This article was originally written and published in
a longer form by the American Bar Association
on March 22, 2023.
Non-fungible tokens (NFTs) are not likely to revolutionize all
forms of intellectual property (IP) marketing, but in some use
cases they can improve the efficiency of licensing and provide
monetization opportunities that might not otherwise be
available.
Like with any new technology, there are many uncertainties about
how NFT markets will develop. Currently, there are significant
challenges to tokenizing IP, including how certain legal
requirements, such as a signature requirement for transfers
included in the Copyright
Act, can be harmonized with tokenized assets; how
tokenization can be compatible with highly regulated industries
such as franchising; and how tokens can be claimed by those with
security interests or contractual rights that are breached.
Despite those roadblocks and uncertainties, every business that
drives its revenue with IP should be closely watching blockchain
developments to identify opportunities on the horizon.
What is Tokenization?
“A ‘non-fungible token’ or
‘NFT’ is an encrypted unit of data on a
digital ledger, typically a ‘blockchain.'” When an NFT
is minted, code is embedded into a digital token associated with an
underlying asset using a smart contract that governs the
token’s ownership, sale and transfer.
“Essentially, an NFT is a unique ‘digital object’ that
someone can own, sell or buy.” They are non-fungible in the
sense that each NFT is unique, has no identical counterpart, and
cannot be exchanged for another identical NFT. That does not mean,
however, that they cannot be exchanged or transferred. It just
means that no two NFTs are identical.
Tokenization of IP is attaching certain IP rights to NFTs. NFTs
may provide a vehicle to streamline transactions involving those IP
rights. By “tokenizing” IP rights and embedding smart
contracts, it may be possible to:
- Reduce transaction costs
- Broaden the number of potential licensees
- Provide more flexibility for nascent or small businesses
Smart contracts are agreements where execution is automated to
ensure performance by eliminating the need for human interaction.
The smart contract self-executes at the time of transfer and
enforces its terms without any human party interaction.
These smart contracts may include all manner of restrictions
related to the sale of NFTs. For instance, should a franchise
operation right be sold through an NFT, all the duties and
obligations of a franchisee would have to be included in the terms
governing the sale of that token.
One particularly attractive feature of smart contracts in the
tokenization of IP is resale royalty rights. As discussed in more
detail below, these resale royalty rights may incentivize IP owners
to allow for a broadened range of licenses and provide protection
for businesses seeking to license IP.
Tokenization Could Reduce Transactions Costs
One of the biggest transaction costs in selling and licensing IP
is the legal cost. By tokenizing certain IP rights, the need for
negotiated agreements can be eliminated. The result is less
friction in the system of IP exploitation. Of course, on the other
hand, the terms offered are take-it or leave-it terms, which may
result in fewer completed transactions.
Additionally, the unique legal requirements of IP transfers must
be considered in creating viable NFTs. For example, exclusive
licenses and assignments of copyrights must bear the actual
signature of the assignor and must be in writing. That means
copyright tokenization of anything other than nonexclusive licenses
must have a written signature. This currently presents an obstacle
to implementation of copyright transfers through a smart contract.
Similar limitations will also apply to patent transfers. These
signature requirements add a layer of inefficiency to the typical
NFT.
Trademarks present even thornier issues, as the sale of a
trademark usually requires the sale of the goodwill associated with
the use of the trademark. Further, licensing trademarks may trigger
both state and federal franchise laws.
With these limitations, finding the right IP to tokenize can
allow for efficient transactions, including repetitive nonexclusive
transactions. In situations where there is a market for repeated
transactions, most of the transaction costs will be in minting the
first token. Each subsequent token could simply follow the path
created by the first smart contract. That is a huge opportunity to
eliminate transaction costs for repetitively licensed IP
rights.
Tokenization Could Grow the IP Marketplace
While some of the problems with tokenized IP rights can
undermine efficiency, the take-it-or-leave-it nature of tokenized
rights can increase the market for IP rights. By offering these
nonnegotiable terms, owners can advertise their IP broadly without
the concern of experiencing expensive marketing or legal costs for
unqualified purchasers. Such a system of take-it-or-leave-it IP
rights may generate a marketplace.
Today, many IP rights are broadly distributed. OpenSea,
the largest U.S. NFT marketplace, is proof that an NFT marketplace
can be viable. OpenSea allows individual users to mint (create)
NFTs and to buy or sell NFTs either at a set price or through an
auction system, and to embed smart contracts in those NFTs.
A similar system might allow those seeking IP rights to engage
in one-stop shopping through a single marketplace where various
NFTs associated with IP rights and their embedded terms would
compete with one another. One-stop shopping makes it easier for
less sophisticated buyers to participate in the marketplace and
could well broaden the scope of potential licensees.
Imagine a marketplace that enables nonexclusive patent licensing
without the need for every single deal to be negotiated or sold and
that allows smaller businesses to license patents on transparent
terms and prices. Such a marketplace could also be a way forward
for some franchise models with every territory marketed by an NFT.
In this instance, whoever owned the NFT would have a right to
operate a franchise in that market pursuant to the terms of the
smart contract. For franchising, this is probably a better fit
where the franchise success is based on business know-how as
opposed to exacting brand standards. In theory, the market would
determine which franchise models best fit into such a tokenized
marketplace.
No matter the IP rights offered, increasing the number of buyers
and licensees will increase the value of IP rights and benefit the
creators. In this way, IP tokenization can be a blue water model
for creating whole new markets.
Tokenization Could Create More Flexibility for Small
Businesses
Most small businesses fail. This complicates licensing to small
businesses both from the licensor and the licensee sides. From the
licensor’s perspective, that a small business will likely fail
means that fewer royalties can be expected. From the licensee’s
perspective, it means the risk in licensing expensive IP rights is
great, because the business is not likely to generate a significant
return on the investment. Some of this risk is just what it means
to start a business. But NFTs and smart contracts can mitigate some
of that risk.
The value of NFTs is, to a degree, determined by how easily
traded they are. This may allow licensees to pay a higher amount
for tokenized IP rights, if the terms allow for resale in the event
that the new venture fails. Smart contracts may incentivize
allowing for the transfer of tokenized rights because a built-in
resale royalty can be included in the self-executing smart
contract.
For instance, such a system could give purchasers the ability to
buy, sell or trade franchise rights with a smart contract that has
a redistribution royalty rate baked in. That could increase the
value of the initial sale and ensure that any subsequent sale would
generate at least some payment to the IP’s ultimate owner.
The more flexibility that can be created in sales and licenses
means more participation in the marketplace and more opportunities
to monetize various forms of IP.
The Importance of Tokenization to Companies
In today’s economy, assertion of IP rights is a major source
of income for some industries. This is true of both practicing and
nonpracticing entities. Assertion of IP is just the enforcement of
IP owners’ rights. The U.S. regulatory system provides for
broad exclusive rights in most IP, but it is incumbent upon the
owner to bear the cost of bringing a lawsuit or other
administrative agency enforcement action.
For assertion, proof of ownership is the very first step to any
action. Tokenization of IP rights ultimately may provide definitive
proof of ownership. If blockchain registries become the best
evidence of ownership, tokenization may be incredibly important to
those looking to enforce their rights.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.