Non-Fungible Tokens (NFTs) are usually classified as digital assets that are not fungible. They vary in rarity and uniqueness, so they are considered rare. NFTs can be anything from a trading card to an in-game item that you cannot trade or transfer to someone else. The rise of crypto-collectibles has been one of the most talked-about subjects of 2018. With this new form of investment and potential return, some risks are also associated with these NFTs. Here are some enlisted risks and challenges in dealing with NFTs.
To name some nightmare risks and challenges in dealing with NFTs are legalities i.e. no intellectual property rights, online fraud risks, cyber threats and a few more to be taken into consideration.
1. Evaluation Challenges
Evaluation of NFTs is a difficult task, even for experienced collectors. And has led to primary risks and challenges in dealing with NFTs.
We have to deal with both the physical and the digital versions of the artwork. It is not enough to own a digital file or even a certificate of authenticity. The problem is that several copies can be made of the same file and dispersed in different places. The original copy owner keeps its uniqueness and authenticity, while other people have no guarantee they own the real thing.
The Internet has been flooded with fake art pieces with low-quality copies of well-known masterpieces (e.g., oil paintings). Such frauds are done for different purposes, including stealing personal data or money from potential buyers. It can also be an experiment to check public interest in a new idea or product. In our case, this will be NFTs and their future marketplaces. This way, scammers know how to improve their scams by exploring consumer preferences and behavior when exposed to new concepts or ideas.
2. Cyber Threats and Online Fraud Risks
The risk of cyber threats and online fraud is inherent in any digital transaction; NFTs are no exception. Because NFTs are not standardized and regulated, more than 30% of all transactions on the NFT platform take place outside the blockchain. In this case, these transactions can be carried out without intelligent contracts or a decentralized blockchain.
Another threat comes from phishing sites. Due to the lack of standardization and regulatory control over the market, many users do not know how to recognize a phishing site and may even give their private keys to attackers.
The overall situation is complicated because most users don’t fully understand how NFT works. This often leads to possible user errors when interacting with smart contracts or passing personal data to third parties.
Considering this point, cyber threats and online frauds are the most stressful risks and challenges in dealing with NFTs.
Legal Risks And Challenges In Dealing With NFTs
Legal challenges will always exist in the crypto world, regardless of how decentralized it is. In the case of NFTs, these challenges are mainly related to copyright laws and intellectual property rights. An NFT’s value lies in its link with a particular individual or a group, which creates many legal challenges. Such as:
3. No Intellectual Property Rights
The NIPR has brought other risks and challenges in dealing with NFTs.
NFTs do not bestow any intellectual property rights on the seller or the buyer. This means that the owner of the NFT does not get any exclusive rights over the underlying work. This is important to understand when buying an NFT, mainly when it contains content that a third party may copyright (e.g., music, art, literature, games, etc.). No one may own the underlying content or IP at all. This is particularly true where the content contains images or other information from a video game.
4. NFT Fractions and Index Funds Can Be Unregistered Securities
The SEC has not issued guidance on whether NFTs are securities or how to treat them for securities laws purposes. However, the SEC has stated that it does view some blockchain assets as securities and that it will continue to assess whether other blockchain assets should be treated as securities, including “digital assets where the digital asset is offered and sold in such a way that it meets the definition of an investment contract under U.S. federal securities laws but is not a security under state law or other recognized exemptions from the definition of a security under federal securities laws.”
5. Anti-Money Laundering (AML) Efforts Can Impact Your Activity
AML has been airing the risks and challenges in dealing with NFTs. As Cryptocurrency platforms have made it easier to buy and sell, pay and receive payments, and move money worldwide. But this ease of use brings with it more significant risk.
Anti-money laundering (AML) laws and regulations that seek to prevent money laundering and terrorist financing are a part of this risk. AML laws require financial institutions to take specific steps to ensure that their platforms are not being used for illicit purposes. The penalty for non-compliance can be significant, including criminal charges against individuals and companies involved in the transaction. As a result, many cryptocurrency platforms have taken steps to expand their AML compliance efforts, including monitoring user activity for red flags for suspicious activity and reporting suspicious activity to authorities.
