The promising future of NFTs remains in flux
The author is Affiliate Professor, HEC Paris, and member of the EU Blockchain Observatory
When it comes to NFTs, the digital art and gaming worlds have been on a rollercoaster ride lately. The dominance of non-fungible tokens in these markets has also drawn attention. Many believe that the next big breakthrough will be designating ownership of virtual goods in the metaverse. But what if NFTs could also provide solutions in cumbersome and archaic systems to secure property rights, thereby unlocking the value of tangible assets?
Such potentially transformative uses of NFTs are only dimly beginning to emerge on the economic and legal horizons. Technically, they are unique cryptographic tokens that exist on a blockchain and cannot be replicated. Unlike cryptocurrencies, they cannot be traded or exchanged on par. By “pairing” an NFT with a particular version of a digital work, it becomes possible to differentiate it from its countless other versions and thus assign it a distinctive value, conferring proof of ownership to a single identifiable owner.
NFTs already represent and “tokenize” physical objects, items such as works of art and luxury goods, expanding the attributes of their ownership in the digital world and enabling more efficient and secure transactions. Real estate experiments are now being undertaken as a new way to provide needed liquidity in a system that has always been hostage to transaction costs.
The fact that NFTs can serve as immutable proof of ownership and provenance could help solve a persistent ownership problem in developing countries. Peruvian economist Hernando de Soto discussed early on the potential of blockchain to establish a cost-effective mechanism for formalizing property rights for the poor. This, he estimates, would unlock $10,000,000,000 of “dead capital” worldwide.
It also seems increasingly possible that co-ownership and crowdfunding of NFTs could be used to support the preservation of World Heritage sites, national artistic masterpieces or biodiversity-threatened areas.
Practitioners are still trying to understand how exactly NFTs fit into or disrupt existing legal notions and, therefore, what should be the applicable legal and tax treatment. Fractional ownership and instruments for syndicating ownership rights are not a new concept: NFTs are only their latest avatar. What is new, however, is that these blockchain-based tools offer the prospect of new (financially and administratively) disintermediated markets for creators and holders of otherwise untradable physical assets.
This perspective raises important questions of governance. Even if each NFT representing a particular valuable stake in the associated asset can be traded easily and individually, what is the basic framework needed to ensure the preservation and integrity of the underlying asset as a whole? When do they become security instruments? What are the rights of the holders on the property and what obligations do they have vis-à-vis the other holders?
Well-documented challenges remain elsewhere, including blockchain reliability and security, the interoperability of different blockchains, and, critically important, the large environmental footprint of NFT minting. Fraud and market manipulation are also on the rise. Regulators are hesitant about the right approach, aware of the need not to stifle innovation while trying to exercise oversight. Neither the EU marketplaces for regulating crypto assets nor the proposed US Crypto Bill make explicit reference to NFTs.
These technical, legal and regulatory considerations should feature much more prominently in the debate. It is not impossible that NFTs will become important new instruments of fractional ownership of assets, far beyond digital art, and into the realm of more tangible repositories for creating and distributing wealth. For now, however, they remain in a state of flux.