Not the Emperor’s New Clothes: Why the International Art Market Must Embrace Blockchain Technology Now

By April 7, 2021DApps
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March was an extraordinary month for the international art market. It saw the art world truly begin to embrace blockchain technology since the first tentative steps were taken in 2017 with the launch of digital collectables, Cryptokitties. Christie’s’ $69m sale of artist, Beeple’s, purely digital work titled, Everydays – The First 5,000 Days, and its unique non-fungible token (NFT), represented an unprecedented endorsement of the commercial advantages of blockchain technology. But, as impressive a month as March 2021 was, the international art market’s utilisation of blockchain technology is still very much in its infancy. Further, as with most new technologies, such as the e-commerce boom at the beginning of the Millennium, there is deeply held skepticism surrounding whether blockchain technology has a future role in the art sector, leading to widespread hesitation. Indeed, many see NFTs as an absurd concept, dismissing them as ‘the emperor’s new clothes’, in that a fortune is paid for works that can otherwise be copied with the click of a mouse and shared online for free. This critique is countered by proponents of the technology who claim that the value of an NFT rests in how each is unique and unequivocally confer rights of ownership over the ‘original’ version of a work, in a definitive way; the likes of which we have not seen before. The question on everyone’s lips now is whether the art world’s embrace of this relatively new technology is permanent, or simply a passing fad akin to the Gamestop ‘pump and dump’ of earlier this year

We consider that blockchain technology will become a feature of most, if not all, future art transactions, given the seemingly limitless advantages it affords. Now is the time for art market participants to carefully put in place the correct infrastructure, tailored to their activities and clientele, so that they can exploit the considerable cryptowealth of technologically savvy millennial investors, before their competitors come to dominate the lion’s share of the market.

We have successfully advised an internationally renowned auction house in recent weeks on an entirely on-chain set up, and so can confirm that this is entirely possible, within the constraints of commercial practicalities and data protection regulation.

The Language

Blockchain is a digital database, commonly referred to as a ‘ledger’, used for recording data. Data is recorded in ‘blocks’ of code resulting in an ever-growing record. Unlike centralised legacy infrastructure systems that are prone to cyber-attacks, blockchain technology is decentralised, with data blocks linked and secured remotely in the Cloud by way of a distributed ledger. Entries are verified by copies of the ledger seeking agreement between each other. Moreover, the blockchain is an ‘immutable source of information’, meaning that once a data block entry is made on it, it cannot be altered or deleted. There are many different blockchains, including Bitcoin and Ethereum and each typically has its own cryptocurrency. The Ethereum blockchain and its currency Ether (ETH) has emerged as the blockchain platform and cryptocurrency of choice for art transactions. The Bitcoin and Ethereum blockchains are both public blockchains which do not require permission to access. Private blockchains, as the name suggests, require user permissions by invite from network administrators, and provide institutions with greater autonomy over the network. While relatively unknown compared to their public counterparts, private blockchains, are becoming increasingly prevalent and do not suffer the potential compliance issues public blockchain encounter with regards to data protection regulation.

An NFT is a piece of code issued by and stored on a blockchain (either public or private) which can be used as a digital representation of an asset (e.g. an image, video or house). Once an asset is tokenised, starting with its creation (i.e. ‘minting’) on the blockchain, its NFT can be easily tracked, meaning that it can be authenticated as an original work or limited edition, notwithstanding the fact that the asset itself can be downloaded and reproduced. We, therefore, agree with the statement earlier in this article, that the value of an NFT is derived from the fact that it is unique and unchangeable, lending itself to best assisting the art world with regards to provenance, as we address in further detail below.

Smart contracts are self-executing programs that operate on the blockchain and create and track NFTs, setting out the terms of the NFT sale, including the conditions under which the smart contract is to be executed. A starting point for many artists is the Ethereum blockchain ERC-721 standard smart contract, as was used in 2017 for the Cryptokitties sale. Smart contracts are usually accompanied by term sheets and text templates.

The Process

An artist who wishes to tokenise their artwork must first register with an online marketplace (e.g. MakersPlace). Once this is done, the artist can ‘mint’ (i.e. create) an NFT on the blockchain, registering the token and associating it with an artwork (e.g. a JPEG file). This process integrates the block of code, similar to an alphanumerical unique identifier, into the blockchain, much like an entry into an inventory, but with added benefits, including immutability (i.e. the entry cannot be changed once entered) and transparency, in that the entry on a public blockchain can be verified by others by way of audits of the respective blockchain. A fee known as ‘gas’ is payable for minting each NFT on the Ethereum blockchain, with the amount payable typically anywhere in the region of $100-£1000, given fluctuations. Artists have the option to mint an NFT only, meaning that the marketplace platform utilises its own smart contract, or use an ‘NFT factory’, allowing artists scope to use their own smart contract, placing control firmly in their hands.

At stage two, the artist consigns the NFT for direct sale on a marketplace platform that utilised the blockchain. This authorises the platform to execute the smart contract associated with their NFT, stipulating the terms and conditions of the sale.

