Imperfect Digital Certificates of Provenance - A Categorical Risk-Based Approach to Non-Fungible Tokens (NFTs)

Abstract

Non-fungible tokens (“NFTs”) are an emerging digital asset that has captured global attention with multi-million-dollar price tags for seemingly basic pixelated JPEG files. In March 2021, British auction house Christie’s sold a digital artwork, ‘Everydays: The First 5,000 Days’, by artist Mike Winkelmann (“Beeple”) for the Ether equivalent of $69.3 million, making it the third-most expensive artwork by a living artist.1 Beeple’s sale was by no means alone—Sotheby's sold an NFT collection of 101 ‘Bored Apes’ for $24.4 million;2 CryptoPunk #7804, one of 10,000 unique ‘CryptoPunk’ NFTs sold for $7.56 million,3 and Twitter founder Jack Dorsey’s first-ever tweet sold for $2.9 million as an NFT.4 NFT sales in the first-half of 2021 have already exceeded $2.5 billion,5 and, as of October 2021, the total value of NFTs on the Ethereum blockchain is estimated to be at least $14.3 billion.6 On one hand, NFTs may be poised to revolutionize creative industries and drastically alter consumer interaction with digital media.7 On the other hand, the NFT market is simultaneously both ripe for speculative investment and vulnerable to criminal activity.8 To date, there appears to be no consensus on the regulation of NFTs, neither from the perspective of generally applicable laws, regulatory capture under existing financial market regulation, nor the implementation of new digital asset laws. This paper attempts to highlight several pertinent dangers of NFTs, from a profound misunderstanding of what an NFT transaction entails, their bubble-like pricing, to various criminal activity concerns. By illustrating how existing laws and regulations may not fully capture nor address these dangers, as well as the potential oversight of NFTs in newly proposed digital asset laws, this paper proposes a categorial approach to regulating NFTs, by reducing the current (and likely future) use-cases of NFTs to their constituent categories and in turn, suggesting the most appropriate regulatory approach to each. Ultimately, given the (potential) wide-ranging use-cases of NFTs, this paper proposes that the NFT’s intended use-case described in broad categorical terms, or more aptly, its underlying reference asset and simultaneous conveyance, or lack thereof, should dictate the regulatory approach.