Sponsored Content

Introduction

Non-Fungible Tokens (NFTs) are rapidly emerging with the recent growth of the virtual asset market.

Originally used only in trading limited edition items or characters in virtual reality, NFTs have given rise to a wide range of trading activities and markets, ranging from arts, games, sports, and fashion. Recently, famous creators, sports players, and major companies have also participated in NFT issuance and investment, showing growth potential.

Why should we be paying attention to NFTs? The reason is their significant role in digital economic activities that will take place in a virtual reality known as the Metaverse.

The application of NFTs, useful for securing copyright and ownership, will gradually expand as the MZ generation,1 interested in metaverse and games, attaches value to digital assets.

Hexlant published this report to introduce the story of the beginning, present, and future growth of NFTs based on blockchain technology. This paper will focus on NFT technology trends, challenges, and prospects.

Table of Contents

1. Definition of NFTs

2. Trends and Prospects of the NFT Market

3. Trends and Prospects of NFT technology

4. Current status and direction of Korea’s and international legal systems in the field of NFTs

5. Ecosystem Analysis

6. Conclusion

I. Definition of NFTs

1. Understanding NFTs

Non-Fungible Tokens, known as NFTs,  have unique values for each token, which another token2 cannot replace. The concept is contrary to a dollar bill having the same value as any one-dollar bill. Typically, most unique values, such as rare game items, limited edition products, collections, and digital art, can be made into NFTs. By adding hash values (a unique identifier) to blockchain technology, it is possible to own and manage intangible assets in the digital domain that were not previously considered assets.

2. Blockchain and NFTs

Many widely known tokens follow the ERC3-20 standard, which has features that enable replacement. For instance, on the blockchain network, one Ethereum (ETH) owned by Owner A has the same value as one ETH owned by Owner B. However, tokens following the ERC-721 standard, known as the representative framework for managing NFTs, are incompatible with other assets because their IDs, values, and other information with respect to the tokens distinguish them.

Fig. 1: ERC-20 vs. ERC-721

Source: RNS Sol Team

3. Understanding NFT Services

CryptoKitties, launched in December 2017, is the first blockchain game to utilize NFT attributes. It is a nurturing game in which users breed cats to collect and trade for rare cats. Via the ERC-721 standard, each cat is unique by virtue of different hash values. 

In blockchain-based games, users can produce elements of the game themselves within the decentralized ecosystem, and individually created elements are applied to NFTs, enabling transactions between users. CryptoKitties also enables users to create new cats by breeding some of the initial cats distributed. For this reason, cats traded in Marketplace may look similar in appearance, but there are no cats with precisely the same details/attributes. Cats expressed in code are valued as assets and can be traded. As of May 24 of this year, CryptoKitties' most expensive cat trade was 600 ETH (Kittyhelper.co)

Meanwhile, a Dapper Labs official who ran CryptoKitties said that he sees NFTs as a tool for communication, not an asset, at an online event. Based on people’s desire to use NFTs as a communication tool, their application is expanding to collections, art, and celebrities’ personal belongings that have stimulated fans' desire for bonding.

Fig. 2: Cats from CryptoKitties

Source : CryptoKitties

Fig. 3: CryptoKitties’ Hash Value

Source : CryptoKitties

Fig. 4: Detailed Information/Attributes that CryptoKitties have

Source : CryptoKitties

Fig. 5: CryptoKitties Marketplace

Source : CryptoKitties 

4. Reasons for the gaming sector’s rapid introduction of NFTs

In the Global Game Industry Trend Report published by the Korea Creative Content Agency, the Agency analyzed the reasons for the earliest introduction of NFTs in blockchain games as an online gaming environment that imitates the real world with conflicts over the ownership of items used in the game. Elements in the game are implemented in the form of digital data, including player’s characters, items, and goods utilized in the game. These game elements were not recognized as unique because they were easily replicated or modulated by developers.

Users are often directly or indirectly affected by the value of paid game items in the general game industry, such as system upgrades, game element changes, new features, and mass distribution of existing items. Nonetheless, game development companies have ownership of the game items, so users could not respond to those changes (refer to part IV.) Blockchain games have the vision to allow users to own the world they create by giving them ownership of items via blockchains.

II. Trends and Prospects of the NFT Market

1. The Scale of the NFT Market

The volume of NFT assets traded globally has increased eightfold in two years. According to a report published by Nonfungible.com4, the market scale of NFT surpassed $ 338 million in 2020. In the second quarter of 2021, the total volume traded passed the $700 million mark.  

The number of buyers is increasing faster than the number of sellers, which demonstrates that NFT’S are attracting more interest than vice-versa. This is the market distribution: collectibles (66%), art (14%), sports (7%), metaverse (7%), games (5%), and utilities (1%) (based on the second quarter of 2021).

Fig. 6: Weekly Number of Sellers, Buyers, and Active Accounts (1Q to 2Q, 2021)

Source : Nonfungible.com

2. The Trends of the NFT Market

NFTs are currently widely used in games and art, but there is a high expectation that their use could be expanded by combining them with DeFi, AI, and ultimately the Metaverse. This anticipation comes from the similarity between the vision of the Metaverse and NFTs’ characteristics with respect to creating a digital economic ecosystem through the activities of various creators to create and distribute digital items themselves.

