As technology is evolving to endorse blockchains and cryptoassets, businesses are also diversifying their portfolios by trading on these platforms. One of the most misunderstood asset is the Non-Fungible Token (NFT). While some people trust NFTs, and look to invest in them, others say that these tokens are just a hype and that purchasing them would be a waste of money. The lack of clear regulations regarding these tokens is also a source of fear for investors.
Therefore, this paper will present several cases that the courts faced regarding NFTs in several domains, with the purpose of legally defining NFTs and recommending regulations.
- Traditional definition of IP infringement and theft. Traditional laws and case studies: the extent of its application on digital art.
It is important to understand the traditional intellectual property principles in order to be able to see if they apply on digital art and more specifically NFTs.
Copyright infringement can be defined by the unlawful use or copy of someone’s copyrighted material. As for trademark infringement, it is the financial gain of someone for copying or using a distinctive sign or logo that is very similar to a trademark.
In the case of Copy Cop, Inc. v. Task Printing[1], Inc., trademark infringement was defined by the likelihood of confusion of the consumer. It included concepts like “bad faith” and presumptions. It furthermore argues the “strength of the mark” as a factor that can lead to consumer’s confusion.
Figure 1 Copy cop’s (plaintiff) registered trademark on the left; the defendant’s logo on the right.
The court here ordered the defendant to modify its logo and found that the defendant did in fact infringe copy cop’s trademarked logo.
It all evokes a very broad concept of the extent of difference that needs to be present.
In another similar case, Bayshore Group Ltd. v. Bay Shore Seafood Brokers[2], the court not only talked about the likelihood of confusion and the similarity of the marks, but also about the similarity of the goods provided.
Moreover, on a larger scale, the French case laws also mentioned the risk of confusion (“risque de confusion”[3]) in order to protect trademarks.
How do the above cases apply if we were to talk about NFTs?
First and foremost, it is vital to remember that buying an NFT does not necessarily transfer the IP right of the token in question. It is usually just the transfer of the NFT itself as a proof of ownership. Therefore, two options can appear. Either a person buys an NFT without the IP rights, which is the usual case, or the person acquires an NFT and the smart contract provides the transfer of its IP rights.
In the first case, it is simple. The acquirer is not allowed to change the art within the NFT. He can only display his NFT as it is, proving he owns it and the underlying asset it represents.
In the second case, the acquirer has the right to recreate and modify his NFT as he pleases.
NFTs are governed by smart contracts where the parties are to comply with the terms including anything related to the modification of the token.
One question remains: both American and Lebanese laws require the person to register their trademark or art in order for it to be legally protected from third party infringement, so what about those NFTs who didn’t file such a request?
In theory, any art or trademark that isn’t registered in a specific country (whether it is the U.S copyright office in the US, or the “Intellectual Property Protection Authority at the Ministry of Economy and Trade”[4] in Lebanon) isn’t subject to legal protection. Therefore, an NFT that isn’t trademarked can be reproduced without legal repercussions.
It is the reason most big NFT projects file for trademark. As such, the BAYC NFTs are trademarked, which was the reason behind OpenSea’s ban on the PAYC and PHAYC NFT projects that presented themselves as parodies of the original apes. However, no legal action was taken against the duplicators.[5]
- Intellectual property, medical secrecy and fashion: the diversified yet limited NFT cases.
Non-fungible tokens are a very recent invention thus very little use cases are present. We will be giving the most prominent examples of cases relating to NFTs.
The “Playboy Enters. Int'l v. www.playboyrabbitars.app” is one of the first pronounced cases regarding NFTs. This suit was filed by Playboy Enterprises international against playboyrabbitars.app that was selling NFTs using the playboy trademark. The famous Playboy rabbit was unlawfully being sold on a different website and therefore was subject to an intellectual property suit, knowing that the real playboy enterprises also has a line of NFTs.
In the case at hand, the court was clear upon the characteristics of intellectual property and forbid the counterfeit website to use the rabbit logo. The court explained that selling, using, reproducing or operating a similar or counterfeit mark causes “irreparable harm” upon the Playboy Inc.
It appears from the reasoning of the court that it used the New York trademark status to decide on the case at hand, which shows one more time that there aren’t any specific texts related to Non-Fungible Tokens in American Law.
Moreover, the lack of cases and examples only shows that this subject is very new. Nonetheless, it also shows that the development of NFTs, especially by big companies such as Playboy, and the copying of the latter by counterfeit websites will only lead to suits and judicial problems. Therefore it is very important for the legislator to take into consideration the growth of such a field.
