Written evidence submitted by DeCaDe and Creative Informatics
DeCaDE Contribution for DCMS Call for Evidence on NFTs
This submission is made on behalf of DeCaDe, the UKRI Centre for the Decentralised Digital Economy, and Creative Informatics, the Research and Development accelerator for the creative industries. Launched in October 2020, DECaDE is a 5-year National Research Centre exploring how emerging data technologies could transform our digital economy through decentralised platforms. DECaDE is a partnership between the University of Surrey as lead institution, the Centre for Design Informatics and Edinburgh Law School at the University of Edinburgh, and the Digital Catapult.
Summary of Recommendations:
- the cautious “wait and see” approach by the European Commission’s Markets in Cryptoassets Regulation proposal (MiCA) that after some contested debate leaves currently most, but not all, NFTs outside its regulatory scope is not unreasonable, given the lower risk profile of NFTs in comparison with fungible tokens. It is also a good “fit” to the post-Brexit UK approach to technology regulation that aims to support innovation.
There were however good arguments both for and against an inclusion of NFTs made. The ultimate result may be a missed opportunity if the aim is to increase consumer trust in the technology. While premature regulation can sometimes unnecessarily hamper the development of beneficial new business models and technologies, it can also give reassurances to unsophisticated users and in this way support their uptake and market success It should therefore be considered if issuers or NFTs or NFT marketplaces should be given the opportunity to voluntarily opt into regulatory regimes for fungible crypto assets.
This could be modelled on the approach now tentatively proposed in the US by SEC Commissioner Hester Peirce, https://nftnow.com/features/the-irs-and-sec-are-eyeing-crypto-and-nft-regulation/ who sees the process of regulation at this stage as a dialogue for mutual benefit rather than enforcement-centric.
- while the underlying blockchain technology on which NFTs are based is highly decentralised, and decentralisation is also promoted as the key virtue of the future Web3, the difficulties that decentralisation can generate for regulation are sometimes exaggerated. In particular, we already observe the emergence of new, centralised players in these markets such as wallet services, third parties that offer new services build around the decentralised substratum but with much more conventional structures. These new intermediaries not only have traditional business structures, but also are disproportionally implicated in many of the recent crypto-asset related” scandals and problems. Regulation these new intermediaries, rather than NFTs directly, is possible without necessarily deterring innovation in the decentralised economy, and might indeed protect its decentralised nature and the benefits that it brings from the “new centralisation” that we observed historically in Web 2.0
- many of the problems with NFTs can be more adequately addressed by other legal regimes. Some of these will also have beneficial effects on general issues beyond that specific technology.
In particular, we recommend the enforcement, and if necessary adjustment, of Advertising and Consumer Protection Law to ensure also unsophisticated buyers are fully aware of the nature of the transaction. This should go beyond statements that NFTs and their market places are not regulated by the FCA, but have clear and easily understandable statements about the scope and limitations of the rights that they acquire, the responsibilities and warranties of the hosting platform and the mechanisms for redress. As some of the abuse in the NFT space was facilitated by new forms of social media based advertising, in particular the use of social influencers, the Online Safety Bill may be one of the places to use for such a tightening of the regime.
-- the proposal by the Law Commission of England and Wales (LCEW proposal) to create a new class of ownable assets has the potential to address several of the problems that NFTs raise, and also to facilitate the creation of innovative and beneficial business models and use cases. However, it creates potential problems for any future UK wide regulation of NFTs, in particular the danger of regulatory arbitrage between England and Scotland. Any UK-wide regulation that refers e.g. to “ownership” in NFTs would have to carefully consider how this would be interpreted north and south of Hadrian’s wall. Similarly, the interaction between the UK wide Copyright and Data Protection regimes, and any devolved regulation of NFTs as ownable assets, needs careful thought to ensure consistency. For this reason, in the long run harmonising the property regime for NFTs across the UK would be desirable and facilitate regulation in those fields that are reserved to the Westminster Parliament.
- for all its merits, the LCEW proposal uses a very technical and narrow definition of NFT that may not only become obsolete quickly, but also create bad incentives for businesses to choose one technology over another (unsatisfactory especially if the “preferential” technology has a significant negative environmental impact). We recommend to consider NFTs as merely one type in a larger group of “digital ownership technologies”, defined by the effect that they have on their owners more than by their technical features.
- related to this, NFTs are already a highly heterogeneous class, and some of the most beneficial uses may still be emerging. NFTs as collectibles raise different issues from NFTs as tickets, for example. Mirroring the UK’s proposed approach to AI regulation, rather than using an abstract definition of NFTs as object of regulation, a sectorial approach that is sensitive to very different risk patterns, supplemented by some cross-sectorial rules, seems preferable.
