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What you need to know about NFTs and smart contracts

A non-fungible token, often referred to as an NFT, is a digital asset that represents real-world objects such as art, music, and videos on a blockchain. Some examples of NFTs include the Nyan Cat gif, Twitter founder Jack Dorsey's first original tweet, and a video of Lebron James' basketball dunk. NFTs use identification codes and metadata that is logged and authenticated on cryptocurrency blockchains, which renders each NFT represented on the blockchain a unique asset. Unlike cryptocurrencies, which are also logged on blockchains, NFTs cannot be traded or exchanged at equivalency, hence they are non-fungible.

NFTs are bought and sold online, most often in exchange for cryptocurrency. Unlike most digital assets that can have an infinite supply, NFTs are usually one of a kind or are available in limited quantities. As a result, the value of NFTs is derived from the scarcity of the digital asset. The Merge artwork sold for USD91.8-million, and Everyday-The First 5000 days, a collage by Beeple, sold for USD69.3-million and is currently being auctioned by major auction house, Christie's.

NFTs are created through a minting process which includes the creation of a smart contract that is also stored on the blockchain. A smart contract is defined as "a self-executing programme or protocol in which the contents of an agreement are inscribed directly into lines of computer code to facilitate the performance of the agreement". The smart contract contains information regarding the NFT including the creator of the work, other parties’ entitled to royalties each time the NFT is sold, and the ownership history of the work. Most NFTs are not stored on the blockchain as storing that much data on the blockchain is expensive and consumes a lot of electricity. Therefore, smart contracts usually contain a link to the work they represent which can be accessed by the owner only.

To illustrate the function and role of a smart contract, the analogy of a vending machine is most relevant. When buying a product on a vending machine, the underlying sale agreement is between the buyer and the owner of the vending machine, and the machine acts based on the actions of the buyer and instructions pre-set by the owner to perform the agreement between the parties.

Arguably, a smart contract is a tool to implement a sale agreement between the NFT owner and the buyer, like a vending machine. Smart contracts, being self-executing, are able to verify that the terms of the contract have been met and execute the terms without the need of an intermediary or central authority. Once implemented, the smart contract is updated and the code will become immutable as soon as it is logged on the blockchain. Since a smart contract’s code on a blockchain is public, any person who uses smart contracts and has the requisite coding skills can inspect the code and verify the authenticity of the smart contract.

With the lack of legislation around smart contracts, in order to understand the validity of smart contracts, one has to apply aged old common law principles (based on 17th and 18th-century Roman-Dutch law) to highly advanced technology, which was inconceivable at the time the law was created. Interesting enough, the essential elements for a contract to be valid can still effectively be applied today. The three essential elements to a sale contract are:

  1. offer and acceptance (willing seller and willing buyer);
  2. something to sell; and
  3. consideration (the price).

The sale must obviously also be possible to perform and lawful. It is safe to say that a smart contract contains all the essentialia of a sale contract, it has a willing seller and buyer, an object (NFT), a price, it is possible to perform and it is lawful (although not regulated yet).

The South African Electronic Communication and Transactions Act, 2002 ("ECTA") further states that where there is a requirement to have a document in writing, a data message will suffice as a written document. Therefore, the mere fact that the smart contract contains provisions of the agreement which are only available in code, would not make the agreement unenforceable in South African law.

However, the rise of the use of smart contracts will likely disrupt sectors such as real estate (where a paper contact is required to alienate immovable property), e-commerce and data storage, which are already subject to existing regulatory frameworks. As the industry becomes more regulated, implementing smart contracts will also require parties to be aware of ever-changing regulations. This will require a joint effort between legal advisors and smart contract developers to ensure that the code is compliant with legal and regulatory provisions in the jurisdiction where the smart contract is concluded. In which jurisdiction a smart contract is concluded and which jurisdiction governs such contract, is a whole different challenge!

Wilmari Strachan
Technology, Media and Telecommunications | Executive
+27 82 926 8751

Rakhee Dullabh

Technology, Media and Telecommunications | Executive

+27 82 509 6565

Naledi Ramoabi

Corporate Commercial | Candidate Legal Practitioner

 +27 72 742 0757