The Controversy
The unregulated revamping of the virtual world leading to disastrous innovations in the form of Non-Fungible Tokens (NFTs), especially in the fashion realm, has concocted some serious real-life issues. A recent controversy in this regard is the buzz surrounding the 100 MetaBirkin NFTs launched by Mason Rothschild in December 2021. Hermes has now approached the Southern District Court of New York with a 47-page complaint against Mason Rothschild accusing him of federal and common law trademark infringement, false designation of origin, trademark dilution, cybersquatting, and injury to business reputation and dilution under New York General Business Law, by imitating the French luxury brand’s one-of-a-kind Birkin Bag.
In this backdrop, the article discusses NFT marketplaces from two legal perspectives, i.e., consumer rights violations and trademark infringement. While delving deeper into the factual aspects of the controversy, the article would entail an extensive study of the existing laws of the United States (US), thereby assessing their applicability and viability in the NFT marketplace.
The Consumer Quandary
The evolution of the virtual world leading to disruptive technologies like NFTs have entered the fashion world and are here to stay. As exciting as they sound, they expose the buyers to an unfathomable ocean of risks. The MetaBirkin controversy casts light on how the consumers are given a back seat when it comes to ensuring the best deal and are offered fake products for hefty prices. While MetaBirkins have already been removed from OpenSea, platforms like LooksRare, Rarible and Zora might also undertake similar actions. This controversy highlights the underlying problems of misrepresentation, data privacy, and money laundering.
What’s in a name? Seller-Verification.
The Hermes experience is emblematic of the huge problem with NFTs, i.e., anyone can mint anything. NFT marketplaces like OpenSea and Rarible have imprecise verification policies. OpenSea, on the one hand, has been ignorant in verifying the real owner before uploading an NFT on the blockchain; on the other hand, the verification policy of Rarible, although in existence, is nothing more than a sham. Inspite of asking the user for two social media handles, Rarible hardly verifies if the user actually owns those accounts or not. Such substandard policies not only open the door for unverified third-party sellers to display fake NFTs on these platforms for exorbitantly high prices but also expose consumers to misinformation and false advertising. Eminently, mainstream purchasers of NFTs often have a negligible understanding of what they are purchasing and resellers may delineate erroneously what they are selling. Furthermore, customers who purchase through an NFT marketplace are subject to the limitations of liability and buyer beware clauses set forth in the terms of service or public standards of each marketplace. These terms of service are used by NFT marketplaces to disclaim liability for any counterfeits, fraud, or user misbehaviour that may occur in their marketplace.
In the US, Federal regulators led by the Federal Trade Commission (FTC), under the FTC Act[i] have the power to utilize laws governing Unfair or Deceptive Acts or Practices against misinformation flowing through the NFT advertising, sales, and reselling process. This regulation however falls short of the ability to cater to the grievances of the buyers who purchased NFTs from unverified third-party sellers because it becomes difficult to trace their origin in the vast NFT domain .
This raises another serious concern regarding the data privacy of such buyers who not only paid huge sums for buying counterfeited products but also passed their confidential information into the hands of fake NFT sellers. The FTC Act is one such act that could ensure remedial measures by empowering the FTC to hold an app liable in case it breaches its own privacy policy. However, even the presence of such a provision leaves ample room for unverified third-party sellers to utilize the loopholes in the legislation because in spite of FTC’s power to hold NFT Marketplaces liable for the breach of their privacy policies, the third-party sellers can still go untraced given the lack of technological advancement to trace them in these vast unregulated domains. In addition to this, only three states have laws ensuring consumer’s data privacy which include, California(and its amendment), Virginia and Colorado. However, such laws apply only to people belonging to these states, in particular, thereby restricting the scope of these legislations.
Legalizing The Illegal Currency: Camouflaging Ulterior Motives
The seller anonymity not only paves the way for counterfeit NFTs to enter the market but also highlights the abusive NFT tendencies to act as a catalyst for money laundering. This process could range from traditional methodologies involving the sale and purchase of NFTs by criminal groups via third parties to modern techniques entailing the purchase of NFTs from oneself by creating and selling anonymous NFTs at exorbitant prices. However, unlike other spheres, the legislation in this regard is somewhat in place. The U.S. anti-money laundering laws are vast enough to cater to the ever revolutionising digital world by way of expanding the ambit of definitions of “money transmitting business” and “financial institution” under the Bank Secrecy Act, as amended by the Anti-Money Laundering Act of 2020, to cover businesses involved in the exchange or transmission of “value that substitutes for currency.[ii]” Although there exists a lacuna in this amendment with regard to the specific inclusion of the word “NFT”, yet it provides the Financial Crimes Enforcement Network (FinCEN) with an added legislative authority to control not just the prevailing virtual currencies but also the novel asset classes and emerging payment methods, which should be considered vast enough to include and extend to NFTs.