- the LCEW is right in carefully distinguishing the NFT as a digital asset from any “off-chain” objects, digital or physical, that it is linked to. While this distinction is conceptually sound, it is also the one most misunderstood by ordinary users (who typically think that acquiring an NFT also means ownership, and copyright, in the artwork associated with the NFT. While computationally, the distinction between NFT and associated asset is important, the law can be used to create normative connections between them, so that transfer of the one also impact on the title to the other, beyond mere issues of provability as considered by the LCEW. In particular, we recommend to consider smaller, more technical changes in copyright law that facilitate the granting of valid licenses through smart contract, and update any “in writing” requirements for the digital decentralised economy and its smart contracts.
- similarly, for some regulatory regimes, it seems desirable to treat as a matter of law trading in NFTs as also trading in the associated artwork, for instance for anti-money laundering purposes. It is currently unclear if NFT trading entities are covered by the EU AMLD5 or 6 (and if so, which ones – the platform that stores the linked digital assets, the exchange that hosts the smart contracts etc) Since much of the trade in NFTs uses in turn fungible cryptocurrencies, some of these entities will be covered by AML regulation, but not necessarily all of them. Even more uncertainty exists for the post-Brexit UK landscape.
Discussion
Non-Fungible Tokens (NFTs) are digital representations of media items, such as images, videos, audio or documents that may be created (minted) and traded openly on decentralized marketplaces. During the global pandemic, NFTs became popular as a digital market for creative works when traditional routes became unavailable. Notable sales of creative works such as Beeple’s montage “Everydays: The First 5000 Days” reached $69.3M. NFTs have also gained traction as digital collectibles, representing in-game virtual items, or moments from sporting events (e.g NBA HotShots). Recently, social media sites such as Reddit, Facebook and Instagram have launched features that showcase NFTs held by their users [x]. Ownership of NFTs can gate access to exclusive experiences such as entry to events associated with the collectible, and may be used outright as a form of ticketing.
Web2.0 is characterised by large centralised platforms that enable trade, but where the data controllers (e.g. Facebook, Google) have been accused of appropriating value from individuals through the (ab)use of their data. Centralised systems provide the creators control over governance mechanisms. Web3 seeks to address some of the drawbacks of centralised systems Web2.0 through decentralised systems (Catalini and Gans, 2020) that provide users agency over their data, digital assets and some influence over governance mechanisms. However, also because of regulatory gaps, we see already the re-emergence of centralised entities within the Web3 environment – with the danger that for all intents and purposes “behave like” traditional intermediaries are (even) less regulated than their Web 2.0 counterparts. Under these conditions, regulation of these new intermediaries can also help to ensure that Web3 does not replicate the creeping centralisation that prevented Web 2.0 to live up to its full potential.
The term asset is usually associated with notions of ownership and value. Digital assets definitions refer to any parcel of code that is uniquely identifiable and may help create value. Digital assets may include any format and can be stored, transferred, or accessed electronically, which covers a wide range of items, including documents, photographs, videos, music, etc. A key characteristic of digital assets is their ability to be replicated and distributed, which can make it difficult to verify ownership or authenticity. This has led to the development of technologies such as blockchain and non-fungible tokens (NFTs), which provide a way to verify ownership and authenticity of digital assets.
Distributed Ledger Technologies (DLTs), colloquially referred to as `Blockchain’ technologies, are used to securely track the ownership of NFTs, which may be openly traded in exchange for crypto-currencies – which in turn may be exchanged for fiat. It is estimated that the NFT market was worth $11.3Bn by transaction volume in 2021, and is predicted to grow beyond $230Bn by 2030. Marketplaces that list and mediate transactions for NFTs often command transaction fees. OpenSea, a popular marketplace interacting with major DLTs (Ethereum, Polygon) was valued at over $13Bn in early 2022.
Many artists working with digital media have enthusiastically embraced the new technology and see it as a possible avenue to address the negative impacts that the digital turn had on artists’ ability to monetise their work. The easy, cheap and identity-preserving replicability of digital assets, the pressure this put o notions of copyright and also the loss of a concept of “uniqueness” and the value-enhancing scarcity that it brings have had a lasting impact on the creative economy. Beyond creative endeavours, It is generally remarkable how the digital economy managed to prosper in the absence of one of the most fundamental legal concepts for a free market economy, a robust property regime. Re-creating an online equivalent of traditional, physical property rights, as also recognised in the LCEW proposal, meets a clear need.
