With the advent of blockchain technology and its ability to store data in a public, distributed and secure manner, tokenisation has created an entirely new asset class where authenticity and demand through digital scarcity appear to be the only criteria necessary for economic activity to follow.
As legal minds around the world catch up to the technology, I thought to make a small contribution to the thinking around NFTs in the South African context, and problems I see for us to fully participate.
What is an NFT, briefly?
For this post, I am focusing on the use of NFTs in relation to digital assets in the form of copyrighted works (e.g., texts, artworks and music), as this is where a lot of economic activity is taking place and as such, poses many opportunities for South African artists to benefit.
An NFT is created by minting (i.e. tokenising) data or properties relating to a digital asset in a way that cannot be changed, namely by committing the token to a blockchain (Ethereum is currently the blockchain with the most activity, but others are growing in popularity). The token serves to uniquely identify the digital asset and has some related data, such as the current owner's unique identifier.
The NFT is tied to the digital asset, either by storing the asset on the blockchain, or committing the asset to centralised or decentralised storage that is linked to the NFT. Typically, the digital asset is not committed to the blockchain, because storing data on the blockchain is expensive. In such a case, it could be said that an NFT is used to generate a type of "certificate of authenticity" of the digital asset to which it points.
If follows that if centralised or decentralised storage is used and it goes down, the NFT points to nothing and the NFT could be worthless if the digital asset cannot be recovered.
What happens when an NFT is sold?
Selling an NFT – like selling a certificate of authenticity – does not sell the rights in the underlying digital asset.
There was the unfortunate recent case of Spice DAO that was reported in the media. They paid a whopping $ 3 million for an NFT, which they thought would land them the rights to the copyright in the Dune manuscript. It did not – they only acquired rights to the NFT itself, and even that was contentious for being a derivative work.
When an NFT is sold, the buyer and seller typically enter into a contract of sale, pursuant to which the ownership details that may be stored on the blockchain are updated to reflect the change in ownership.
Another ingredient is however required for an NFT to have any value, namely that there must be an underlying contract that effects the transfer of ownership when the ownership of the NFT changes. Smart contracts are designed to be able to facilitate such transactions.
A smart contract is a self-executing contract, meaning that it can give legal effect to pre-agreed rights and obligations between the parties thereto automatically on being triggered, for instance when the ownership details of the NFT are updated.
In the context of trading NFTs for digital assets, a smart contract could accordingly simultaneously transfer ownership of the digital asset from the seller to the buyer. If implemented in a legally effective manner, the purchaser of the NFT is then listed on the blockchain as the owner of the NFT and the underlying digital asset, which can conclusively be established as the true and original work.
Where will South Africans miss out?
The commercial success of NFTs is driven by the large addressable market and the ability to trade these assets seamlessly from numerous crypto wallet providers and marketplaces across the world.
Irrespective of how an NFT may be architected, in order for it to be truly of value, ownership of the underlying digital assets must pass in a legally effective manner when the NFT is traded.
Electronic signature laws that create unique requirements
In terms of South Africa's current copyright legislation, an advanced electronic signature ("AES") is required to conclude a valid electronic assignment of copyright wherever this legislation applies. The AES is a uniquely South African creation, and it is highly unlikely that any foreign buyer or exchange will support it; that is if someone has even bothered to implement it into a smart contract in the first place.
Therefore, the title to the underlying digital asset cannot be efficiently assigned from one person to the next when an NFT is traded, unless the parties resort to a contract signed in wet ink, making the process slow and cumbersome.
This requirement also denies reliance on the benefits of blockchain technology as the sole record of ownership, as a reference to external evidence is now required.
Exchange control laws that require regulatory approvals
If a South African artist mints and sells an NFT to a foreign buyer, the sale of the underlying digital asset would typically be subject to prior clearance by the South African Reserve Bank, which is similarly a slow and cumbersome process.
As far as I am aware, South Africa is one of the very few countries in the world that operate such a system. It often catches foreigners unaware, undermining their confidence in transacting with South Africans and denying participation in fast paced crypto trading.
Conclusion
My assessment is that legislation that frustrate South African participation in the commercialisation of digital assets could make us miss out on the massive economic opportunities that could uplift our communities by placing our artists on the world stage.
The economic activity around blockchain technology is nothing short of a force of nature. We'll have to keep up, or simply risk becoming irrelevant.