Mastrucci: The Future of NFTs in the Metaverse: Utility and Liability | Shook, Hardy & Bacon LLP

With NFT sales taking a nosedive in recent months amid rank speculation, scams, and hacks, many are justifiably wondering whether NFTs have any value or utility or whether they’re just a passing gimmick. The answer is somewhere in between: As an emerging and easily commercialized technology, the NFT market is understandably experiencing growing pains. But as NFT marketplaces and platforms become more secure, regulators step in, and new use cases surface, this blockchain-based technology will likely see a resurgence and become a key, if not integral, part of the unfolding Metaverse. In this article, I explore what the Metaverse and NFTs are and may become, and what companies can do to limit liability when selling worthwhile NFTs in the future.

What Is the Metaverse?

Before I attempt to define the Metaverse, I should first note that the Metaverse is not fully here yet. Talking about the Metaverse now is like talking about the internet in the 1970s. We have some of the building blocks in place, but we still do not yet know what form or path the Metaverse will take.

Many attribute the term “Metaverse” to Neal Stephenson’s 1992 dystopian sci-fi novel Snow Crash, in which people connected to the “Metaverse”—a massive virtual urban world—via terminals using VR (or virtual reality) headsets. In June 2021, venture capitalist Matthew Ball, published a 9-part essay called The Metaverse Primer, in which he offered his “best swing” at a definition of the Metaverse: The Metaverse is a massively scaled and interoperable network of real-time rendered 3D virtual worlds which can be experienced synchronously and persistently by an effectively unlimited number of users with an individual sense of presenceand with continuity of datasuch as identity, history, entitlements, objects, communications, and payments” (emphasis original).[i] In other words, the Metaverse is “a quasi-successor state to the mobile internet,”[ii]—a new way of experiencing the internet, one that is not just mobile and dynamic like the current internet, but interconnected, immersive, and in 3D. Mark Zuckerberg, who renamed Facebook’s parent company “Meta” in October 2021, has called it an “embodied internet.”[iii]

In the fully formed Metaverse as envisioned by Ball, Zuckerberg, and others, users will have avatars, or virtual identities, as well as virtual belongings, and they will be able to take both their avatars and their belongings from one virtual world or platform to another.

What Is a “Non-Fungible Token” or NFT?

Simply put, an NFT is proof of “ownership” (more on ownership later) of a unique, non-fungible asset that is recorded on the blockchain. A blockchain, in turn, is a decentralized database comprised of a network of autonomous computers around the world that each validate and record a particular transaction (ie, “recorded on the blockchain”), thereby minimizing the risk of transaction disputes and counterfeiting without the need for centralized oversight. Two examples of blockchains are Bitcoin and Ethereum. The asset associated with the NFT is typically, though not necessarily, a digital asset like a virtual artwork or video clip that, unlike the NFT itself, is generally not recorded on the blockchain. While the NFT market has taken a hit in recent months, many retailers have already invested in it, such as Ticketmaster, Formula 1, the Gap, Under Armour, and Adidas, and many others await the market’s emerging potential.

In addition to selling NFTs, companies can also use NFTs as a promotional tool and give them away as a freebie, or as a limited-edition collector’s item. Moreover, NFTs can be coupled with smart contracts—which, simply put, are self-executing blockchain-based software programs—to become revenue-generating devices in perpetuity.

To illustrate, imagine that Nike gives you a free Air Jordan NFT when you purchase a real-life pair of Air Jordan sneakers. That NFT gifting is recorded on the blockchain. Now imagine that Nike’s gifting of the Air Jordan NFT to you was part of a smart contract, whereby Nike permitted you to transfer the NFT to someone else and anytime you or a subsequent transferee transferred the NFT, Nike automatically collected a royalty. That is the power of the smart contract. And if Nike created artificial scarcity by minting or creating only a limited number of Air Jordan NFTs, those NFTs could be the gift that literally keeps on giving.[iv]

NFTs in the Metaverse

So what do NFTs have to do with the Metaverse? Potentially a lot. Returning to the Air Jordan example, imagine that the Air Jordan NFT was linked to not just a virtual image of a pair of sneakers but a digital wearable, ie, virtual sneakers, that you could store in your crypto wallet and equip on your avatar. In the envisioned Metaverse where virtual worlds are interoperable and linked to users’ crypto wallets, your avatar could wear the virtual Air Jordans while world-hopping, with the NFT serving as proof of purchase and thus the right to wear. For some, buying an NFT-backed virtual good like a Gucci purse or a Ferrari is purely an investment. For others, it is a vehicle for creative self-expression and identity construction, and can provide a sense of community and belonging.

What Do You “Own” When You Buy an NFT?

If an NFT is linked to a purely digital asset, as most are, what are you buying when you buy an NFT? Relatively few have addressed this question to date, and the answer is still murky.

To bring the issue into sharper focus, I want to use a recent class action against Amazon as an analogue. In 2020, Amazon was hit with a putative class action filed by an Amazon Prime subscriber who alleged that Amazon’s description of its movie streaming services as “purchases” amounted to false advertising and consumer fraud because, as it turns out, the subscriber does not actually own any movies “purchased.”[v] Rather, the subscriber is buying a license to watch the films that can be revoked for various reasons, and the movies consequently removed from the subscriber’s library.