It remains however highly questionable if the current incarnation of NFTs, for both technological and legal reasons, is really capable of meeting that need. “Acquiring an NFT” is by many buyers (mis)understood as the equivalent of buying a physical painting – or indeed a painting with additional copyright entitlements. This however misunderstands what an NFT computationally is, misidentifies the NFT and the linked art object, misjudges the control that as a result the off-chain hosting platform of the art exercises over it, and misunderstands the legal title that is acquired and the protection it brings.
Ownership of most digital things currently determined by ‘End User Licence Agreements’ (EULAs) – presented to consumers by centralised tech platforms, and often subject to unilateral change. In context of cloud computing, where most files and data are not stored on individual devices, but shared, remote cloud storage, this situation has been described by some as the ‘End of Ownership’ (Perzanowski & Schultz). For example, consider how one may ‘own’ a physical record or CD through possession of a physical thing, whereas streaming platforms such as Spotify extend no such ownership rights, despite arguably widening access to music. In essence, convenience and access to digital media and digital things is provided at the cost of real personal ownership of them. We suggest therefore that the rapid emergence and popularity of NFTs, has not been solely driven by financial speculation and market hype, but also in response to a real lack of ownership of digital things and assets. As however noted above, the current configurations of NFTs may not meet this need: while the NFT itself for instance may well have lasting existence on the blockchain, the linked digital asset, the thing the buyer is really interested in, will typically be hosted offchain by a third party, and subject to their control. What is missing in our view is not regulation of the NFT alone, but the duties, rights and guarantees that the hosting party of the artwork has to provide, including clear rules for the insolvency of wind-up of these third parties.
Under these circumstances, prudent regulation should aim to achieve three related goals: on the one hand it should acknowledge that NFTs try to address a genuine need, the demand for some type of property-facilitating technology beyond the hype, and be willing to adjust legal concepts if necessary to enable them achieving their full potential. At the same time, it should not set the current expression of NFTs in stone, rather, it should provide a framework within which they can achieve their full potential in the future. Third, it should acknowledge that as the technology becomes mainstream and moves outside small, specialist Internet communities, there are massive information and power differentials between technology-savvy providers and lay users. The decentralised economy will only achieve its potential if the latter feels confident enough to use them, and regulation has a key role to play to ensure the necessary trust.
NFTs derive their value from scarcity, but contain no counter-measures such as digital rights management (DRM) that prevent their associated media items being duplicated and created (copy-minted) as fresh items on the market. (this is analogue of buying a print that was marked “5/100”, but where the artists later on used the same plates, or identical replicas of the same plates, to create thousand more prints). This apparent paradox is partly resolved by recognising that the uniqueness of an asset may be derived from its provenance, specifically the history of its ownership from the original creator (minter) through to its current owner. By analogy with the physical art world, a perfect replica of the Mona Lisa holds considerably less value that the original hanging within the Louvre by virtue of its provenance. Indeed, written ledgers – such as the catalog raisonee - used to track the provenance of artworks in the physical world, are analogous to the distributed ledgers (DLTs) used to track ownership of NFTs. A design feature of DLTs is that information is stored in an append-only manner - data, such as a record of ownership, is immutable once committed to the ledger.
NFTs have attracted criticism on the grounds that markets are unregulated and volatile due to rampant financial speculation, as well as incurring high carbon footprint (although popular DLTs are reducing their energy consumption). One driver for such speculation, is that in their current form NFTs have limited utility; once purchased there is little one may do with an NFT beyond resell it for profit. This is because whilst the act of owning an NFT grants the right to sell or dispose of that asset, it is entirely unclear what else one has the right or license to do with the associated media item. As the sale of NFTs is often carried out with cryptocurrencies, there is also concern that in the absence of true use cases for either, they artificially inflate each other’s value.
In some cases, the creators of NFTs have issued statements as to the rights conveyed to an NFT purchaser upon sale of the minted asset. Yet it is unclear how such rights transfer upon subsequent sale. In the creator economy it is common for an asset to be licensed to multiple end-users under different terms. Not only are NFTs often silent on content rights, for example copyright or the right to make derivative work, but coupling ownership of an asset to rights of use prohibits licensing to multiple parties since an NFT may only be owned by an individual wallet address. Indeed it is may be desirable to decouple to definition and issuance of licenses to use an asset, from the creation (minting) of that asset. This is not possible if rights are defined prior to minting and/or sale, either by notifying purchasers of their a license via the marketplace or baking a license agreement into the NFT metadata which remains immutable after minting. Even when the right holder wishes to grant a copyright license, it is questionable if the formal requirements can currently be met by smart contracts.