In the case at hand, the counterfeit website was using the playboy rabbit to sell its NFTs, and this rabbit was already subject to trademark by the Playboy Enterprises even before producing its NFT line. Therefore, the traditional intellectual property laws are useful in this case. But what is the case of NFTs that aren’t yet been subject to trademark? Are there going to be laws or precedents to deal with them?
We can say that this case sets a clear and good precedent but lacks a little bit of elements related to NFTs and isn’t enough on its own to set the path for future cases.
A Bataclan survivor, claimed to have been shot in the arm, found the picture of her X-ray online for sale.[7]
The French law, very similar to the Lebanese law, only has a traditional intellectual property text and has yet not regulated the use of NFTs. So how will this case be treated?
This NFT was put on OpenSea by Emmanuel Masmejean, a famous surgeon at Georges Pompidou hospital in Paris.
The defendant still hasn’t been prosecuted but the lawyer of the woman in question says that the doctor has violated the medical secrecy or confidentiality obligation and has shown the world this X-ray with no prior approval. [8]
Still with no decision from the court, it seems from the interview with the lawyer made by a news channel that the defense is going to use the obligation of secrecy put upon the doctor to prosecute him. It shows that there is no NFT related law.
The case of Hermes and MetaBirkins
One of the famous cases today involves the famous Hermes and digital artist Mason Rothschild, the creator of MetaBirkins.
Hermes has accused Rothschild of copying one of its Birkin bag designs of 1980[9]. Consequently, Rothschild received a Cease and Desist order.
The digital artist then took social media to denounce Hermes and saying that they should encourage artists instead of being outdated, adding that what he did was art, and his way of interpreting things around him.
Picture 1 MetaBirkins design Picture 2 Hermes Birkin bag design
This case raises the issue of how much difference there should be in a design in order to be protected by intellectual property. Indeed, the artist said it was his “interpretation” of the world.
Moreover, Hermes also claimed that the use of the name “Birkin” in “MetaBirkins” is not acceptable.
Rothschild then files a motion to dismiss considering his MetaBirkins bags fall under the art category and therefore do not fall under the Lanham Act (trademark law). According to Rothschild, the Rogers test is the one that applies and his work falls under the grounds of the First Amendment (relating to freedom of expression). Hermes, on the other hand, argues that there is a strong likelihood of confusion. Hermes further contends that even if the Rogers standard is applicable, the Court cannot decide the truth of the matter at the motion to dismiss stage regarding the artistic importance or explicit misleadingness. Hermes further argues that Rothschild used the name “MetaBirkins” for commercial use and therefore this falls under the trademark infringement act.
In its opinion, the court relied on two factors: it first studied the “artistic relevance” of the case and then its “explicit misleadingness”.
It first concluded that the artistic relevance element assures that the defendant meant an artistic—i.e., noncommercial—association with the plaintiff's mark, as different to one where the defendant seeks to connect with the mark to monetize the mark's fame and goodwill. The new complaint contains enough claims to show that Rothschild did not intend an aesthetic association when he created the "MetaBirkins" mark; rather, he meant to associate it with the fame and goodwill of Hermes's Birkin mark.
The court then decided that even if Rothschild's use of the "MetaBirkins" mark fulfilled the Lanham Act's artistic relevance requirement, the updated complaint contains enough factual accusations to show that it is intentionally misleading and still subject to legal action. Moreover, in Rogers, the Second Circuit determined that the Lanham Act should only be interpreted to apply to artistic works when the public interest in preventing consumer confusion surpasses the public interest in free expression, but it later added in Twin Peaks that when evaluating explicit misleadingness under the Rogers balancing test, the Court should take into account the Polaroid factors (strength of the mark, the bad faith of the artist and other factors) to determine whether the likelihood of confusion is compelling enough to outweigh the public interest in free expression. The court also considered that applying the Polaroid considerations requires in-depth factual analysis, and it is inappropriate to address the probability of confusion in a motion to dismiss posture.
In conclusion, the court denied Rothschild’s motion to dismiss.[10]
NFT’s growing field in the fashion industry
In other news, NFTs are nowadays being used as a toll of marketing and sales in the Fashion industry. If Hermes didn’t yet join the trend, many other famous fashion designers did. As such, Lebanese Fashion designer Rami Kadi launched his NFT collection on the Cardano blockchain consisting on 120 NFTs. The holder of this token will be able to design his NFT into a real life dress, in addition to some other utilities including being invited to any future event in both the physical and the digital worlds.[11]
Furthermore, Forever 21, DKNY, and Estée Lauder are among the brands who participated in the first Metaverse Fashion Week in the virtual world of Decentraland. As such, Estée Lauder is giving out 10,000 NFT-backed digital wearables during Metaverse Fashion Week, claiming they will give avatars a radiant aura. Additionally, Forever 21 has rented the equivalent of 450,000 square feet of space in Decentraland's fashion area to construct a virtual store with 10 NFTs for sale and digital avatars working as sales staff. Those NFTs provide avatars with clothing to wear or collect.[12]
- NFT recent hacking schemes, losses and the legal repercussions:
For so long, hackers have viewed the blockchain as an impenetrable network. Nonetheless, recent news have surged about NFT thefts.
