The boom in NFTs and potential legal issues in Japan

Recently, digital art and digital trading cards represented by Non-Fungible Tokens (NFTs), which are non-replaceable digital tokens issued on a blockchain, have been traded for tens, hundreds or even billions of yen. As a result, NFTs have been rapidly gaining attention in Japan.

While digital data is inherently free and easy to copy, NFTs are considered innovative because they involve creation of unique, one-of-a-kind data based on blockchain technology.

However, as the legal status of NFTs and the regulatory framework surrounding NFT transactions are still unclear, significant legal issues will likely arise in the event of unforeseen circumstances, such as the hacking of NFTs or disputes over the rights of authors and purchasers of NFT art.

For example, because of the unique digital data characteristics of NFTs, they are often said to enable data ownership or to allow their holders to acquire ownership and copyright of digital art and digital characters.

Under the Civil Code of Japan, however, an object of ownership is contemplated to be a ‘tangible item’. This could be potentially problematic because NFTs, like Bitcoin and other crypto assets, are only issued in digital form on a blockchain and exist as data, and therefore do not constitute ‘tangible items’ under the Civil Code. As a result, NFTs cannot be considered objects of ownership.

Moreover, a digital artwork or expression cannot be considered unique just because it had been created using NFTs. This is because the image data of the artwork can be reproduced by anyone. A case in point is the NFT artwork Everydays: The First 5,000 Days by the digital artist Beeple, which Christie’s auctioned for approximately 7.5bn yen in March 2021. Although the image data of the artwork is stored in the Inter Planetary File System (IPFS), the URL where the image data of the artwork is stored is accessible to anyone through their internet browser from the smart contract address provided on the artwork’s introductory webpage on Christie’s website. In other words, the image data of the artwork can be downloaded by anyone through access to the URL where the image data of the artwork is stored.

Given the current technical characteristics of NFTs and the fact that ownership rights are not granted to intangible objects like NFTs, careful consideration is required as to what (including what rights) exactly are being traded in the sale of NFT art.

Additionally, NFTs, which are issued on blockchains, may not fall within the definition of ‘crypto assets’ regulated under the Payment Services Act of Japan. NFTs, like digital tokens issued on blockchain, are not clearly defined under Japanese law, and their legal status under Japanese financial regulations varies depending on their specific functions. For example, crypto assets like Bitcoin or Ether are defined as electronically recorded property values that are transferrable through electronic data processing organisations, and usable as a means of payment to unspecified persons. On the other hand, NFTs, being so-called unique and irreplaceable digital ‘items’, do not serve economic functions like crypto assets. Accordingly, NFTs are not typically considered crypto assets.

Because of their unique attributes, NFTs are attracting interest from those who have not previously had involvement in crypto assets and blockchain technology. Consequently, further development of businesses using NFTs is expected to continue. This, in turn, will draw attention to the legal issues outlined above, which will have to be considered on a case-by-case basis.