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 use of NFTs in real estate. Though the first NFT-based auction of real estate took place in 2017, the idea is only now taking hold on a larger scale, probably because of 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. That generation is facing much the same problem with real estate and with NFTs, however: both are becoming increasingly unaffordable. One answer to this has been friends co-buying housing, and another has been the arrival of fractionalised NFTs. In both cases, buyers are able to invest a smaller amount while obtaining shared ownership. An interesting development, and one that poses new legal questions. In this blog we 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 quick refresher: 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 a certificate of authenticity, or perhaps to a land registry entry. 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 that may be the case in some sales, because of the specific agreement, it is definitely not a given. Unless explicitly stated otherwise, all an NFT entitles you to is the position on the blockchain itself, not the copyright connected to an object or the ownership of the object itself.

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

Part one: fractionalised NFTs

So, now that we are 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.’ With the introduction of fractionalised NFTs, that is no longer entirely true. 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, producing a kind of NFT of an NFT. In other situations, 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 at the time. 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).

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. An owner may also see some liquidity without selling the entire piece, by selling only a part of it. In this way, the original NFT comes 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.

Some questions also arise, however. 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 for whether an artist can prevent fractionalisation, probably not, though it cannot be said for sure and it depends on the type of NFT. It turns entirely on whether exhaustion applies to NFTs. Exhaustion means that if a copy of a work is sold by the copyright owner (or with their permission), the copyright owner “exhausts” their right to control distribution any further. In other words, 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 someone were to buy Van Gogh’s Starry Night, cut it into a million pieces and sell those individually, there would not be much Van Gogh could do about it, even if he were alive (the work would be destroyed, and only in specific circumstances can artists rely on their moral rights to prevent destruction). Digital assets are notoriously controversial as far as exhaustion is concerned, so a court may take a different view. Fractionalising an NFT is obviously very different from cutting up a masterpiece. No moral rights are involved, since the work itself remains intact.

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

Another interesting issue is how the splitting actually works, and what your position in relation to the original NFT is if you own a fractionalised NFT of it. When someone splits an NFT, the original NFT (the ERC-721) is locked into a smart contract. In the case of fractionalised NFTs, you create a vault in which a basket of fractionalised NFTs is minted. As the owner of the vault, you are entitled to a curator’s fee. Your original NFT, however, is “locked”. That 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 in a company, which probably also means that the buyers of the fractions have voting rights. So if someone else owns the majority of the fractionalised NFTs, they will be able to decide what to do with it.

The legal position here is murky, as we do not really know what a fractionalised NFT is in law. Dutch law provides rules for shared ownership, but since ownership is limited to tangible objects and certain specifically defined rights, those rules do not apply to NFTs (nor to fractionalised NFTs). A court may come to regard a fractionalised NFT as a type of investment contract, but we simply do not know yet. Put simply, fractionalised NFTs are NFTs on NFTs. There are also situations, such as on Fractional.art, in which there is one big distinction: unlike original NFTs, fractionalised NFTs may 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. That means you can also buy part of one of those 17 billion tokens. Since these are divisible already, the question remains why you would not just mint a single ERC-20 token, as you could already buy one seventeen-billionth of that token anyway. This may have to do with the fact that it feels better to own 33 of something than 0.00000001, even though the two may essentially be the same thing.

That also prompts the question of why you would bother with NFTs in the first place. You could opt to mint a single ERC-20 token directly, denoting ownership of 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 the NFT at 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 that NFT is subsequently sold for 300 ETH, you can redeem 3 ETH. Whichever route you take, you had better read the (smart) contract carefully in order to know what you are buying and what your rights are.

Part two: shared accounts

It is 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 likes 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 would have to sign off on it.

That eases the shared ownership difficulties, as the nature of the wallet requires every single investor to sign off on the transaction. The risks and rewards of the NFT are therefore likely to be evenly divided among those participating in the account. Note, though, that the term ‘shared ownership’ is a little misleading, since ownership under Dutch law is limited to tangible objects. The thing about NFTs is that they are not considered ‘goods’ or tangible 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 you buy through a shared account, you are still entitled to your share of the sale proceeds. How this type of position is treated in law is still a little unclear. Ideally, a court will look at the economic reality and extend property and ownership rights to NFTs (and other digital assets). In civil law countries that is more likely to require a change to 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 where an NFT has been fractionalised and you buy one or more of the fractionalised NFTs. That works rather like being a shareholder, as you invest in a percentage of an original. In this way, NFT frontrunners are aiming to democratise the NFT market and make it more liquid. As the technology is very new, it is not yet clear what your position in relation to the NFT is as the owner of a fraction of it. The second way is buying an NFT through a shared wallet. That method is more straightforward, as it is quite similar to jointly buying a house, an artwork or anything else. Established rules can therefore be applied. For example, if you and your partner buy a CryptoCat with a joint account and both sign off on it, you will each own 50% of the NFT, meaning that you will both be entitled to the proceeds of any sale and will need the other’s permission to sell (or fractionalise).

---

In cooperation with Saar Hoek.