Lifecycle of a digital asset: Getting started with NFTs - Boodle Hatfield

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13 May 2022

Lifecycle of a digital asset: Getting started with NFTs

Remarkably, around one fifth of the UK population now own at least some form of 'crypto', be that an NFT or cryptocurrency. In this series of insights, Alexander Martinelli and Hugo Brown touch briefly on the steps involved in creating and transferring NFTs before exploring in more depth some potential use cases for Blockchain technology.

Getting started with NFTs

In part one, Alexander Martinelli and Hugo Brown look at the steps involved in creating, minting and trading an NFT and how they can be used.

Creation: First things first, you have to create your asset.  That means taking a picture, writing a poem, singing a song. Once you have done that, you have something to sell. Clearly, traditionally, you could do that in a number of ways but in this article we are looking at incorporating the Blockchain so…

Minting: Once you have created your asset, you have to tokenise it. This is called “minting” and it makes it transferrable on the Blockchain. In the same way that banks mint currency, you have to mint your asset to bring it to life.  Once you have minted it, you have a tradeable NFT.

Auction: Once you have minted your asset, it can be traded on a marketplace. In order to actually sell or trade any NFTs, you need a Crypto Wallet. These are like normal wallets, only, instead of storing money, they store your private keys to cryptocurrency or crypto assets. The private keys are the strings that actually point to the digital assets; as such they are utterly critical.

How can I use my NFT?

One of the criticisms of NFTs to the layman is that they are unusable in the real world. For those that have seen Black Mirror and Ready Player One, you will be aware of the idea of a metaverse, or an online world, where digital assets can be purchased and used. Indeed, this idea is not new – we are all familiar with the idea of purchasing items in games. The difference here is the use of the Blockchain.

That said, although it is important to understand that only digital assets can be tokenised. It is possible to link ownership of a digital asset to a physical one; the way this has generally been done so far is to tokenise the right to ownership of the physical asset. This is, however, not entirely straight-forward. What happens if the physical asset, say a case of vintage port, is lost, destroyed or worse(!?) enjoyed…? The accepted solution is to use a trusted custodian to prevent this. The asset itself is held and never moves. The tokens represent ownership and instead of having to ship a painting to an auction house, due diligence need only be carried out once and then purchasers can trust the current status by only concerning themselves with the token in question.

This is critical because no one would pay for an NFT representing ownership of a physical asset if it was destroyed.

That being said, critics may well say that if assets are never actually seen or used, it gives rise of a kind of Schrödinger’s Cat style situation where the asset may or may not exist… we look at how you might link physical and digital assets below.

Isn’t a token just another way of saying ‘a share of’?

Sort of. Except the challenge is linking the ownership of the token to the underlying asset itself. This is difficult because a company might own a property directly and by owning shares in that company, you have a direct legal right to a share in the property / its value / income if sold.

However, owning a token doesn’t quite work in the same way. To achieve the desired result – readily tradeable tokens representing ownership of an asset – we need to consider how we might link the token to the asset.   Our initial view was to revisit trust structures.   At their most basic, trusts arrangements allow us to split the legal and beneficial ownership of an asset. Arguably, one might take the same approach here; the beneficial ownership of the asset in question could be assigned to a number of tokens. However, this does not quite work because when we split the beneficial ownership of an asset, we have to transfer the beneficial interest to a legal person, and a token itself is not a legal person. Accordingly, a better analogy is in units of funds structured as partnerships. In these cases, investors receive “units” or a contractual right to a return based on the amount they invest. In the same way that a fund is usually governed by a partnership agreement, an NFT is subject to a ‘smart contract’ on the Blockchain. Smart contracts are simply digital ‘if this, then that’ contracts. When a fee is paid in respect of an NFT, the smart contract is executed and automatically results in the transfer of the NFT (i.e. the token representing the contractual right to ownership of the asset) to the purchaser and the money transfers to the seller.

Part Two: What else can be tokenised?

In the second of a series of expert insights looking at the lifecycle of a digital asset, Alexander Martinelli and Hugo Brown explore what else can be tokenised.

Read More.

Responding to recent demand, we have created a digital assets group, pooling our expertise to ensure we can navigate the legal issues that arise with such assets for our clients. The group brings together specialists from around the firm, who can advise on everything from corporate structuring and intellectual property through to tax, financial claims in divorce and estate planning. If this series sparks interest or you have further questions around digital assets, please get in touch.