6. Estate and Sequence Planning
Estate and sequence planning generally involves the transfer of assets to beneficiaries. These transfers may be by gift, inheritance, or legacy, or they could be effected through trusts, joint ownership arrangements, or other means. Assets could include property (real estate), intellectual property (copyright and trademarks), and virtual property (non-fungible tokens). Transfers can also take place upon death or during life in certain circumstances.
Estate planning can be complicated for several reasons. First, it involves the coordination of various legal regimes to create the desired outcome. Second, it requires considering all relevant personal circumstances that might impact a family member’s ability to enjoy their inheritance. E.g., a beneficiary with a disability requires special needs trust protection.
Thus, estate and sequence planning-related matters cannot be ignored; and are the unexpected risks and challenges in dealing with NFTs.
7. What About Royalties?
The unprecedented sales of NFTs by digital artists have prompted questions regarding how royalties are distributed to the artists who create them. Many digital artists whose works were recently sold for millions of dollars have been vocal about the need for more equitable distribution.
There are often disputes regarding who owns a work of art, especially when multiple parties are involved in its creation or sale. These issues can become even more complex when dealing with NFTs where, under some circumstances, the artist may no longer own their work once it is sold as an NFT.
However, some platforms like Opensea make the ownership of the art public by listing owners’ transactions.
8. How to Use Trusts Properly
We are now entering an era in which individuals can create digital collectibles representing unique, scarce items or concepts. These digital collectibles will be made as non-fungible tokens (NFTs), and they raise a host of legal issues.
Trusts are a standard mechanism for holding property, including NFTs. For example, the trust can be used to hold NFTs for the benefit of minors and others who cannot directly have a property with their account at a blockchain wallet provider.
Trusts also offer other benefits when owning NFTs, such as gatekeeping access to the NFT by requiring certain conditions to be met before it is released to a beneficiary. Such conditions could include completing specific educational courses to receive a valuable NFT; or obtaining an NFT only upon reaching a certain age, such as 18 years old. However, trusts have potential issues that must be addressed to work correctly.
Negligence of trust-related matters could build up more risks and challenges in dealing with NFTs.
9. Taxation Aspects
The tax treatment of NFTs may differ depending on the type of NFT transaction and the location of the parties involved. As a general matter, most jurisdictions should treat NFTs as property and subject them to traditional property tax rules. In addition, depending on the jurisdiction, a transfer of an NFT may be treated as a taxable event and taxed at the time of purchase or sale.
The tax treatment would vary depending on the nature of each specific transaction. If, for example, an artist creates a piece of art in the form of an NFT and then sells it, that would likely be considered a sale of goods (if it is not a work created by the artist under contract) and treated as such for income tax purposes. In most jurisdictions, a subsequent sale by that purchaser to another purchaser would be treated as a capital asset for income tax purposes.
As noted above, however, many purchasers who buy NFTs do so with the expectation that they will appreciate over time and then sell them at some future point for profit. This type of transaction will be treated differently than if an individual simply buys an item for its utility or novelty value.
10. Data Hosting and Information Safekeeping
The main legal issues associated with NFTs are data hosting and information safekeeping. The first issue relates to the storage of the crucial information required for the proper functioning of NFTs, including the identity of parties involved in a transaction, the terms of a transaction, and any disputes or claims arising from it.
Blockchain is decentralized. This means that no one has ownership over it. In contrast to traditional computer systems, blockchain does not have an exclusive server (or servers) where all the data is stored. Instead, critical information is stored across a network of computers run by different people worldwide distributed in data centers. This distribution prevents hackers from obtaining control over all data at once and makes it difficult to modify or delete records.
However, as mentioned above, blockchain technology is constantly evolving; several competing systems offer different solutions to ensure security and scalability. One example is EOSIO, which uses a delegated proof-of-stake (DPoS) consensus mechanism. EOSIO runs on permissioned blockchains where a group of nodes can decide what transactions can be added to the ledger and which nodes will validate them.
Prior to investing in NFTs, it is recommended to understand the outcome, risks and challenges in dealing with NFTs.
You should also go through the following:
Besides predicting the consequential risks and challenges in dealing with NFTs, get to know:
- What Are NFTs And How Do They Work?
- How To Create NFT And Sell It Safely?
- How Opensea NFT Marketplace Can Help Me Onboard?