The Business of Law: On the Verge of Disruption

By Marc Beckman

The Business of Law: On the Verge of Disruption

10.24.2022

By Marc Beckman

busoflaw

The latest evolution of the internet, known as Web3, will disrupt all aspects of the legal profession, from drafting contracts and filing documents to storing records and establishing trademarks. As corporate leaders, government entities and philanthropic organizations embrace this technology, tech-savvy attorneys who understand the implications will be rewarded with enormous opportunities to expand their businesses.

Well-known companies are already plunging into the Web3 world to generate new revenue, carry out high-profile marketing campaigns, launch philanthropic initiatives and reach a younger demographic. Popular brands adopting the new technology include Dolce & Gabbana, Tiffany, Gucci, Adidas, Time Magazine, Budweiser, Nickelodeon, McLaren and Pepsi.

These companies have become part of a new world that has been coined the metaverse – a shared digital environment filled with 3D spaces where visitors can socialize through gaming, concerts, academics and other pursuits. McKinsey & Co. estimates that the metaverse, enhanced by virtual reality, augmented reality and social media, will be worth a staggering $5 trillion by 2030.

Here’s what to expect as Web3 matures:

Intellectual Property

The biggest issue facing attorneys practicing intellectual property law will be establishing what rights are conferred by the sale of non-fungible tokens (NFTs), a piece of data that is permanently embedded on a blockchain, a decentralized ledger that records all transactions that take place on a peer-to-peer network. NFTs typically hold a digital asset such as artwork, music or film.

For example, do purchasers of an NFT have the right to use it however they see fit? Are they allowed to show, license and sell the NFT to third parties? With this new technology, how are legal rights defined? Is it necessary to use long-form traditional contracts, or is the code embedded in the NFT sufficient to govern?

Deciding whether a company can use an NFT that incorporates the trademark of another entity for marketing purposes is another hot issue. Nike sued StockX, an online secondary-market retailer, in February 2021 for minting NFTs that prominently featured the iconic swoosh mark on StockX’s digital artwork. The question of whether StockX misappropriated Nike’s protected mark for marketing purposes is central to the case.[i]

StockX argues that the first sale doctrine governs because the digital artwork promotes the resale of the accompanying physical Nike sneaker. The first sale doctrine is a legal principle that generally limits the rights of an intellectual property owner to assert infringement claims in connection with products already sold and are being promoted.[ii]

Attorneys should keep an eye on this case because it will almost certainly establish guidelines for corporations regarding the use of trademarks as NFTs for advertising purposes.

It is important to note that a lot of money is at stake here. Nike’s non-fungible token sales have generated almost $200 million in revenue, but the real money has been made on the secondary market, where there have been close to 68,000 transactions worth almost $1.3 billion.

Even after purchasing digital artwork, some NFT collectors are unsure of what commercial rights they have. Is it possible for the holder of an NFT to further monetize the digital artwork and, if so, how? Where are these rights expressly stated? Is the information only found within coded material?

 

Significant investments continue to flow into the NFT digital artwork space, yet confusion in the marketplace remains. Owners of NBA Top Shot digital collectibles are frequently surprised to learn that their rights are limited to personal display of the digital artwork, even though they are expensive (LeBron James dunking fetched more than $200,000 in February 2021). Surprisingly, the NBA Top Shot platform has exceeded $1 billion in transactions involving the sale of collectible “moments,” which are essentially modern-day digital playing cards with in-game highlights.

Creative entrepreneurs hoping to create this generation’s Disney have rushed into the NFT arena with the commercial idea that by granting full usage rights, the property value of the entire community will rise. Enter the Bored Ape Yacht Club, a property with a $1 billion market cap and a current floor price for each NFT trading at nearly $120,000. Notable celebrity owners include Justin Bieber, Jimmy Fallon, Snoop Dogg, Madonna and Paris Hilton.

