What brands need to know about NFTs

Non-fungible tokens, most commonly referred to by the shorthand acronym, NFTs, are tokens that usually live on the Ethereum blockchain and are implemented as smart contracts. They can contain additional metadata, such as a pointer to a digital media asset, and each token is unique (“nonfungible”), which allows their provenance and ownership to be easily established.

Individual artists and brands have turned to NFTs to sell digital art and trading cards, and since the beginning of the year, purchases of these have exploded. This boom has not only been driven by crypto investors spending eye-popping amounts to purchase high-profile NFTs — $69m in the largest sale to date — but also by consumers buying digital trading cards created by one of the most popular sports leagues in the world.

Here’s what brands need to know about NFTs.

Real money is being made

While the current NFT craze has sparked a lot of heated discussion, one thing is not subject to debate: that NFTs are making some people and organizations lots and lots of money. At the end of February, NBA Top Shot, the NFT marketplace created by the National Basketball Association, was said to have generated $230m in revenue, with much of that coming in 2021 as high-dollar, high-profile sales of Top Shot NFTs have sparked a speculative flurry of buying.

Top Shot is operated by NFT pioneer Dapper Labs, which shares revenue with the NBA, and the world’s most prominent basketball league is almost certainly getting a substantial chunk of the pie.

What’s more, NFTs give their creators the ability to earn a percentage of every future sale, generating revenue each time the NFT changes hands. For instance, the creator of an NFT can specify in the NFT that it will be paid by the selling owner a fee of 5% of the purchase price every time the NFT is sold. So high prices combined with a vibrant resale market can turn NFTs into a gift that keeps on giving for brands that launch successful NFTs.

NFTs don’t convey “real” ownership in the underlying digital assets

Absent a legally-binding agreement that is established and enforced outside of the blockchain, NFTs convey ownership of a unique digital token itself, not the media assets that the digital tokens point to.

For example, an NBA Top Shot NFT pointing to a video of a LeBron James slam dunk that sold for $208,000 does not give the owner of the NFT any actual ownership interest in the video itself; it merely gives the owner ownership of a digital token sanctioned by the NBA that contains a metadata field that points to the video.

The video itself can be viewed online by anyone, and has no doubt been downloaded countless times.

Put simply, the owner of this high-priced Top Shot NFT cannot control where this video is distributed or who views and downloads it. She will receive no income from the video and have no ability to sell or license the video or any derivatives of it to third parties. All of these benefits of ownership of the video itself belong to the NBA because the NBA hasn’t sold these rights with the NFT. All the NFT owner owns is the NFT itself.

The fact that NFT ownership doesn’t covey any ownership in the digital asset that it’s tied to raises obvious questions about the lasting value of NFTs.

“Piracy” is a problem — sort of

Nothing prevents individuals from creating NFTs that point to digital files, namely images and videos, that they do not own, and offering them for sale. This is reportedly a growing problem as unscrupulous people seek to cash in on the NFT boom. As such, NFTs are not just an opportunity for brands but also a potential new IP rights challenge.

The good news for brands is that each NFT is unique and contains a signature that makes it easy to determine the provenance of the NFT. For example, anybody can create an NFT that points to Twitter founder Jack Dorsey’s first tweet, but it would be trivially easy to determine that it is not the NFT created and sold by Dorsey for $2.9m.

This is one of the biggest selling points of NFTs and in effect, gives brands that get involved an out-ofthe-box ability to ensure that the NFTs they create and/or sponsor can be verified as authentic by any interested party.

Thinking of NFTs as digital art and trading cards might not be a good idea

The $69m sale of Beeple’s Everydays: The First 5000 Days and the success of NBA Top Shots lends itself to characterizations of NFTs as the digital equivalents of physical artwork and trading cards, but it’s not clear that these characterizations are appropriate and will stand the test of time. That’s because while NFTs are unique and come with their provenance attached, there are substantial differences between physical and digital assets.

With physical art and trading cards, the owner possess a physical asset, unique or limited in number, that cannot be perfectly copied and is subject to viewing on her terms only. Physical art and trading cards can also deteriorate with age, or be damaged, which can affect the value of the asset in question, as well as any copies of it.

For example, the person who bought a rare T206 Honus Wagner baseball card for $3.25m can choose to put it on public display, show it only to friends, or lock it in a safe never to be seen again. If it is damaged, its value will almost certainly decrease, and the value of higher quality T206s will likely increase. A person can view a photo of a T206 Honus Wagner baseball card and print out the photo, but she cannot view an original unless the owner of one allows her to, and she cannot produce a copy of the card that is indistinguishable from the original.

NFT owners, on the other hand, have no ability to prevent others from viewing and downloading the digital assets their NFTs point to and when these digital assets are viewed and downloaded, they are perfect copies identical to any copies viewed and downloaded by the owner of NFTs and not subject to degradation or damage.

Brands should be careful about how they represent NFTs to consumers

At a minimum, brands that get involved with NFTs should have an intimate understanding of what NFTs actually represent and ensure that they accurately, clearly and conspicuously describe to consumers what they are buying when they buy an NFT.