Therefore for NFTs to move beyond their current primary use case as a speculative digital asset, to provide true utility to the creative industries and beyond, they need to embody reliable mechanisms for determining their authenticity and to go beyond their current representation of simple tokenized ownership to embody a dynamic tokenized model for rights (licenses) for use. This requires improved computational methods, but potentially also adjustments in applicable IP and contract law.
The inquiry considers NFTs primarily as vehicles of financial speculation, via NFT marketplaces. However, this is not necessarily always the case, and we believe it is important that the inquiry considers the wider potential applications and implications of NFTs, beyond speculative finance. Most recently, we have developed a unique, interactive NFT exhibition, called A Token Gesture, through which passers-by, with no prior knowledge of NFTs or blockchain technology, could generate an artwork, and ‘mint’ an NFT to create an immutable record of metadata and their ownership of this artwork, via the Tezos blockchain. Further details on this specific project are available via our website (https://nft.inspace.ed.ac.uk/),
In our exhibition, we created and provided NFTs which were non-transferable, meaning they could not be bought or sold, and could only be created by interacting, in-person, with our exhibition in Edinburgh. Elsewhere, such NFTs have been described as being ‘soulbound’, a metaphor drawn from video gaming – as they cannot be transferred from one character, user, or wallet, to another (Buterin, 2022). They present a clear case where the value and meaning of NFTs extends beyond their economic value, and exploitative speculation is expressly prevented and prohibited. In our exhibition, these non-transferable NFTs were valued as providing a ‘proof of participation’ in a unique experience; enabling a sense of belonging or connection to a specific community; providing means to share, display and demonstrate certain values or experience. These findings highlight the potential social meaning and values of NFTs, which may underpin economic value, but also can supersede it.
An example of NFTs as an ownership technology, and rights management tool, may be observed in the application of live event ticketing. There are numerous companies beginning to explore the use of NFTs as a ticket – for example where possession of a token is required for access (aka ‘token-gating), and also where NFTs are used to enforce very particular rules around transfer of tickets to prevent fraud and exploitative secondary sales. (For example, Ed Sheeran’s recent tour has used a blockchain- based ticketing mobile app - https://www.secutix.com/tixngo/ed-sheeran-digital-ticketing-stadefrance).
We suggest that the committee recognise that NFTs are fundamentally an ownership technology. This ownership often facilitates trading, buying and selling, but these are far from the only purposes of demonstrable ownership. Similar to approaches to ‘Self-sovereign Identity’ (SSI), (Fraser & Schneider, 2022) NFTs offer a decentralised infrastructure for recording metadata about other digital objects, including records of rights and ownership. Ownership in this case conferred solely by possession of specific non-fungible tokens. Crucially, NFTs do not necessarily provide ownership of digital media itself – which often remains freely and publicly accessible – but offer means to demonstrate ownership of metadata about these media. The real-world applications of owning such metadata remain an open-question, but for example, could allow users to independently demonstrate how long they have possessed or interacted with some media; or entitle the token-holder to certain future interactions with a creator or artist. All these applications will create vastly different risk profiles, some, but by no means all of them posing risks for fraudulent speculation, money laundering or other illegal and deceptive practices. To prevent low-risk and beneficial applications being caught by regulatory requirements only appropriate for some high -risk applications favours a sectorial approach to regulation that avoids regulating the technology as such, but specific business implementations instead.
There are very valid concerns as to the abuse and exploitation facilitated through many crypto-assets and economies, evident in market crashes and fraud throughout 2022 (for a comprehensive record, see https://web3isgoinggreat.com/), NFTs have been stolen, NFT-based projects disappeared in thin air with the money of the investors (rug-pulling), NFTs were minted that violated rights of third parties, in particular copy- and trademark rights, and there is strong suspicion that they have been involved in money laundering. An initial promise of DLT technology was to “replace trust in centralised institutions, including legal institutions, by trust in technology”. It should be clear by now that this promise is untenable. Indeed, if the benefits of a decentralised digital economy, which in our view are significant, are to be realised despite the high profile scandals of the least year, regulation that creates rational trust is very much needed. Far from preventing innovation, prudent regulation can play a key part in generating needed trust and public acceptance. Good regulation is in the interest not just of the public, but the DLT providers and businesses too. At the same time, different use cases for NFTs pose radically different risk profiles. A risk based, sectorial approach to regulation, not dissimilar to that proposed for AI regulation, is therefore more promising than one that defines NFTs in law and builds a regulatory regime around them. As the experience with the ICO as “critical friends” of data driven businesses show, a dialogue with the regulator, including the possibility to “opt into” stricter regulatory regimes to leverage certified good governance as a market advantage, can lead to better and more sustainable businesses. Current US proposals by the SEC chair point in a similar direction. https://nftnow.com/features/the-irs-and-sec-are-eyeing-crypto-and-nft-regulation/
A key question to consider is the value of NFTs and how they may, or may not, be good. Value may be considered as the measure of goodness. In business value is often financial worth, but it can have numerous meanings including utility, perceived satisfaction (PS) , net benefit, and phenomenological experience (C.L., Ng and Smith, 2012). Value is not in the object but in the use experience of the customer. Thus, value is subjective, as it is perceived in context and in time (Kewell, Adams and Parry, 2017; Akaka and Parry, 2019).