Empowering The Fabricator: Flouting IPR
Trademark Infringement
The MetaBirkins controversy has made it pellucid that in the blooming NFT marketplace, Intellectual Property Rights (IPR) are the easiest to violate. Numerous brands have entered the virtual selling place offering NFTs of real-world products, for instance, the acquisition of RTFKT by Nike to sell digital sneakers or Warner Brothers selling collectibles of the comics, superhero movies, and science fiction. These real-world brands mint NFTs and sell the tokens under their trademark thereby expanding their consumer base to this burgeoning market. Currently, no law regulates the creation and sale of NFTs in the marketplaces. However, the Lanham Act, explicitly states that if the counterfeited product is being offered “for sale, distribution, or advertising”, then the registrant can claim remedies for the same under Section 32 of the Lanham Act, 1946[iii]. In the MetaBirkins controversy, Mason Rothschild minted replicas of the Hermes handbags, put them up for sale on various NFT marketplaces, and named the tokens MetaBirkins of which the trademark “Birkin” and its trade dress is registered with Hermes under the United States Patent and Trademark Office. The minted NFTs entail a “likelihood of confusion” with the Birkin bags by Hermes, and this fulfils the essentials of the relevant provision as the buyers may purchase MetaBirkin under the impression that they are authorized by Hermes. Thus, we can rightfully say that the provisions of the Lanham Act are expansive to the NFT marketplace as the essentials of the relevant provision are being fulfilled. Another supplementary argument for the applicability of real-world provisions governing the NFT marketplace can be drawn from the 2008 paper titled “Virtual Trademarks” by Candidus Dougherty and Greg Lastowka, who argued that a trademark is not only a symbol that aids in distinction, but it also encapsulates the way a customer identifies the brand and its values. Taking the example of the swoosh logo owned by Nike, they argued that users who wore real life Nike sneakers would be more likely to purchase virtual sneakers as they can be viewed as “complimentary products to or marketed to the same class of consumers as the real sneakers”. This not only justifies the need for the expansion of trademark protection laws to the NFT market but also highlights the possibility of trademark dilution of famous brands in the arena of virtual markets.
Trademark Dilution
The lawsuit filed by Hermes alleges not only trademark infringement but also trademark dilution. Trademark dilution occurs when the distinctive image and quality of the brand is deteriorated and tarnished in the eyes of the buyers. Section 43(c) of the Lanham Act[iv] provides remedies for “harms the reputation of the famous mark” and its proprietors might suffer. The provisions for the remedy of trademark infringement, as argued above, are applicable in the NFT world; however, this may not be the case with trademark dilution. To establish a claim of trademark dilution the mark must prove its recognition, and one of the important criteria to determine this as per Section 43(c)(2)(A) of the Lanham Act is “the amount, volume, and geographic extent of sales of goods or services offered under the mark”. Herein, “geographic extent”, which is a crucial aspect in the determination of trademark dilution, is a grey area as it is difficult to ascertain if the said geographical extent is expansive to the virtual world of the NFT market; colloquially the term only encompasses territorial extent of a particular state or territory. One may take the stance that any known trademark in the real-world is equally known and famous in the virtual marketplace too as the consumer base can relate to the trademark from the physical world. Nonetheless, one may also argue that the consumer base of the NFT market is dissimilar to real-world and the tokens in question are intangible. This implication will remain unsolved until NFTs are classified into their asset class because the above provision is only applicable on “goods or services”; as of now, NFTs are being treated as property by Internal Revenue Service. Therefore, even if the geographic extent is considered to be extensive to the NFT marketplace, the implication will remain unresolved as the above provision is not applicable to “property”. This does not aid the proprietors in determining if trademark dilution can be claimed against creators damaging the goodwill of their brand in the eyes of the consumers. With the speculative growth of the market projected to reach USD 3,57,316.3 million by 2030, brands may want to protect their trademarks in order to draw in the bankable benefits of this burgeoning industry. Hence both proprietors and NFT-creators are anticipating the findings and judgment of the lawsuit filed by Hermes to avoid liabilities and pitfalls in this blooming, lucrative marketplace.
What could be done?
The flourishing NFT marketplace is a double-edged sword, in spite of having tremendous value as a digital asset, it exposes the trademark holders as well as the consumers to several legal violations. The following two-fold outlook can be deliberated to view the discrepancies.
Firstly, a major lacuna existing in this domain is the lack of a verification policy that legitimises the buyer and seller relationship as well as the IPR of the NFT displayed on various platforms. In order to fill this gap, NFT platforms should aim at developing an ecosystem where the sellers are held accountable for ensuring the rightful ownership and trademark authorization so that neither do they infringe upon the IPR of brands nor do they lure the consumers into buying unauthorized, counterfeited tokens. This can be achieved by regulating the marketplace through proper trademark verifications before allowing the creators to list and sell tokens through their platform. Further, a Know Your Customer (KYC) system ,which has been enforced by FinCEN as a part of the Customer Due Diligence Rule to cover financial institutions in order to cater to illicit activities, should be expanded to include NFT marketplaces. This will ensure a transparent relationship between the sellers and the buyers which, in turn, will rule out the possibility of intrusion by third-party sellers offering fake products. These verification policies will automatically lead to reduced instances of data privacy violations and money laundering by completely eliminating unverified sellers from NFT marketplaces.
Secondly, instead of different NFT platforms conducting separate authority checks, a centralized, legally regulated marketplace should be established that not only regulates the entry and exit of all the stakeholders into the NFT market but also formulates a universal protocol for the marketplace so that the entire consumer base across all countries is imparted with the same set of remedies and grievance addressal. Thus, the jurisdictional boundary of the consumers’ respective countries would not be a bar for them to seek adequate solutions to legal violations in the NFT market.
Conclusively, the burgeoning NFT marketplace cultivates weeds of legal violations and, if not addressed on a priority basis, might lead to catastrophic consequences.
[i] Federal Trade Commission Act, 15 U.S.C. § 45 (1914).
[ii] Bank Secrecy Act, 31 U.S.C. § 5312 (1970).
[iii] The Lanham Act, 32 U.S.C § 1114 (1946).
[iv] The Lanham Act, 43 U.S.C § 1125 (1946).
This article has been authored by Tisha Kalra, Associate Editor, and Dhanya Jha, Assistant Editor at RSRR. This blog is a part of the RSRR Editor’s Column Series.