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NFTs and Shared Ownership

Another season, another NFT trend. The market in non-fungible tokens that made global headlines this year, is still making waves. One of the more recent developments has been the application of NFTs in the real-estate realm. Though the first NFT-based auction of real estate occurred in 2017, the idea is only now taking hold on a larger scale, probably due to all the publicity. Using the technology may provide a more efficient, traceable and secure way to go about real-estate transactions. A more fitting method for the digital generation. This generation is facing some issues with real estate and NFTs alike, however: both are becoming increasingly unaffordable. One of the solutions to this issue is that friends are co-buying housing and fractionalised NFTs have been introduced. In both cases, buyers are able to invest a smaller amount while obtaining shared ownership. An interesting development which poses new legal questions. In this blog, we will discuss what shared ownership means for NFTs. 

A quick recap 

We have discussed what NFTs are, how NFTs relate to copyright and what ownership of an NFT means in previous blogs. A freshen-up: NFTs are blockchain assets that are connected to objects. This may be any type of object, ranging from digital artworks to – as mentioned – real estate. The connection to that object is established by a position on the decentralised database that is blockchain. You can compare an NFT to an authenticity certificate or maybe a cadastre registration. A common misconception is that when you buy an NFT, you also buy the object it is connected to or obtain the rights to that object. While this may be the case in some sales, due to the specific agreement, it is definitely not a given. Unless explicitly stated elsewise, all an NFT entitles you to is the position on the blockchain itself, not the copyright connected to an object or the ownership of an object itself. 

Be mindful of what you’re buying and what is stated in the agreement before you choose to invest. If you think you are buying a house, but in actuality are only buying a blockchain position connected to that house, it will be difficult to decorate.

Part one: fractionalised NFTs

So, now that we’re up to date, we can complicate things further. In a previous blog, I said that ‘[NFTs] can be rare (if the developer limits the number of items in existence) and indivisible. Remember, you cannot buy half an artwork, a quarter of a concert ticket or only Dragon’s tail.’ This is not entirely true anymore, with the introduction of fractionalised NFTs. An NFT is a specific type of token, ERC-721, to be exact. An NFT can now be fractionalised. In some instances, this results in new NFTs, resulting in a type of NFT of an NFT. In other situations, different types of fungible tokens, ERC-20, are minted for that NFT. With this recent change, NFTs can now be split up into many parts, sometimes even billions. For example, the original image picturing the dog that was the inspiration for the Doge meme (and later the Dogecoin) sold for 1,696 ETH in June (about $4 million then). The buyer of the NFT, an art collective, decided to split the NFT up into 17 billion parts and sell them for only $1 apiece. The total value exploded to over $220 million (and is now back to around $96 million).

Photo by Executium on Unsplash 

This illustrates some of the advantages of splitting up NFTs. For one, it may make investing in popular NFTs much more accessible to a wider range of people. Secondly, splitting up an NFT may increase the value of the asset for the owner of the NFT. Additionally, an owner may see some liquidity without selling the entire piece by selling only a part of it. In this way, the original NFT is under shared ownership. Generally, this helps keep the NFT market liquid. It also helps with price discovery: if one of a hundred fractions of a specific NFT is traded for $5, you may assume the original is worth about $500. 

However, some questions also arise. Can an artist selling a unique position to a digital artwork prevent a buyer from fractionalising the NFT? Are there any risks of downstream infringement? 

As far as an artist preventing fractionalisation, this is probably not possible, though it cannot be said for sure and depends on the type of NFT. This depends entirely on whether exhaustion applies to NFTs. Exhaustion regulates that if a copy of a work is sold by the copyright owner (or with his permission), the copyright owner “exhausts” his rights to control distribution further. Meaning that if you sell something, you cannot prevent the buyer from selling it again or giving it away. The same probably goes for fractionalisation. To use a rather crude example, if one were to buy Van Gogh’s starry night and decided to cut it into a million pieces and sell those individually, there is not much Van Gogh could do about that, even if he was alive (the work would be destroyed and artists can only under specific circumstances stop destruction based on their moral rights.). Digital assets are notoriously controversial as exhaustion is concerned, however, so a judge may feel otherwise. Obviously, fractionalising an NFT is very different from cutting up a masterpiece. There are no moral rights involved since the work itself will remain intact. 

Downstream infringement is probably not a very high risk, though this depends on the way the tokens are marketed and sold and whether an accompanying image is provided. However, these risks are not very different from regular NFT infringement risks, which you can read about here

Another interesting issue is how the splitting actually works and what your position towards the original NFT is if you own a fractionalised NFT to it. When someone splits an NFT, the original NFT (the ERC-721) gets locked into a smart contract. In the case of fractionalised NFTs, you create a vault in which a basket of fractionalised NFTs will be minted. As an owner of the vault, you are entitled to a curator’s fee. However, your original NFT will be ‘locked’. This makes sense, as it would be outrageous if you could split your NFT into fractionalised NFTs, sell those separately and then also sell the original NFT, thereby doubling the revenue. This is similar to selling shares to a company. Which probably also entails that the buyers of the fractions will have voting rights. Therefore, if someone else owns the majority of the fractionalised NFTs, they will be able to decide what to do with it. 