However, alongside the value the NFTs may create are drawbacks that need consideration. The primary issue relates to the false claim for NFTs uniqueness. NFTs are usually formed of metadata that link them to a digital asset, that is then placed on a blockchain. This is supposed to provide evidence of ownership or some form of rights over a digital asset. However, an NFT can be (re)created on numerous exchanges that utilise multiple different underpinning distributed ledger technologies, which are non-standard and have limited to no interoperability. Therefore, as with any digital asset an NFT is easy to replicate, so the NFT linking to a digital asset may be recreated on any number of different systems, effectively creating multiple NFTs for any given asset. Which one is the ‘real’ NFT becomes as meaningful as which digital asset is the original.
Centralised governance providing provenance of ownership is a potential solution, but that could be applied more easily to the original digital asset, which somewhat obfuscates the value of NFTs.
There is a lack of legal clarity surrounding NFTs and while the LCEW proposal will address some questions regarding of their status as a form of property, others remain open. Here we also want to mention their treatment in tax law - again bearing in mind that ownership of the NFT token is not the same as owning the linked digital art, one of the examples where that distinction will require adjustments in the language of existing laws wif their scope is to be extended to the decentralised digital economy.
This can make it difficult for individuals to understand their rights and obligations when it comes to owning and selling NFTs. The lack of regulation of NFTs in the market makes the reproduction problem significant. Because NFTs are a relatively new asset class, there are few rules and standards in place to protect buyers and sellers. This can make it difficult for individuals to know if they are getting a fair deal or if they are being taken advantage of. The lack of regulation and the high value of some NFTs has also made them a target for fraud and scams. There have been numerous instances of individuals being duped into buying fake or stolen NFTs, which can be difficult to detect and often result in significant losses. Several of the more problematic practices surrounding NFTs came from the way in which they were promoted to the public, for instance through celebrity endorsements on social media platforms such as Twitter. NFTs may come with potentially high transaction costs. Because NFTs are stored on a blockchain, each transaction requires network fees that may be dynamic and expensive. This can make it difficult for individuals to afford to purchase or sell NFTs, especially if they are buying or selling in large quantities. It also makes it difficult for them to anticipate the costs of a purchase. For these reasons, we see a strong role for advertising and consumer protection law. The technological complexity of NFT/blockchain, and the lack of “lived experience” with these new assets, makes transparency particularly important. Contrary to the more ideology-driven claims sometimes made on behalf of DLT technology, merely putting data on the blockchain does not create transparency – it is merely an enabler for it. True transparency requires interpretability and intelligibility – here the debate surrounding AI regulation and DLT regulation converge. Unsophisticated users need text-based, easy to understand and fair explanations of what exactly it is they are acquiring.
Depending on the type of blockchain employed, NFTs may also impact on the environment. The process of creating and trading NFTs, particularly if linked to a Proof of Work blockchain, requires a significant amount of energy, which can contribute to carbon emissions and other environmental problems. For NFT regulation at the bare minimum this means that great care needs ot be taken not to accidentally privilege more environmentally harmful technologies over cleaner alternatives that achieve similar outcomes but with different set-ups. More ambitiously would be to use regulation to push towards environmentally sound (er) NFTs. Environmental regulation too has in recent years leveraged “market transparency” as a tool requiring e.g. clear, prominent and intuitive labels about the energy efficiency of some electronic goods. Competition between different forms of NFT technology could be stimulated by also requiring similar labelling for the environmental impact of an NFT.
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Submitted by Burkhard Schafer, John Collomosse, Glenn Parry, Chris Elsden and on behalf of DeCaDe and Creative Informatics.
Burkhard Schafer, Professor of computational legal theory, the University of Edinburgh
John Collomosse, Professor of Computer Vision. Director DECaDE
Glenn Parry, Chair of Digital Transformation, The University of Surrey
Chris Elsden, Chancellor’s Fellow, The University of Edinburgh