NFTs Hit the Mainstream—And Risk Follows

Nonfungible tokens, or NFTs, burst into our collective imagination with the auctioning of Crypto Punks and Bored Ape Yacht Club illustrations in 2021. Initially minted and launched in April 2021, the NFTs quickly rose in value from initial offerings at around $190, or 0.08 Eth, gaining rapid popularity and culminating in a market surge, with one Ape notably selling for $3.4 million, or 852.39 Eth.

These “overpriced pixels” quickly became a new status symbol for pop stars, professional athletes, and wealthy entrepreneurs, and in turn, propelled rapid growth in peer-to-peer marketplaces that support trading digital assets. The iconoclastic apes, punks, owls, and skeletons became popular avatars and street clothing artwork. Emerging artists with names such as Beeple, XCopy, and Mad Dog Jones embraced this digital art world, creating a crypto renaissance of sorts with digital pieces of meta heroes, political commentary, surreal still-lives, and dystopian worlds. And major brands noticed.

Luxury brands Gucci, Tiffany, and Mercedes Benz are joining Main Street brands Coca-Cola, McDonald’s, and Frito-Lay in their new Web 3.0 ventures. Even Time Magazine has joined the fray, issuing TIMEPieces with an inaugural mint that features an interview with Ethereum’s Vitalik Buterin.

Each company’s NFT strategy may vary greatly. Indeed, their strategy may change with each minting. But are there new risks that come with such a nascent technology as Web 3.0? The answers may be surprising.

Promotional Campaigns

This summer, the History Channel made waves with its promotional offering of a limited number of NFTs during the popular series Shark Week. Viewers were prompted by a QR code between segments with instructions to download the free NFTs that featured stills of their favorite sharks in action. McDonald’s plans to give away a limited number of McRib-featured NFTs beginning in November. Fans of the limited-time sandwich will have a chance to win a free NFT during McDonald’s marketing campaign celebrating the McRib’s 40th anniversary.

Superfans of both brands may appreciate the novelty of these NFT offerings, but their NFTs’ monetary worth likely won’t grow over time. The risks to the brands associated with this type of promotional campaigning are limited, but vendors that assist with the minting are at risk of copyright violations and intellectual property violations without proper authorizations from those brands.

Collectibles

Coca-Cola, Kia, and Tiffany developed NFT collectibles with differing strategies. Coca-Cola offered NFT artwork by fashion designer Rick Minsi in July celebrating Pride Month, where proceeds benefited LGBTQIA+ charities. Kia Automotive replaced their street-savvy hamster characters with DASK (Dark Army Skeleton Krew) skeletons during a TV commercial for its Soul SUV. Viewers were given a brief glimpse of a QR code with download instructions for a free promotional DASK NFT. The offerings were quickly exhausted. Perhaps the most brow-raising minting is from staid jeweler Tiffany & Co., with its NFTiff offering. Consumers are offered a limited number of unique Crypto Punk NFTs minted as NFTiff. The NFTs then grant the rights to purchase a custom Tiffany necklace and pendant depicting the Crypto Punk.

These strategies differ, as the NFTs offered contain inherent value—even as some are part of a marketing promotion. The NFTs are immediately tradeable on peer-to-peer trading markets. Corporate governance challenges surface as federal anti-money laundering laws are increasingly being enforced with NFT creators.

Metaverse

For fans and collectors seeking refuge in the metaverse, UPS, Frito-Lay, and Mercedes Benz are there. UPS and Frito-Lay have filed new trademarks to offer products, services, and multimedia in the metaverse. The full details of each offering haven’t been announced yet. Mercedes Benz, however, has issued NFTs of its iconic G-Class SUV. Now status-conscious collectors can take their “G-Wagons” to the metaverse.

The creation and development of the metaverse is in its infancy. However, crimes including NFT theft and fraud are already making headlines.

Access Control/Ticketing

Sports franchises, entertainment venues, and concert festivals are exploring NFTs that provide special access and enhanced fan experiences.

As the NFTs are being offered as virtual tickets, the technology to allow venue entrance varies. Should those NFTs not function properly or slow the entrance process, the NFT issuers may find themselves exposed to reputational harm and class action lawsuits from fans not allowed access.

Fractionalized Ownership

Perhaps one of the greatest potential growth areas also contains the greatest risk for NFT issuers. Recording artists and independent filmmakers have struggled with production contracts perceived as unsustainable for those artists. The criticism is that film and music studios retain disproportionate shares of revenue streams from unit sales, touring, and other sales promotions. As a result, artists are exploring ways to monetize their work while marketing directly to their fans with, perhaps, different levels of customer experience reserved for super fans.

The idea is compelling. Artists would offer their work as an NFT that confers fractionalized ownership to that work, while the artists retain most of the intellectual property rights. In turn, the artist shares that fractionalized portion of subsequent royalties to the NFT owners. The artists may also reward the NFT owners with periodic drops of content or products. This novel approach would also incentivize owners to promote the artists’ work to increase future royalty payments.

This idea, though appealing, could run the publisher afoul of the Securities and Exchange Commission (SEC) with authorized selling of unregistered securities, per the Howey Test. Currently, the SEC is pursuing several cryptocurrency issues and trading platforms under the same theory of securitization as is being considered by these artists. For publishing firms, this represents another elevated risk their directors and officers must consider, along with the governance requirements, technology risks, and cyber exposures.

Where to Turn

The insurance underwriting community has proceeded cautiously when offering insurance solutions for both incumbent companies launching Web 3.0 initiatives and digital asset organizations natively founded in this technology. The impact on both the scope of coverage and pricing can vary greatly among different companies.

Consult with your Woodruff Sawyer digital assets team on how to best navigate this rapidly evolving underwriting environment and optimize your outcome.