast this week. “Especially for less experienced NFT collectors.”