The internet is buzzing about 35 NFTs that has been stolen via a phishing attack on twitter[13]. Their worth is calculated to be more than 900 000$. More precisely, the hackers infiltrated known twitter accounts to promote a link that allegedly offers you the new Ape Coin launched by BAYC. As such, the scam victims report falling for the attack, commenting that they recognized the twitter accounts in question.
It appears that the blockchain is not “impossible to hack” as some claim it is.
Since blockchain technology is known for its decentralized monitoring system, with miners or validators on several ends of the transaction confirming its legitimacy, hackers aim to drag the victim into giving them access to their wallets. Therefore, phishing is the most used technique for crypto hacks, as per the example given above.
Aside from phishing, other ways of hacking can also be perceived.
The first one is to theoretically control 51% of the nodes in the mining process. If this might be feasible in little chains, it is very hard to do that in larger blockchains. Nevertheless, the pooling of miners previously mentioned in the functioning of the PoW system might contribute to a hacking attack in the future.
The second one is for hackers to search for creation errors or glitches in the blockchain or within the smart contract. If the algorithm in question contains a glitch, the hacker might be able to access this transaction before miners can invalidate his fraudulent doing. This technique was used in 2016 with the DAO hack. The DAO (decentralized autonomous organization investment) was a decentralized investment fund that granted its investors decision-making authority based on their investment balance, theoretically eliminating the need of banks or financial intermediaries. The hackers were able to extract 50 million dollars from the Ethereum-backed blockchain in just a few hours. The consensus algorithms that form the backbone of blockchain and need a specific percentage of users (called nodes) on the blockchain to accept information as authentic before it is posted to the blockchain were eventually proven to be the source of the hack. Before the other nodes could reject the theft as an illegal transaction, the hacker was able to take cryptocurrency directly from the blockchain. Due to an issue in the way the blockchain executed the smart contract and processed approvals, the mechanism within the blockchain that was supposed to only allow authorized transactions allowed nothing but illegal transactions to post. A key defect in the smart contract, a complex system of code and algorithms on the blockchain, was exploited by the thief on a blockchain thought to be unhackable[14].
Furthermore, many hacks of hot wallets have been reported. The most famous one was the Coincheck hack, where 500 million dollars were stolen. Binance also suffered a 40 million dollar loss from hacks of hot wallets.
In December 2019, the death of Gerald Cotton, the CEO of one of the biggest cryptocurrency exchange platform (QuadrigaCX) shook investors. Briefly, Cotton was allowed to transfer the funds obtained regularly into cold wallets to avoid thefts. Being the only person to hold the cold wallet key, around 135 million dollars of funds were lost[15]. Some considered it to be a Ponzi scheme[16], as most of the funds were allegedly used for fraudulent trading. The Company ended up filing for bankruptcy, and some amounts were recovered by the bankruptcy trustee and returned to clients.
Moreover, in 2021, rug pulls generated 37% of all cryptocurrency fraud earnings, rising from 1% in 2020, according to blockchain monitoring firm Chainalysis[17]. Rug pulls can be briefly defined as selling NFTs and raising funds whilst promising the minters that they will get benefits, only to exploit the funds for their own personal benefit.
The Quadriga Case: an unprecedented court decision
First of all, regarding the hacking schemes, no reported legal action was taken against any hacker in the past few years. The reason can be the complicated technical issues that result from the hack, and the inability to determine the hacker or the criminal.
Second of all, regarding the Quadriga case, the Supreme Court of Nova Scotia in Canada published an opinion regarding the case where three counsels were appointed to represent 3 groups of users of the cryptocurrency application in the Insolvency Case[18]. The case was then transferred on September 2019 to the Ontario Superior Court of Justice (Commercial List). The court proceeded to a one of a kind decision where it included cryptocurrency under the definition of “property”, which made bankruptcy applicable[19].
This case was the first ever case to introduce cryptocurrency in bankruptcy. It raises many questions.
First and foremost, bankruptcy was possible because Quadriga was a registered company. Therefore, the cryptocurrency was evaluated as “property” of the company. However, what about the hypothesis of a similar case but where the platform isn’t registered as a company? Can bankruptcy still apply?
