Sunidhi Kashyap and Shagnik Mukherjea are second year law students at RGNUL, Patiala.
Introduction
The rapid rise of NFTs has formed the basis of the billion-dollar industry that we see today. In May of 2014, Kevin McCoy, a digital artist, minted and released the first-ever NFT, titled ‘Quantum’. In essence, it was a pixilated image of an octagon in GIF format, with fluorescent colours pulsing between the changing shapes.
At its core, Non-Fungible Tokens (NFTs) are assets that are encoded on a blockchain, containing unique assets or a set of rights. They are ‘minted’ by creators and are predominantly purchased on virtual market places like Open Sea and Rarible using crypto currencies. NFTs are characterised by their non-fungibility, which means that no two NFTs are identical. They are unique in their own way. This is in contrast to currencies, where a $10 note is always equivalent to another $10 note as they are ‘fungible’ in nature. The originality rights that come with the exchange of NFTs and subsequent distribution rights regardless of the number of digital replicas are floating around the internet. It is pertinent to note that NFTs are not limited only to virtual spaces. They can represent any type of asset, including assets existing in the real world, which makes owning and exchanging physical possessions in virtual marketplaces possible.
In parallel to the confusion surrounding the commodity, NFTs have continued to experience exponential growth over the past few years, reaching sales valuations of upwards of $10.7 billion as of Q3 2021. Following the hype, a Sotheby’s auction in June 2021 saw the sale of McCoy’s ‘Quantum’ for $1.4 million and another NFT titled ‘Alien Crypto Punk #7523’ for $11.7 million. Owing to its characteristics, the NFT industry faces two major concerns: the applicability of the doctrine of first sale and its effect on distribution rights; and the possibility of NFTs falling within securities laws. And thus, this article seeks to answer these questions, illustrates the legal status quo, and ultimately, enhances the discourse surrounding such thriving industries
NFTs and the Doctrine of First Sale
In a digital auction co-organised by Sotheby’s and Burning Man, Raghava KK recently sold his digital artwork portraying the physical feeling of orgasm for $94,500. Such eccentric innovations in the art industry are barely niche anymore, and as digital art has often been overlooked and undervalued, the NFT industry provides a great opportunity for digital artists worldwide. This, however, raises the question of the author’s legal rights concerning the protected digital work in the event of a resale. According to the Doctrine of First Sale, the copyrighted works can be resold without going through the hassle of negotiating with the owner each time they contemplate a further sale. As an example, the sale of a painting from a private gallery collection does not require the buyer to ask for permission for a subsequent sale. In India, although not codified, the Doctrine of First Sale can be deduced from a combined reading of the various provisions outlined in the Copyright Act. It enables the distribution of copyrighted products if the protected artwork remains virtually unchanged. And thus, a distribution right infringement only occurs when a retailer acquires a product and sells it unlawfully.
Digital assets, however, present a whole new set of challenges. The First Sale Doctrine applies to tangible copies, whereas NFTs are intangible and thus may not be legally considered as material objects. More importantly, in the case of Capitol Records LLC v. ReDigi Inc., the court refused to apply the first sale doctrine to the resale of an MP3 file because it involved an unauthorised reproduction of the work. This distinction between tangible and intangible copies seems outmoded now, and courts have been unable to defend the protection guaranteed by this doctrine due to an absence of precedent. Additionally, it should be noted that the transfer of NFTs related to a protected work of art is not always accompanied by its reproduction for subsequent sales. In this regard, only if the new owner of the NFT accesses the underlying work does it result in a new copy of the work being created. In such a case, the transfer will subsequently fall out of the scope of the doctrine of the first sale and, thus, put purchasers of NFTs at a disadvantage. As a result of protecting NFT’s creator in the event of a resale, several benefits of NFTs are also being restricted since arguably, the most prized feature of the NFT is the ability to resell. One of the biggest challenges is the fact that making another copy is an inherent part of selling digital copies and thus brings reproduction rights into the legal discourse. Under the Copyright Act, only the copyright owner has the authority to reproduce the copyrighted work or to authorise its reproduction. In the case of Used Soft GMBH v. Oracle International, it was held that for reproduction rights to not be violated, the original copyright owner must render his original copy unusable at the time of sale. However, as illustrated previously, in the case of Capitol Records LLC v. ReDigi Inc., it was held that reselling pre-owned music infringes copyright as it requires the unauthorized reproduction of copies, even if the original is rendered unusable. The ambiguity in the legal interpretations leaves NFTs in a confounding position. Owing to the ease of reproducing digital copies, a lack of Digital Doctrine of First Sale significantly impacts the sustainability of this industry.
Furthermore, it is important to note the legal distinction between copyright and a copy of the original work. Creators have copyright protection over their works, but not over physical copies of their work. If creators were granted power over the distribution of their work beyond the first sale, this would equate to giving them control over the physical copies of their work as well, thus negating the primary objective of copyright jurisprudence. It would be essential for the law to clearly define the reproduction right of the author to create a legally acceptable Digital First Sale Doctrine. This would also have to include reproduction rights for distribution purposes. It is this kind of initiative and change that will help ensure that reproduction rights do not negate distribution rights, resulting in the free flow of digital artworks.