The Legit Ledger Episode 3:
Licensing Considerations for NFT Creators and Owners with Jim Gatto and Gabe Khoury
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Listen to the original podcast released June 14, 2022 here: https://www.sheppardmullin.com/multimedia-406
In this episode of The Legit Ledger, Sheppard Mullin attorneys Jim Gatto and Gabe Khoury discuss licensing considerations for NFT owners and creators, including the range of licenses creators are using, the recent trend toward more commercial NFT licenses, and practical considerations to keep in mind when drafting an NFT license with commercial rights.
Guests:
Jim Gatto is a partner with the Intellectual Property Practice Group in Sheppard Mullin's Washington, D.C. office, where he co-leads the Blockchain & Fintech Team. His practice focuses on blockchain, interactive entertainment, digital art, AI, and online gambling. He advises clients on IP strategies, development and publishing agreements, licensing and technology transaction agreements, and tech regulatory issues. Jim has been involved with blockchain since 2012 and has been recognized as a thought leader by leading organizations, including Best Lawyers in America 2021-2022; Cryptocurrency, Blockchain and Fintech Trailblazer, The National Law Journal, 2018; and Thought Leader on Blockchain & Cryptocurrencies, National Law Review, 2018.
Gabe Khoury was an associate with the Corporate Group in Sheppard Mullin's Washington, D.C. office. As Lead Associate of the Blockchain and Digital Assets team, he handled regulatory compliance issues relating to the use of blockchain technology, social media, Web3.0, video games, online gambling, virtual goods and currency, social tokens, decentralized autonomous organizations, decentralized exchanges, cybersecurity, privacy, Esports, the metaverse, money transmission, financial technologies, NFTs, and artificial intelligence. Gabe holds certifications in NFT technology, Metaverse Technologies, and Blockchain Law from the Blockchain Council.
Transcript:
Gabriel Khoury:
Welcome to another episode of Legit Ledger. My name is Gabriel Khoury, the lead associate of the Sheppard Mullin blockchain team. And I'm here with Jim Gatto, the lead partner of the blockchain team. In other episodes, we've covered the importance of NFT licenses in general. And in this episode, we're going to drill down a little bit further and we're going to cover the range of licenses that NFT creators are using. So with that introduction, Jim, can you provide a little bit of an overview of the different types of NFT licenses?
Jim Gatto:
Sure. So there really is kind of a wide range, I'd say at one end of the spectrum, you have very limited licenses that might grant a right for the NFT owner to have a personal non-commercial license to display the digital asset associated with the NFT. Kind of moving up the chain, you have some licenses that are restrictive, but provide maybe some level of commercial rights, and then with some limitations. Then there's others that are granting broader commercial rights. And in very, very few instances, the owner may actually have an outright ownership of the digital asset. That's pretty rare. Usually, it's some form of license and the creator maintains copyright.
Gabriel Khoury:
Okay. Thanks, Jim. And it seems that early on, most of the licenses that were granted were personal and they were non-commercial in nature, but there seems now to be a trend where there's more commercial licenses. Could you speak a little bit to that trend and what's exactly going on?
Jim Gatto:
Sure. Yeah. So I'd say that there's just in general, there's more experimentation going on with NFT licenses. And certainly we've seen a couple of big projects use commercial licenses and some of them have been successful and that's, I think, caused others to think about whether they should be granting commercial licenses or not.
Gabriel Khoury:
And in those that have granted, are there any brands or other IP owners that are granting some of these commercial licenses?
Jim Gatto:
We're seeing a little bit of experimentation by the brands and traditional IP owners, but I think more and more, or more commonly rather, I would say what we've seen to date is that the NFT projects that are getting commercial licenses are typically more the Web3 type companies where there's really not a lot of preexisting IP or revenue associated with preexisting IP that is of concern to protect as it's used as part of the NFT, but rather it's kind of IP that's created for the NFT. And in many cases by a company that started out just selling NFTs and that was the beginning of the business.