The parent company of the Bored Ape Yacht Club, Yuga Labs, grants NFT owners unlimited commercial rights to each one-of-a-kind Bored Ape. As a result, the owners of Bored Ape have monetized their digital assets by creating, selling and marketing a variety of physical items, such as coffee, water, candles, hoodies and CBD cream. One group of Bored Ape owners even signed a recording deal with Universal Music Group to launch a new digital Ape band called “Kingfish.”

Andy Warhol’s groundbreaking inclusion of iconic corporate trademarks in his artwork, such as Coca-Cola bottles and Campbell’s soup cans, paved the way for modern artists and their use of valuable and protected trademarks. However, how does this apply to digital artwork sold as an NFT? Is this a new medium for artwork comparable to a printed edition or an exploitation of a valuable trademark sold as a new type of object? How should a company prepare to protect its intellectual property in Web3?

Mason Rothschild, a digital artist, was sued by Hermes for trademark infringement in January 2022. The suit involving Rothchild’s “MetaBirkin” digital artwork collection by the venerable luxury house is compelling for several reasons, including whether an NFT creator can display a brand’s protected trademark as a form of artistic expression without the owner’s permission or compensation. It was widely reported that Rothschild generated almost $500,000 through the sale of his MetaBirkin digital artwork NFT collection.[iii]

Are IP attorneys prepared to protect luxury houses from this form of use in the future?

Contract Law

Attorneys who practice contract law are already experiencing Web3’s impact with smart contracts. Effectively, a smart contract defines the rights of the parties and typically provides conditions that automatically execute the agreement when realized.

In Web3, the terms of an agreement are built into the coding of a smart contract and then permanently embedded into a blockchain. Once minted on a blockchain, the smart contracts are secure, transparent and immutable. Because blockchain transaction records are encrypted, they are extremely difficult to hack, limiting the likelihood of alteration and fraud.

Now attorneys and their clients can employ blockchain technology to hold and secure records to land deeds, personal identities such as driver’s licenses, voting records, payments such as royalties and charitable donations, wills and trusts, and talent agreements.

It is clear that attorneys are needed to provide sound advice to clients and, in turn, to shape the data entered in each smart contract, even if Web3’s process of contract formation, enforcement and dispute resolution is streamlined and more cost-efficient. Indeed, this service can provide attorneys with a new, significant and sustainable revenue stream.

Paperless filing is a game changer and can increase the legal profession’s client base by offering more affordable legal services. This streamlined and paperless process can also eliminate costly errors often found with manual filings.

Securities Law

We are still in the early stages of Web3, and, as a result, its elements have yet to be defined as a security. Because Web3 technology–enabled innovation touches multiple business sectors, from art and music to sports, banking and real estate, legal counsel should be involved as early as possible in the planning stage. Without the advice of expert counsel from the start, strong ideas that can create meaningful economic wealth for the American business sector could be at risk.

Indeed, the question of whether NFTs are securities still needs to be settled. The Howey Test is being considered by Securities and Exchange Commission Chairman Gary Gensler and the agency’s enforcement lawyers to determine whether digital assets should be defined as securities. In the 1946 case SEC v. WJ Howey Co., the U.S. Supreme Court defined a security as an investment with a reasonable expectation of profits derived from the efforts of others.[iv]

A class action lawsuit against Dapper Labs and its founder and CEO, Roham Gharegeozlu, began in May 2021 in the Southern District of New York and is likely to be the most high-profile case regarding the issue of whether NFTs are securities. NBA Topshot, a highly profitable NFT platform, is owned by Dapper Labs. In this case, the defendants invoked the Howey Test, arguing that their product is merely a collectible, like a baseball card, and thus NFT owners do not expect to profit from the efforts of others. The outcome of this case will have far-reaching implications because other similar NFT marketplaces may feel less vulnerable to government regulation if Dapper Labs prevails.[v]