Should the NFT sell to a buyer, the smart contract self-executes upon an event to be stipulated in the smart contract (e.g. payment to the artist). This results in payment to the artist and transfer of ownership to the buyer occurring near instantaneously. Smart contracts, therefore, do away with the administrative burden and delays associated with the traditional art transactional model, such as the manual sending of invoices, verification of wire transfers, shipment of artwork and confirmation of insurance arrangements, to name a few.

The completion of the three steps above constitutes an entirely ‘on-chain’ (i.e. conducted entirely on the blockchain) NFT transaction. By contrast, Christie’s sale of Beeple’s work, was only a partial ‘on-chain’ sale, in that the auction house utilised its existing online interface for the sale and accompanying standard terms of sale, rather than conducting the sale on MakersPlace and having the ERC-721 standard smart contract govern the transaction. This resulted in stages two and three (i.e. the connection of the NFT to the platform and the transfer of title to the buyer, Metakovan) occurring ‘off-chain’ and a near 38 hour delay to the entries for these stages being made on the Ethereum blockchain. Had Christie’s of conducted the sale entirely ‘on-chain’, the smart contract would have self-executed, completing the transaction within moments of the transfer of payment to Beeple.

Christie’s decision to deviate from the ‘on-chain’ process has attracted much criticism, as many perceive this as a compromise too far, amounting to no more than a ‘media stunt’, with the immediate transparency and other technical benefits of blockchain absent from the sale. Indeed, some go so far as to say that the auction served to perpetuate the reputation of the art market as unduly secretive, with auction houses and dealers habitually catering to somewhat dubious clientele. Without involving ourselves in this debate, we have successfully advised an internationally renowned auction house in recent weeks on an entirely on-chain set up, and so can confirm that this is entirely possible, within the constraints of commercial practicalities and data protection regulation.

The Benefits

Clearly, conducting NFTs ‘on-chain’ using a smart contract brings considerable administrative and cost saving benefits. In addition to these, there are several more that we will now discuss.

Authenticity, Provenance and Ownership

Questions of authenticity, provenance and ownership have long dogged the art market. Conventional provenance research methodologies have included searching for attribution entries in catalogues and inventories, as well as conducting forensic investigations, such as pigment analysis. With the advent of NFTs, works can now be ‘digitally carbon dated’, with the NFT entry indelibly recording the precise point in time at which an artist authenticated the work as their own. Once the NFT is sold, and each time it is resold thereafter (i.e. by way of a smart contract), the trading history of the NFT is transparently recorded, resulting in an immutable and irrefutable ownership history. Blockchain technology thus removes the need for extensive provenance research; yet another timely process art market professionals engage in or outsource, with verification and auditing of entries on public blockchains independently and inexpensively checked with ease.

Enhanced Confidence Lending

A key issue for art lending has been the lack of visibility of securities against artworks. Blockchain overcomes this hurdle by providing art lenders with greater confidence when issuing loans, thereby boosting liquidity, and driving down interest rates. This is achieved, in part, by the technology building in notifications of security against artworks.

Copyright

Another perennial problem artists face is the unauthorised copying of their original works. NFTs and smart contracts address this threat by allowing for detailed attributions to be recorded, particularly in the right metadata, such that artists can easily document and thereby assert their intellectual property rights.

What many do not appreciate is that in the vast majority of NFT sales, the artist retains the copyright to the underlying work. Indeed, this was the case in the Cryptokitty sale, where the imagery associated with the generations of cryptokitties remained under the copyright of the developers. Ownership was not addressed in the ERC-721 standard smart contract, but instead set out in the separate licence that governed the use of the Cryptokitties app, operated by Dapper Labs Inc. The licence stipulated that the NFT of each limited edition cryptokitty was owned by the buyer, such that they could trade or gift the NFT, but that buyers did not have any rights or licences with regards to the elements of the app, referred to in the Terms of Use as the ‘Dapper Materials’. Therefore, artists can choose to assert their rights in the NFTs and smart contracts, or otherwise draft a licence to run alongside these documents and govern the scope of the rights conveyed to buyers.

Artist Resale Right (ARR)

The ARR was introduced into UK law in 2006, and since 2012 has applied to all sales of works by living artists, or those who have died in the last 70 years, entitling them or their estates to a royalty of between 0.25-4% in the event of secondary sales. As with intellectual property rights, artists can embed an ARR into a smart contract and consequently receive royalty payments upon the future resales of their work automatically. We note with caution, however, that the Ethereum ERC-721 standard smart contract does not codify an automatic ARR payment, and so this must be manually input by a programmer to secure the royalty for the artist. Most online marketplaces, however, provide for the payment of ARR in their terms of service in any event, however, this must be checked to ensure the artist’s entitlement to the royalty.

The Final Word… for Now

As is often the way, with blockchain technology and the popularity of cryptocurrency powering ahead, legislators and regulators have been left scratching their heads. It is only a matter of time then until the art market becomes subject to restrictions surrounding its use of blockchain technology. Therefore, the legal sector must be poised to assist art market participants in ensuring that their infrastructure, once up and running, is compliant with what we anticipate will be a rapidly changing legal and regulatory climate.

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