Gabriel Khoury:
And that's all interesting and I'm sure our listeners would appreciate an example. Is there a well-known project or anything that you can provide to the listeners that use this commercial license?
Jim Gatto:
Sure. Well, early on CryptoKitties was one of the, probably the most famous early crypto projects. And that had one of the limited commercial licenses that I had mentioned earlier. It was largely a personal non-commercial right but you could commercialize up to, I believe it was $100,000 per year in different types of commercialization. So whether it was T-shirts or that had an image of the Kitty or other types of commercialization, but I think probably more recently and the one that's I think gathered the most attention is the Yuga Labs license for the Bored Ape Yacht Club project. That project as many of you may be aware there were 10,000 unique Apes that were generated and sold as NFTs. And that project has become very popular. Many of the Apes, which are just digital images, have gone for seven figure numbers. People are using them as PFPs, but as mentioned the right goes well beyond just the right to display.
Gabriel Khoury:
Speaking of some of these rights, can you explain some of the other ways in which the NFT owners are leveraging some of these commercial rights that they're granted in the licenses?
Jim Gatto:
Sure. So the license for the Bored Ape Yacht Club project includes a provision that grants ownership of the underlying art that's atypical. As I mentioned, usually the license only conveys a license, not the ownership of the underlying asset, but they also grant a commercial license. And the commercial license includes an unlimited worldwide right to create derivative works, among other things, based on the actual art. So you have rights to do pretty much what you want with the art itself as is, but you can also create derivative works. And while the license refers to things like for purposes of creating T-shirts or merchandise products that display the art, in practice, what we're seeing is a number of people are going well beyond that in exercising their commercial rights.
Gabriel Khoury:
Okay. So Jim, what are some of these ways in which these NFT owners are leveraging some of these commercial rights in their licenses?
Jim Gatto:
Well, sticking with the Bored Ape Yacht Club project, one of the NFT owners that owned a particular ape created a burger restaurant called Bored & Hungry. And it's branded with that name. And if you go in, this is a restaurant out in California their menu has an image of the Ape that the NFT owner has and it's a burger joint. And it also sells merchandise as well. That's one example, there's another interesting use. And there is another NFT Ape owner who created the Bored Breakfast Club and what they did was they used the Ape that they own to create these images of these breakfast scenes, featuring that Ape. And they generated 5,000 new unique NFTs depicting these breakfast scenes and they sold those. And part of what the NFT owners received was free coffee. But beyond that, what was really interesting.
Jim Gatto:
So, they created an actual coffee brand and they sell the coffee to the public, but the NFT owners get a certain amount of free coffee, but they also created what they called the community wallet. And the community wallet collects a percentage of the resale of the 5,000 NFTs that the Bored Breakfast Club sold as well as a percentage of merchandise sales. And when that wallet gets to a certain threshold, the Bored Breakfast Club typically issues a new blend of coffee, for example, and the NFT owners at that time get more free coffee. And so this is kind of an ongoing set of benefits that are derived from owning that NFT. And from that, they've created an actual coffee brand that other people are paying for. Another example is when a couple of different groups have taken the Apes or a collection of Apes and created a backstory around the Ape.
Jim Gatto:
And from that, they've done different things. So in one case there's a band that they've formed from four Apes and the Apes are these digital musicians and they're actually creating a record label around this. So they're going to publish music from these Apes to start, but I understand their goals are to create a broader publishing label. And one of them is called Ape-In Productions. And so that was one that was launched. And there's another one, there's this group at 10:22PM. They formed Kinship, which they're calling a Web3 recording label also based on a set of Apes. One other use, I think is really interesting and I think kind of typifies a bit of the decentralized Web3 ethos is another project that an NFT owner has this one Ape who's named Jenkins. And as many of you may know, if you own an NFT, one of the Apes, you have membership in the Bored Ape Yacht Club.