In February 2022, the SEC and state regulators levied an unprecedented $100 million fine against BlockFi Lending, a popular cryptocurrency exchange. The crux of the matter surrounds the issue of whether BlockFi illegally offered a product that pays customers high interest rates to lend out their digital tokens.[vi]

Similarly, in September, eight states, including New York, announced plans to commence legal action against Nexo and Nexo Capital, a crypto platform that enables consumers to purchase, borrow and trade digital currency.[vii]

The Digital Financial Assets Law is expected to be passed soon by California’s Legislature and signed into law by Gov. Gavin Newsom. The bill requires crypto asset exchanges and other crypto financial services companies to obtain a license to conduct business in the state. If passed, this will have far-reaching consequences across the country.[viii]

It’s worth noting that New York State’s “BitLicense” cryptocurrency regulations took effect in 2015. Crypto funds based in New York are now subject to additional regulations in addition to those governing fiat currency.[ix]

To navigate this fast-changing Web3 world, new companies entering the space will need legal counsel.

Real Property Law

Lawyers with concentrations in the real estate sector will be enthusiastic about Web3’s impact on the process of buying and selling physical real estate. A few key elements include the use of an NFT as a deed, which can provide the public with a true history of ownership and price value. Transactionally, the use of cryptocurrency can validate the existence of buyer’s funds in almost real time.

Lawyers are needed to consider innovative investment vehicles that can provide first-time opportunities to individual investors, such as partial ownership of real estate. Furthermore, real estate developers should seek legal counsel to avoid having their new digital assets classified as securities.

Tokenization, smart contracts, NFTs and blockchain protocols significantly change and improve how fractional ownership takes form. For example, AspenCoin is an asset-backed digital token that gives holders part-ownership in the Aspen St. Regis Resort. Depending on how many AspenCoins are owned, guests of the property receive cash back equal to a percentage of the end-of-stay bill at the resort.

Physical real estate legal knowledge will certainly be required in the digital space, too.

Consider the investment potential of prime real estate such as Fifth Avenue and Rodeo Drive a century ago. This is where we are right now in terms of digital real estate in the Web3 space. Investors anticipate valuable community-based metaverse opportunities such as retail, banking, live events, gaming, academics and more.

The two leading digital metaverse real estate platforms, Decentraland and Sandbox, are valued at nearly $1 billion each and have attracted major digital property owners including Sotheby’s, Samsung and PricewaterhouseCoopers.

City Initiatives

Cities across the country are using blockchain technology to attract tourism, combat urban decay, create new revenue, secure records and more.

Reno’s mayor, Hilary Schieve, is widely considered a visionary in the Web3 space. To date, Reno has leveraged blockchain technology to launch a digital city key that provides owners exclusive access to unique experiences, a public art fund (the Space Whale), and the first recordkeeping system providing a register of historic places (the Biggest Little Blockchain).

For obvious reasons, individuals within the lower socio-economic demographic are unable to use traditional banking and, as a result, do not have access to credit, banking cards and saving accounts. Predictably, cryptocurrency payments will provide these citizens a practical, new and affordable way to hold money and transact business in lieu of a credit card. It is interesting to note that Deloitte predicts that 75% of retailers will accept cryptocurrency as a form of payment within two years.

Cryptocurrency Policy and the Case for Regulation

At the federal level, actions taken by the Biden administration provide a snapshot of Web3’s future reach. On March 9, President Biden issued the Executive Order on Ensuring Responsible Development of Digital Assets. This set the stage for lawyers to start shaping Web3’s federal governance. President Biden’s executive order is multifaceted, and, if made legally binding, it will have ramifications for businesses and government agencies across the globe.

Initially, Congress will enact new consumer protection regulations, which may constrain entrepreneurship. Although free-market capitalists will oppose congressional action, the marketplace will benefit from the perception of safety and certainty. As a result, Web3 innovation will attract new investment, and the technology will be more widely adopted.