While In re: Amazon Prime Video Litigation is still in the pleading stage, it begs the same question that can be asked of NFTs: What are you getting when you “buy” an NFT? Normally, when you buy a painting in real life, you are really “buying” only the physical canvas—you’re not buying the intellectual property rights in the painting itself. But with an NFT, there typically is nothing physical associated with it—it’s all IP. And it is unlikely companies are going to want to fork over their IP rights when they “sell” you an NFT. More likely, they will want to offer you a license to use any digital asset(s) linked to the NFT. If Amazon Prime Video is any harbinger of litigation to come, I suspect we will soon see class actions surfacing in the NFT market about what consumers are actually “buying.”

So how can companies protect themselves from liability in the NFT space? In letter, by watching what they say. If your company is going to license and then sell or gift NFTs, make sure your advertisements, marketing materials, and especially licensing agreements are clear on who owns what and specify that the acquirer of the NFT is getting only a license to use the digital content (the wearable, artwork, song, video, etc.) associated with the NFT and not the IP rights to that content.

And if you are licensing third-party content (eg, as Amazon does with Prime Video and Kindle, or as Nike might if its NFT sneakers feature images of famous NBA players), make sure that your licensing agreement with the third party allows you to pass those licensing rights on to the ultimate consumer or that any applicable third-party copyrights or other IP rights have expired. In 2009, Amazon came under fire for remotely deleting digital editions of George Orwell’s 1984 and Animal Farm from readers’ Kindle devices after learning it did not have the rights to them.[vi] While Amazon issued refunds to those affected, customers still felt aggrieved, with Amazon facing both bad press and litigation.[vii]

The NFT market has already faced similar controversy. In November of last year, the film studio Miramax sued director Quentin Tarantino when it learned he planned to auction off seven “’exclusive scenes’” from the handwritten screenplay of Pulp Fiction as NFTs.[viii] According to Miramax, Tarantino’s planned auction was in breach of the parties’ contract whereby Tarantino assigned to Miramax “’all rights (including all copyrights and trademarks) in and to the film.’”[ix] The lawsuit, which settled in September, serves as a cautionary tale to others seeking to market NFTs that are potentially laden with third-party rights.

Conclusion

As the Metaverse emerges and companies perhaps join forces, NFTs will be used as far more than just a receipt for a particular virtual good. Because NFTs are recorded on the blockchain for all to see, the tokens themselves are nearly impossible to counterfeit. As such, NFTs can be linked to both virtual and real-world benefits and simultaneously serve as proof of your right to use those benefits. For example, Nike could partner with a virtual gaming platform such that any user who wore their Air Jordans in the game world would be gifted a special power or granted access to an otherwise restricted area of ​​the world. Likewise, an NFT—whether or not linked to a virtual good—could serve as your ticket to a virtual or real-life concert, permit you entry into a pre-sale of virtual land, or even grant you membership into an exclusive Metaverse community that promises additional perks.

The possible benefits that can be linked to an NFT are virtually endless (pun intended). We have only just begun to uncover their potential—and the potential liability they pose.

[i] See Matthew Ball, The Metaverse Primer: Framework for the Metaverse (Jun. 29, 2021), available at https://www.matthewball.vc/all/forwardtothemetaverseprimer (last visited July 8, 2022). In his long-awaited book that “updates, expands, and recasts everything [Ball has] previously written on the Metaverse,” Ball reaffirms this definition of the Metaverse. See Matthew Ball, The Metaverse and How It Will Revolutionize Everything (Liveright Publishing Corporation 2022), at xv, 29.

[ii] ID.

[iii] See Kyle Chayka, The New Yorker, “Facebook Wants Us to Live in the Metaverse” (Aug. 5, 2021), available at https://www.newyorker.com/culture/infinite-scroll/facebook-wants-us-to-live-in-the-metaverse (last visited July 8, 2022).

[iv] In fact, Nike has already entered the NFT sneaker business. In April 2022, Nike released its first collection of virtual sneakers, called Cryptokicks, comprised of 20,000 NFTs, one of which was sold for $134,000. See Alex Williams, The New York Times, “Nike Sold an NFT Sneaker for $134,000” (May 26, 2022), available at https://www.nytimes.com/2022/05/26/style/nike-nft-sneaker.html (last visited July 8, 2022).

[v] See In re: Amazon Prime Video Litigation, no. 2:22-cv-00401 (WD Wa.)

[vi] See Brad Stone, “Amazon Erases Orwell Books from Kindle,” The New York Times (July 17, 2009), available at https://www.nytimes.com/2009/07/18/technology/companies/18amazon.html (last visited Sept. 12, 2022).

[vii] See Alexandria Sage, “Amazon settles Kindle lawsuit over ‘1984’ copy,” Reuters (Oct. 2, 2009), available at https://www.reuters.com/article/us-amazon-lawsuit/amazon-settles-kindle-lawsuit-over-1984-copy-idUSTRE59151X20091002 (last visited Sept. 12, 2022). In particular, customers claimed that their digital purchases were deleted without notice or consent and in purported contravention of their purchase agreements and that any digital notes they had taken on their Kindle-edition books were irretrievably lost once the books were deleted. ID.; Stone, “Amazon Erases Orwell Books from Kindle,” supra.

[viii] See Compl. [ECF No. 1] at ¶ 1, Miramax, LLC v. Quentin Tarantino, et al., case no. 2:21-cv-08979 (CD Cal. Nov. 16, 2021).

[ix] ID. at ¶ 20.