Jim Gatto:
And the owner of Jenkins created this backstory where Jenkins was the valet at the Bored Ape Yacht Club. And so he saw all the comings and goings and all the things that people did, of course, that's all made up, but it's a great story. And based on that, they're creating what they call a community generative book. And so they created, of course, new tokens, there's different classes of tokens and different token holders will have the right to participate in the creative direction of the book. So they can vote for example, on the genre of the story and parts of the storyline and other aspects of the story. But they also, certain classes of token holders will have a chance to have their NFTs featured as characters in the book and presumptively, if your character gets into the book and the book's popularity, the value NFT will go up. So again, another interesting example of going from just an image of an Ape to creating this community generated book and this ongoing, they plan to do a series of books, but a whole brand based on all of that.
Gabriel Khoury:
So those are all very interesting examples and I'm sure all of our listeners appreciate them, but they seem mostly to benefit the NFT owner or the NFT holder. What about looking from the perspective of the NFT creator or the licensed issuer? Are there any benefits for a company like Yuga Labs to grant some of these broad rates?
Jim Gatto:
Yeah. So this is the great debate that's out there about whether granting a commercial license is beneficial or harmful. I think it really, the answer is it depends. So if you look at Yuga Labs, as I mentioned, they're a Web3 company. I mean, they basically started, made a name for themselves by launching this project of Bored Apes, and they granted the commercial license. And we just touched on how other people are leveraging that and benefiting from it by creating their own businesses really around the Apes that they own. But Yuga is benefiting from this as well. So the first way that they're benefiting is that like many other NFT projects, Yuga collects a resale royalty on the resale of each of the 10,000 original NFTs. And so mention many of these NFTs have been sold a couple of times, many of these sales gone for seven figures.
Jim Gatto:
And so the resale royalties are starting to add up just from that original project. They created the Bored Ape Yacht Club. So they have this community they've built. And that's I think a big theme among some of the projects that we're seeing where NFTs are successful. It's not just, "Here's a piece of digital art. Good luck. Have fun with it." But rather creating community and community engagement and ongoing interest in the project. And that's easier said than done. But when it's done and you create that community, you have longevity to your project, at least what's gone on to date and you can create additional business models. So one of the things that Yuga did was they created the Bored Ape Kennel Club, which was another NFT project, where if you owned an ape, you could adopt a dog which was represented as an NFT.
Jim Gatto:
And that dog had characteristics or traits that mimicked the different traits of Bored Apes. And you could keep that dog, or you could resell it. And of course Yuga would get a percentage of the resales as well. They also launched another NFT project where they basically created these digital vials of mutant serum. When owners mixed it with their existing Bored Ape they would create a new Ape, new NFT based Ape that they called Mutant Apes, because they had new and different characteristics. Those also can be resold and there's resale royalties associated with it. So you can see how they've created this series of NFT projects. And interesting to note is that one of the things that makes these projects successful is how they're designed. In other cases, it may be like who purchases them. So with the Mutant Apes, the day before Yuga Labs was going out with a public sale, Steph Curry had purchased one of the original Apes for then I believe was $180,000, which was, I don't know, seven, eight months ago.
Jim Gatto:
And I think the press around that and people seeing that he purchased it the next day, when Yuga did their sale, they actually generated 96 million in the sale of the Mutant Apes and serum. They've also built a metaverse that they're calling the Otherside and as with other metaverses, they did a land sale and they generated a significant amount of money through their land sale. But they've gone much broader than that. So what they've done is because of the popularity of Bored Ape Yacht Club, they're creating what they call a lifestyle brand and they ran what they're calling Ape Fest, which was an in person event where they had gallery parties, yacht parties, a bunch of other parties and exclusive merchandise and charity dinners and stuff. And this was all in New York, but now they're doing community get-togethers in Hong Kong, the UK and other places around the world.