This can be challenging given that many consumers don’t understand cryptocurrencies and NFTs in the first place.

At a minimum, brands should be very careful about the words they use. For example, the NBA Top Shot website invites fans to “own the best moments from NBA history” and the Common Questions page of the website claims that “for the first time, you can own the NBA’s greatest highlights” without clearly explaining what an NFT is and what ownership does and does not constitute.

As previously discussed, NFTs don’t convey any ownership of the assets that the NFTs point to, which is contrary to what most laypeople would likely assume “ownership” means. From this perspective, language that suggests ownership of the assets pointed to by NFTs as opposed to ownership of the NFTs themselves seems very problematic and even raises questions about whether brands could eventually find themselves on the receiving end of lawsuits alleging that they misled consumers and sold them a false bill of goods.

NFTs raise ESG concerns

Cryptocurrencies are responsible for astonishing amounts of energy consumption and this has sparked a fury of discussion around cryptocurrency and climate change, as most of the energy used to mine cryptocurrencies comes from dirty sources.

The energy issue raises an important question for brands that have committed to being environmentally and socially conscious: is it possible to do this and participate in a cryptocurrency ecosystem that is effectively causing lots of pollution?

Cryptocurrency and NFT proponents point out that Ether, the cryptocurrency behind most NFTs, will soon move to a proof-of-stake model instead of a proof-of-work model, which in theory could reduce energy consumption by a whopping 99%.

But the reality is that today, a typical Ethereum transaction requires more energy than an average US household uses in a day. Even Vitalik Buterin, Ethereum’s creator, has admitted that this level of consumption is “just a huge waste of resources, even if you don’t believe that pollution and carbon dioxide are an issue. There are real consumers—real people—whose need for electricity is being displaced by” cryptocurrencies like his own.

While the changes that could drastically lower how much energy Ethereum requires look promising, these have been talked about for years and still haven’t materialized, so brands that are considering jumping on the NFT bandwagon should take into account the current state of the technology and how it might reflect on their ESG initiatives and messaging rather than assuming that energy use will be a non-issue soon.

An NFT bust could harm brand reputation

While the stunning rise in the values of cryptocurrencies like Bitcoin and Ether supports the argument that cryptocurrencies are here to stay and only going to become more prominent, critics counter that NFTs specifically, because of their characteristics, are dubious in nature.

Some also argue that many if not most of the biggest NFT transactions are occurring between a relatively small number of cryptocurrency whales who stand to benefit by proving that cryptocurrency-based assets are valuable.

By spending their cryptocurrency fortunes buying cryptocurrency-based assets, cryptocurrency’s 1% can increase the value of their cryptocurrency holdings. Of note: since NFTs can only be purchased with cryptocurrency, the NFT craze results in cryptocurrency being purchased, which can help drive further increases in cryptocurrency prices. Even when, say, an NBA fan uses a credit card to make a purchase on NBA Top Shot, credit card dollars are being exchanged for cryptocurrency behind the scenes to effect the transaction.

The risk for brands here is clear: if the NFT boom turns to bust, brands that were involved in selling NFTs could be shamed for it. And if consumers sue them for their losses, their reputational damage could be lasting.

With this in mind, brands should be thoughtful about how they approach NFTs. Specifically, they would be wise to balance their exploitation of the NFT opportunity to make money with the potential harm to consumers who pay significant amounts for NFTs that end up worth far less or, in a worst case scenario, worthless.

Additionally, since most brands are relying on third parties to create and sell their NFTs, brands should vet and manage their partners carefully. Security is by necessity always a concern, and given the amount of money at stake, they will also want to take a hard look at how partners deal with issues such as automated purchasing and manipulation / collusion in resale marketplaces.

Brands should also consider whether it’s sensible to restrict insiders from trading in and profiting from their NFTs. For instance, some have raised questions about the fact that the CEO of Dapper Labs, which powers NBA Top Shot, is said to personally own Top Shot NFTs that are reportedly worth millions of dollars. Even if there was nothing untoward involved in the acquisition of these NFTs — executives and employees eating their own dog food is seen as a virtue in the tech industry — brands will obviously want to be careful about being involved in situations that are fertile ground for suggestions of impropriety or conflicts of interest.

NFTs can be used to deliver unique content and experiences

While the digital media assets that NFTs point to are accessible to the public, popular NFT marketplaces like Rarible allow NFT creators to include content that can be accessed only by the NFT’s owner. In addition to unlockable digital content, some NFT creators are offering buyers of their NFTs unique experiences. For example, National Football League star Rob Gronkowski promised the person who bought the single edition from his NFT collection VIP access to a beach party and attendance at one of his games. That NFT sold for $416,000. By including so-called unlockable content and tying NFT purchases to special experiences, brands can potentially make their NFTs more enticing to consumers who aren’t convinced of the value of buying an NFT that points to digital media that anyone can view or download.

What’s next?

Rocket ship or Titanic? Time will tell whether NFTs are a fad with a near-term expiration date or a new asset class that’s here to stay. In the meantime, brands that decide to experiment with the technology should be prepared to manage volatility, uncertainty and controversy, because these are all but guaranteed to be a part of the NFT market for the foreseeable future.