Secondly, the court only mentioned cryptocurrency as “property” but forgot to mention other kinds of crypto-assets. However, we can say that this decision is the first step towards the consideration of any asset on the blockchain, including NFTs, as part of a person’s estate.
Thirdly, let’s take the hypothesis of a person who has many crypto-assets and suddenly dies just as the CEO of Quadriga. What is the fate of these assets? Knowing that you can only access the wallet with the private key, people owning a million’s worth of crypto-assets will be unable to transfer their belongings to their heirs after their death. There is no legal nor technical way to inherit a digital wallet’s assets.
To summarize, even though Quadriga introduced a new and broader definition of “property” into Canadian law, many aspects remain missing. This further deepens the need for a special law that takes into consideration the nature of crypto-assets and NFTs.
The arrest of two men for a 1.1 million dollar “rug pull”
Two individuals have been charged with fraud and money laundering in connection with a bitcoin "rug pull" operation. Ethan Nguyen and Andre Llacuna are culpable of earning $1.1 million by selling non-fungible tokens (or NFTs) based on "Frosties," a cartoon-like character. They shut down the initiative and shifted its cash to a variety of separate crypto wallets after selling the NFTs, leaving Frosties owners without the promised benefits.
The Internal Revenue Service, Criminal Investigation (IRS-CI), and Homeland Security Investigations (HSI), according to the criminal complaint, began investigating Frosties in January, immediately after receiving complaints about the scam. Frosties was a popular initiative, with 8,888 NFTs (each equal to $130 in Ethereum) selling out within an hour of its public introduction. The creators even confessed to not going through with the project on their discord server.
Investigators matched data from Nguyen and Llacuna's Discord accounts (including Nguyen's IP address and Llacuna's email address and phone number) with corresponding Coinbase accounts. Law enforcement was able to trace the couple down since their Coinbase accounts were linked to a Citibank credit card and a government ID. Investigators then discovered a sequence of transfers in which Nguyen and Llacuna reportedly attempted to conceal where the Frosties earnings were being sent, leading to the money laundering charges.
Although crypto "rug pull" techniques are very popular, criminal trials are significantly less so. For one thing, the creators of NFT series rarely divulge their legal names — until recently, even the creators of the ultra-expensive Bored Ape Yacht Club series stayed anonymous. Furthermore, profitable NFT series launches are a recent phenomenon. Furthermore, the legal position of NFTs in general can be a bit hazy.
However, the Justice Department's press release is unequivocal in branding Frosties a con. In a statement, IRS-CI Special Agent-in-Charge Thomas Fattorusso said, "NFTs represent a new age for financial investments, but the same laws apply to an investment in an NFT or a real estate development." He added that you can't raise money for a money making proposition, then dump it and disappear with the money of your creditors.[20]
The two alleged con artists were apprehended in Los Angeles, California, and incriminated with "one count of perpetrating wire fraud," a crime that carries a possible 20-year prison sentence if found guilty. They've also been charged with conspiracy to launder money, lending them a possible extra 20-year sentence.[21]
Conclusion and recommendations
After studying all these cases, we can see that NFT transactions are indeed prone to risks. Whether we are talking about hacks, losses, rug pulls or trademark infringement, the concerns regarding NFTs seem to be valid. Nevertheless, courts have taken huge steps prosecute those who misuse this technology.
Moreover, even if traditional Intellectual Property rights can apply on the art of the NFT, smart contracts still need to be integrated into the laws in order to differentiate between those that include the transfer of intellectual property and those that don’t. This will allow the courts to identify easily how NFTs and IP rights are to be approached.
However, we also saw that these courts still rely on traditional regulations instead of special NFT or blockchain rules. Therefore, the following recommendations can be formulated:
- NFTs need to be legally recognized and divided in the law according to their uses, like financial NFTs if they represent financial assets or benefits, trademark NFTs if they represent an ad for a company and so on. This will help legislators put in place the right legal guideline for each different NFT.
- It is preferable that NFTs are subject to an international convention that will regulate transactions, beyond a national currency or guideline, since ethics differ from a country to another, so we need an international consensus regarding this matter.
- The cases that are seeing light in this matter should be communicated to investors. This will allow them to see the legal point of view of NFT trading and take precautions accordingly. These cases should also be the starting point to creating a legal framework for NFT transactions.
[4] مصلحة حماية الملكية الفكرية في وزارة الإقتصاد والتجارة
[14] Castonguay, J. “, & Stein Smith, S. (2020). Digital assets and blockchain: Hackable, fraudulent, or just misunderstood?*. Accounting Perspectives, 19(4), 363-387. doi:10.1111/1911-3838.12242
