why it matters

NFT revenues could exceed $130 billion by 2030, and NFTs could help advance the digital economy. However, despite the media attention and celebrity endorsements, they are misunderstood and the current market is prone to speculation and fraud. Additionally, the lack of NFT expertise in the federal workforce makes it difficult to resolve statutory and regulatory issues.

Technology

What is that? A non-fungible token (NFT) is a digital identifier, similar to a certificate of ownership, that represents a digital or physical asset. In general, a non-fungible asset is unique and not interchangeable with others. An NFT, like an original painting, has its own unique value. In contrast, fungible assets are interchangeable, such as dollar bills or units of a cryptocurrency.

The most widespread use of the technology is currently for digital collectibles, such as the NFT for a digital collage that sold for $69.3 million in March 2021. The use of NFTs for other applications is emerging (see fig. 1). For example, NFTs could enable a decentralized marketplace for music or other creative works, allowing creators to collect revenue for digital assets directly and automatically, rather than through a third party.

Figure 1. Examples of current and emerging digital and physical NFT applications.

How it works? NFTs typically rely on the following technologies:

• A block chain is a decentralized digital ledger that uses cryptography, such as data encryption, to improve the security and permanence of transactions.
• A NFT Market is a website where one can create, sell and buy NFTs, similar to other online platforms that allow users to do business with each other.
• A digital wallet is a contactless payment application that can store payment forms, ID cards, NFTs, etc.

To create, or “create,” an NFT, the creator uploads a digital file, such as an image, photo, or piece of music, to a marketplace. The market runs code to create a unique identifier – the NFT – and adds it to a blockchain, which verifies, stores and tracks it. Once created, the NFT can be sold, destroyed or retained as a record indicating ownership. Typically, buyers purchase NFTs with digital currency, but legal tender, other assets, or credit can also be used.

Most NFTs are not the asset itself. In the case of a physical asset, they represent ownership of the asset. For digital assets, they represent ownership of the unique code linked or associated with the asset’s metadata, i.e. information about the asset, such as date of creation, size, or where it is stored on the Internet. In the case of a digital image, others can view the asset or even download a copy, but the NFT proves which digital image is the original and can, in conjunction with other information, show who owns the NFT.

NFTs rely on smart contracts, computer code that automatically executes a transaction when stipulated conditions are met. For example, a smart contract could stipulate that the original creator will receive a percentage of all subsequent sales of the NFT.

How mature is it? NFTs were first created in 2014 for digital images, but interest grew in 2021. One company estimated that 360,000 people held 2.7 million NFTs between February and November 2021. According to a market research company, the value of the NFT market size was $50.1 billion in 2021 and could reach $130 billion or more by 2030, largely due to growing demand decentralized marketplaces and digital collectibles.

Some researchers suggest that current NFT buyers are primarily interested in reselling NFTs for profit. As with collectibles like first-edition books and sports cards, rarity and popularity can determine the value of collectible NFTs.

NFTs can also provide opportunities for a wider group of artists and creators. For example, they can help artists sell their work without relying on a third party, like a gallery. The decentralized marketplace can allow artists to take full advantage of their art and interact directly with buyers around the world. And it can empower buyers to support artists’ freedom of expression and autonomy.

Other NFT applications are emerging. For example, some researchers suggest that storing electronic health records as NFTs could give patients more control over who has access to their data and when or how to share it. A company uses NFTs to track and monitor clinical trial consent. Individuals will be able to track and monitor their consent agreements in real time across different data sources. The company says this will give individuals control over their personal information and allow flexibility to manage their consent. The company also believes it will increase efficiency by reducing redundancy and the need for human intervention.

What are some concerns? Areas of concern related to current uses of NFTs may affect public trust and hinder their expansion into emerging areas. Some technology users have purchased collectible NFTs with the intention of making a profit, but like other investments, NFTs carry financial risk and have shown volatile prices. Cryptocurrency, which has fluctuated in value, is often used to buy and set value for NFTs and can exacerbate this volatility. NFTs are susceptible to artificial price influences, such as celebrity endorsements and illicit activity. For example, NFT owners may set up multiple digital wallets to sell NFTs to each other, thereby inflating the perceived value of an NFT.

The federal government and private industry have also identified concerns related to NFTs. In March 2022, the President issued Executive Order 14067 aimed at developing a whole-of-government approach to addressing the risks and harnessing the potential benefits of digital assets and their underlying technology. Additionally, in March 2022, the Justice Department indicted two people in an alleged $1 million fraud scheme after promising an NFT collection to investors, then transferred all the money collected without making the collection available. . At least one insurance company is considering options to cover fraud and other NFT-specific risks. Additionally, some government organizations are considering how to protect and educate consumers about NFT risks. In April 2022, the Joint Chiefs of Global Tax Enforcement issued a bulletin on how to recognize money laundering and other illicit uses.

NFTs could also pose a privacy risk. For example, without proper safeguards, an individual’s digital wallet assets may be publicly visible, which could reveal identifiable information. Users could also receive unwanted or illicit NFTs, such as NFTs associated with obscene content, as some transactions do not require the recipient’s approval.

Another concern is the federal government’s long-standing difficulty in hiring and retaining a highly skilled science and technology workforce. Some researchers suggest that sufficient expertise could help inform policy makers when considering what actions, if any, are needed to regulate NFTs.

Opportunities

• Decentralization. Creators and buyers of NFTs can interact and set the terms of their transactions without third-party involvement, which could allow creators to keep a larger share of the profits.
• Digital Economy. NFT applications can improve the efficiency of the digital economy. For example, they could facilitate case processing, help businesses attract seed money, and help match fundraisers with donors.

Challenges

• Investment risk. Like other investments, NFTs carry financial risk and can have price volatility. Additionally, when individuals buy NFTs on the internet, they may not be risk-aware as they would be for a traditional investment.
• Unlawful activities. Criminals can take advantage of users through fraudulent activities to steal NFTs or the assets used to purchase them. Smart contracts can pose similar cybersecurity risks.
• Privacy. NFT information on distributed digital ledgers and in digital wallets may be publicly visible and reveal personally identifiable information.
• Lack of federal expertise. NFTs are evolving rapidly. Many members of the federal workforce may not understand current and emerging uses in different sectors, which could make it more difficult to identify and resolve statutory and legal issues.

Policy Context and Issues

• What, if anything, could policymakers do to better protect individuals or entities using NFTs, including through the use of regulatory or criminal enforcement mechanisms?
• How might policymakers improve the expertise of the federal workforce to address the use of NFTs and clarify the applicability of current legislative and regulatory frameworks to current and future uses of NFTs?

For more information, contact Karen Howard at 202-512-6888 or [email protected]