Jim Gatto:
So, the final thing I'll say is when you look at all of what Yuga has done to date with these projects and the Ape Fest and the metaverse, it's really just the beginning. They announced that they recently raised back in March $450 million at a $4 billion valuation from one of the top VCs in the space. And they plan to use that money to build what they call a media empire around its NFTs, by launching games, metaverse projects and other media. So I think it's interesting to see how they came kind of out of nowhere. They started this NFT project, gave away broad rights to commercialization and from it, they've created this big commercial brand and will they become one of the brands that then try to protect their IP going forward more so, we'll kind of see as that plays out, but certainly it worked for them. And it's really, I think a good case study of how granting commercial licenses in some cases can create tremendous benefit to a company if they build community and have interest in their project in an ongoing way.
Gabriel Khoury:
So in the grand scheme of things, it seems like the summary is that there's a lot of IP issues to think about in regards to granting these NFT licenses. And through the years, there's been a lot of examples and case studies out there and our listeners can read more about some of these issues and the various blogs that you've written. And I know that you've worked on many NFT licenses as well. So in light of that experience, what are some of the practical considerations that NFT owners can think about when drafting a NFT license with commercials?
Jim Gatto:
So really the first thing is you need to think through your business model and if you want to grant commercial license rights then, and you've thought through it and you understand the pros and the cons and you have a plan, then I'd say, go for it, assuming you do. I think you want to ensure as with any NFT license, as we've covered before that the license is clear and covers many of the relevant points. And now not to pick on Yuga. But if you look at the Bored Ape Yacht Club license, just from a factual perspective, as I mentioned, they grant complete ownership of the art that is what they stayed in the license that may or may not be advisable for you, depending on what you want. Respect to that. In many cases, it's just a license.
Jim Gatto:
You can grant commercial rights around it, but you need to think through that and make sure you then articulate it the way you want it to be. Another issue is if you're going to grant commercial rights, do you want to grant unlimited rights to create derivative works? Do you want to impose any restrictions? So for example, some of the things to think about is if you grant a right to create derivative works, as we saw with Bored Breakfast Club, do you want someone creating another NFT project that might be based on these Apes? In that case, they did the breakfast scenes, as I mentioned, but in other cases, someone could just do a pure NFT project that's a variation of the Apes. Do you want to permit that? Do you want to exclude it? And again, there's no right or wrong answer, but you want to think through that, do you want to grant just merchandising rights?
Jim Gatto:
Do you want just to grant someone a right to be able to use the Ape they own the image on T-shirts and hats and physical merchandise. That would be a limited commercial license and for some brands, maybe that's okay. But again, you want to think through that scope and any restrictions on the right to commercialize, do you want people to be able to create other media properties using the apes or whatever your digital asset is? So that's one whole set of issues is the scope and/or any restrictions you want to impose on the commercial rights. Another issue that I think is interesting and the Bored Ape Yacht Club license is silent on this is trademark rights. So the digital art that's associated with the Bored Ape Yacht Club project is just an image. There's no real words, but as we've seen Bored Ape Yacht Club has become a brand.
Jim Gatto:
And so there's trademark rights associated with it. The NFT license that they use doesn't address trademarks one way or the other. So the question is, what does that mean? What rights does an NFT owner have if they're exercising commercial rights to use Bored Ape or Bored Ape Yacht Club, as we saw Bored & Hungry is using bored in the name and Bored Breakfast Club is using bored and they're using the image of the Apes, but what if someone used “Bored Ape” or some variation of that, where do the trademark issues kind of fall out? And so, again, I think from the standpoint of, if you're creating your own license, you want to think about trademarks and you want to think about, do you want to impose restrictions on the use of certain trademarks that are associated with the main NFT project or other IP of whoever the NFT issuer is?