In fact, the Federal Reserve is considering creating a Central Bank Digital Currency to ensure a “safe and efficient payments system.” Theoretically, this will provide a more stable digital currency for consumers but will move power from the individual back to the government, despite Web3’s decentralized nature.

The president’s executive order also addresses the problem of digitally based financial transactions that are associated with criminal activity. Federal Reserve Chairman Jerome Powell, in a Sept. 27 speech, mentioned a growing concern about money laundering via un-hosted, anonymous digital asset wallets.

The executive order issued by President Biden also addresses the global financial system. It is worth noting that Russia recently established its own digital currency to settle payments with China and ostensibly to avoid SWIFT-related sanctions. Shortly after Russia invaded Ukraine, the United States and the European Union imposed financial sanctions barring Russian banks from membership in the Society for Worldwide Interbank Financial Telecommunication, known as SWIFT.[x]

Not surprisingly, the private sector is attempting to provide Congress with technology-based solutions to the safety and regulation of Web3. In fact, Cardano founder Charles Hoskinson presented the idea of an automated, self-regulating approach to cryptocurrency in June. (Cardano is a well-known blockchain protocol.) Hoskinson believes that regulations can be built into the code because cryptocurrencies store and move data.

In September, Hoskinson argued in favor of congressional action, arguing that “[w]e’d probably see a mega bull market because a huge amount of institutional money would enter and also all of the regulatory risk [with] crypto would disappear.”

Still Unconvinced?

Bill Gates, a Harvard University dropout, appeared on “Late Show with David Letterman” in November 1995. The internet was still in its early stages at the time of the interview, with only 14% of Americans reporting using it, according to a Pew Research Center poll. Gates said he envisioned internet users watching a baseball game on their computer in the future, and he even predicted artificial intelligence.

David Letterman was skeptical. “It’s too bad there is no money in (Web1),” he proclaimed.

Marc Beckman is the best-selling author of “Comprehensive Guide: NFTs, Digital Artwork, and Blockchain Technology.” He is a senior metaverse fellow and adjunct professor at New York University and a consultant to the New York State Bar Association’s Task Force on Emerging Digital Finance and Currency. Beckman earned his JD from the Maurice A. Deane School of Law at Hofstra University. As CEO of DMA United, Beckman has launched several Web3 programs for brands worldwide.

 

[i] Nike v. StockX, No. 1:22-cv-00983 (S.D.N.Y Feb. 3, 2022).

[ii] First sale doctrine, 17 U.S.C. § 109.

[iii] Hermes v. Rothschild, No. 22-cv-384 (S.D.N.Y. May 18, 2022).

[iv] SEC v. Howey, 328 U.S. 293 (1946).

[v] Friel v. Dapper Labs, No. 1:21-cv-05837 (S.D.N.Y. June 7, 2021).

[vi] SEC BlockFi, https://www.sec.gov/litigation/admin/2022/33-11029.pdf.

[vii] New York v. Nexo, https://ag.ny.gov/sites/default/files/2022.09.26_nexo_complaint_final.pdf.

[viii] California Digital Assets Law, https://ag.ny.gov/sites/default/files/2022.09.26_nexo_complaint_final.pdf.

[ix] New York BitLicense, https://govt.westlaw.com/nycrr/Browse/Home/NewYork/NewYorkCodesRulesandRegulations?guid=I7444ce80169611e594630000845b8d3e&originationContext=documenttoc&transitionType=Default&contextData=(sc.Default)&bhcp=1.

[x] President Biden Executive Order on Ensuring Responsible Development of Digital Assets, https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets; White House Fact Sheet: United States, G7, and EU Impose Severe and Immediate Costs on Russia, Apr. 6, 2022, https://www.whitehouse.gov/briefing-room/statements-releases/2022/04/06/fact-sheet-united-states-g7-and-eu-impose-severe-and-immediate-costs-on-russia.

 

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