The legal situation around this is murky, as we do not really know what a fractionalised NFT is, legally. The Dutch law provides rules and regulation for shared ownership, but as ownership is limited to material goods and some specifically detailed rights, these laws do not apply to NFTs (nor to fractionalised NFTs). Maybe a judge will regard a fractionalised NFT as a type of investment contract, but we just do not know yet. To put it simply, fractionalised NFTs are NFTs on NFTs. However, there are also situations (like on Fractional.art)  in which there is one big distinction: unlike original NFTs, fractionalised NFTs might be fungible. To take the picture of the dog as an example, the 17 billion ERC-20 tokens that were minted are interchangeable, divisible and of the same value. Meaning you can also buy a part of one of those 17 billion tokens. As these are divisible already, the question remains why you would not just mint a single ERC-20 token, as you could already buy 1/17 billionth of that token anyway. This might have to do with the fact that it feels better to own 33 of something than 0.00000001, even though they may essentially be the same thing.  

This also prompts the question why you would bother with NFTs in the first place. You could also opt to just mint a single ERC-20 token directly which denotes ownership to the Mona Lisa, for example. The benefit of the F-NFT method here, is that you retain ownership of the initial NFT and that it can still be sold. The fractional owners can vote on a reserve value and when a potential buyer wants to bid on this NFT for that value or higher, an auction is triggered. If the NFT is then sold, the fractional owners can redeem the percentage they have rights to. For example, if an NFT is fractionalised into 100 NFTs of 1 ETH apiece and you buy one of them, and subsequently that NFT is sold for 300 ETH, you can redeem 3 ETH. Whichever you do, you better read the (smart) contract carefully in order to know what you are buying and what your rights are. 

Part two: shared accounts

It’s also possible that an NFT is bought through a shared account. Maybe you and your sweetheart share a love for CryptoPunks, maybe you and your broke millennial friends lack the funds for a personal account, maybe your firm enjoys the extra security a shared blockchain wallet can provide. Whatever the case, it is sometimes possible to have a jointly “owned” blockchain account. Such a shared wallet is also called a multi-sig wallet, as it requires multiple signatures for transactions. Which means that, if you were to buy an NFT, the co-”owners of the wallet must sign off on it.

This eases the shared ownership difficulties, as the nature of the wallet requires every single investor to sign off on the transaction. It is therefore likely that the risks and rewards of the NFT will be evenly divided amongst those participating in the account. Mind here though, that the term ‘shared ownership’ is a bit deceiving. As ownership in Dutch law is limited to material objects. The thing about NFTs is, that they are not considered ‘goods’ or material objects, nor do they grant rights in and of themselves. As we said in a previous blog: “With an NFT, you are entitled to the NFT itself, not to the underlying asset nor to the corresponding copyright. So, that would mean that NFTs themselves cannot be considered ‘goods’. They are not rights. They are nothing more than factual control over the position on the blockchain. Such factual control is pretty similar in a philosophical sense to “possession” of a material object or even ownership, but it is not a “right” under Dutch law. The blockchain ensures immutability and strict transferring rules. But it does not grant rights.

Just because an NFT is not a good or a right, does not mean that it is worthless. NFTs are still selling for millions. If bought through a shared account, you will still be entitled to your share of the sales value. How this type of position is regarded in a legal context, is still a bit unclear. Ideally, a judge will consider the economic reality and extend property- and ownership rights to NFTs (and other digital assets). In civil law countries this is more likely to require a change of the civil code than in common law countries.

In conclusion

There are two main ways in which you can be a shared owner of an NFT. The first is when an NFT has been fractionalised and you buy one or more of the fractionalised NFTs. This works kind of like being a stakeholder, as you invest in a percentage of an original. In this way, NFT frontrunners are aiming to democratise and liquidise the NFT market. As this technology is very new, it is not yet clear what your position towards the NFT is as an owner of a fraction of it. The second way is buying an NFT through a shared wallet. This method is more straightforward, as it is quite similar to jointly buying a house, an artwork or anything else. Therefore, established rules can be applied. For example, if you and your partner buy a CryptoCat with a joint account and both sign of on it, you will both own 50% of the NFT, meaning that you will both be entitled to the revenue of potential sales and will need the permission of the other to sell (or fractionalise). 

In cooperation with Saar Hoek.

05 January 2022 - Blockchain and law, Copyright, NFT

About Jetse Sprey

Jetse is associated with our office as legal counsel. Jetse finds solutions instead of problems and is able to break stalemates again and again. He speaks his mind and is not guided by what he thinks his clients want to hear.

He writes sharp, readable contracts. He has extensive experience with Blockchain and is an entrepreneur in this field himself. He writes convincing procedural documents and advice. He is knowledgeable in intellectual property, privacy and corporate law.

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