Jim Gatto:
Do you want to grant certain trademark rights? Many times, companies will grant certain rights to use a name, for example, subject to trademark usage guidelines. If you grant a trademark license and don't exercise inequality control provisions that can impact the scope of your trademark. So there's a lot to think about with respect to trademarks, if you're granting others the right to commercialize the image. And you want to really think through both protecting your trademark, ensuring you don't lose rights and permitting people to use it in a way that you want them to use it or purposely restricting them from doing so. One other thing I would just mention is that we've covered previously in another episode, how to ensure you have a valid license and that there's affirmative acceptance and all those kinds of things. There's other just kind of basic principles that I think are important to think about.
Jim Gatto:
And one of those is the Bored Ape Yacht Club license. Doesn't state that there's a resale royalty, but the smart contracts are, as I understand, a program to collect that. If you're granting a license to someone, I would think you'd typically want to have all the material terms in there. And that would include if you're collecting a resale royalty. So these are just, again, some of the things to think about, I would say the more general and broader and more complete part of the answer is many of these licenses are unique and specific to what you're doing. In some cases, the NFT may represent a single asset. Some cases it might represent more than one asset. In some cases it may represent not just an asset, but entitlements as well, such as exclusive access to Discord channels, or celebrities, or whatever the access is to. I think you need to really make sure when you're drafting a license, as you understand the scope of the NFT and what it represents the business model around it, and then capture the relevant, legal issues that are associated with all of that.
Gabriel Khoury:
Before we wrap up this episode, do you have final thoughts or advice you give about licensing considerations and separately? What final thoughts for an NFT owner?
Jim Gatto:
Sure. So from the standpoint of the creator I think we touched on a lot of the key issues. I mean, there's no one right or wrong way to get a license. I think you need to think through the issues from a business perspective, identify the legal issues and then do a clear license. As we talked about, one of the things we're seeing is different types of NFTs. So many of the NFTs we've been talking about are what I'll call static NFTs, where the NFT represents a single digital image. We're seeing dynamic NFTs where the image can change in a design way based on different data or conditions. We're seeing soulbound tokens where NFTs may be limited to a particular digital wallet, like if it's associated with digital identity. So there's many different types of NFTs. And so I think when you look at the different types of NFTs and the different types of licenses that may be relevant, it just requires an understanding of what the NFTs are, what they represent and then the legal issues around that.
Jim Gatto:
So from a creator perspective, there's a lot to think of from an NFT owner perspective, if you're paying big money for an NFT, I think you need to understand what you're getting and in some cases what you're not getting. Read the license agreement. One of the things that you know is a potential issue is where the digital asset is stored. If the digital asset is stored somewhere, and that server goes down or ceases to exist, you have an NFT that points to a file location where there's nothing there.
Jim Gatto:
So there's many issues that can arise from the owner's perspective. It's a bit of a buyer beware out there and putting aside, there's a lot of fraud out there too. So I think you want to, as a NFT purchaser, you want to do a bit of diligence. We've seen a number of UDRP, or we filed a number of UDRP actions where someone used a domain name that had a brand in it and was selling unauthorized NFTs that included brand content and people at a high level would think it's coming from the brand, because they saw the name in the domain.
Jim Gatto:
So that's another way people are getting defrauded, but putting all the fraud stuff aside, which you should definitely be careful about is even with legitimate licensors that have ownership of the IP. And they're trying to do honest projects. There are issues it can arise. And so you need to understand not just the license terms, but how is the NFT structured? Where's the file? And various other issues. So a bit of diligence, both technical diligence and legal diligence on the part of purchasers make sense as well.
Gabriel Khoury:
All right. Thank you, Jim. And thank you to our listeners. That is it for this week's episode. If you have any questions about the topics discussed today, or if you need assistance with your NFT license, please reach out. Our contact information is in the show notes below, also in the show notes, we're going link various blog posts and articles written by our blockchain team regarding some of the topics that we discuss in this episode. Until next time, keep it legit.
Resources Mentioned
- Tokenization and the Law
- NFTs and Intellectual Property: What IP Owners and NFT Creators Need to Know
- Protecting IP and Limiting Liability When Licensing IP for Digital Art and NFTs
Contact Information:
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