Deeming NFTs as the blood of the blockchain economy, global enterprises continue to invest in NFTs and are declaring their entry into the market. For example, eBay, which introduced the auction concept to online shopping platforms in 1955, has recently suggested that it is considering introducing NFT transactions and virtual asset payment options to become a platform for collections of all kinds, including digital assets. In addition, Binance, the world's largest crypto exchange, also opened its NFT market in June 2021.

The First 5000 Days of Beeple, the NFT art creation wherein he integrated photos taken every day over five thousand consecutive days, was sold at Christie's for almost $70 million. The NFT for Twitter CEO Jack Dorsey’s first tweet, posted on March 21, 2006, sold for $2.9 million. Market data from Nonfungible.com shows that NFTs’ trading volume reached about $ 267 million in May of 2021.

Fig. 7: Institutions Entering the NFT-related Business Market

Source: Nonfungible.com, KOTRA, SPRI, Hexlant Research

Fig. 8: Current Status of Korean NFT-related Business Entries

Source: Hexlant Research

Fig. 9: Current Status of NFT-related Business Investment

Source: Nonfungible.com, KOTRA Silicon Valley

As of the first half of 2021, Ethereum, Wax, Flow, Binance Smart Chain are competing in the NFT market on the network side.

There is not much compatibility between NFTs and DApps;  creators are using multiple platforms simultaneously.

Fig. 10: Ethereum-based NFT Network Distribution Diagram

Source: Opensea.io

3. Challenges of the NFT Market

NFTs have provided for creators a new world. The advent of NFTs has made it easier for anyone to issue and trade digital assets. However, although NFTs have the advantage of enabling anyone to register their creations without special training and to confer upon them scarcity and value, side effects have also emerged due to rapid growth.

1) Lack of Legal Protection

Due to the sudden craze, many NFTs revolved around how much attention the artwork could attract rather than the quality of work itself, and particularly famous pieces were traded at high prices. Then some individuals began issuing tokens with the original assets of other creators. Unfortunately, there is still a lack of legal protections for asset creators and NFT transaction participants.

2) Definition of Original

The data source referenced in NFTs is not equated with the real-world source. The NFT itself is more of a digital asset original certificate. Therefore, it is necessary to establish the perception that NFTs have value in digital elements, rather than in the storage of tangible assets.

3) Money Laundering

Regulations in accordance with the Financial Action Task Force (FATF) guidelines also pose a problem to be solved. In the NFT space, because decentralized platforms are the mainstream, there are limits with respect to properly verifying customer identity.

4) Tax (refer to Part IV)

Anyone purchasing NFTs must declare their assets under the laws of their country of residence. In addition, there are tax issues that arise from the sale and transaction of assets. Moreover, creators of NFTs can take a kind of copyright fee for each transaction in the secondary market at the time of token issuance. Therefore, it is also necessary to consider whether or not the tax will be applied to royalties.

5) Transaction Fee and Network Load

In the case of a new mainnet developed to solve the Ethereum mainnet gas fees, it cannot handle the sudden increase in traffic and is experiencing frequent bugs and withdrawal delay issues. Once Ethereum 2.0 arrives, expectations for gas price reduction are high, but in Ethereum Layer 2, other issues are emerging such as the miner extractable value issue, where miners deliberately delay transactions and pay higher fees consequently.

6) Sustainability

It is essential to establish an environment where users can act as creators and consumers within the ecosystem in line with users' rapid content consumption. Furthermore, developers should provide convenient tools to support the incentive design for creators to generate revenue and the issuance of NFTs. Meanwhile, experiences that can share digital and real-life experiences can also promote changes in the perception of data value. An example of this is marketing, where users can wear clothes of the same design in the real world when they buy clothes to wear on their digital avatar.

4. Marketplace Potential and Prospects for NFT

Due to COVID-19, people are spending more time online, and the speed at which their entire lives are going online has accelerated. These life changes are also increasing the value recognition of digital elements that are different from physical values.  With this flow, NFTs’ potential is growing by way of accelerated evolution into the metaverse.

1) Combination with the Metaverse

Metaverse is defined as the digitalized earth. It is a compound word of ‘meta,’ meaning transcendence and virtuality, and ‘universe,’ meaning world and universe. In other words, it refers to a virtual world that transcends reality.5 There are four major characteristics of NFTs that can wed them to the virtual world ecosystem: the non-fungible nature of NFTs, the easy proof of ownership, the impossibility of forgery and tampering, and the ability to trade. NFTs allow users to expand their world into a virtual world and trade assets with other users within it.

If users use tokens to convert goods or other services acquired in the virtual world into cash in the digital world, as a link between the real and the virtual world, doing so will provide a new experience in which both world views can be independent and interconnected.

2) The Beginning of a Digital Economy (STOs, DeFi, and NFTs)

The combination of NFTs and digital systems could kickstart the new digital economy. A financial economy that combines NFTs , STO (Security Token Offering) and even DeFi into a digital economy, e.g. with collateral based on digital assets or investment in artist’ work, is beginning. As the value of digital assets and NFTs are recognized, ordinary investors may invest using tokens in more diverse investment targets. Applications to investment contracts (STOs and SAFTs, i.e. Simple Agreement for Future Tokens) are also enabled by using NFTs, and the boundary between equity (the subject of investment) and token investment will become blurred.

III. Trend and Prospects of NFT technology

1. The Direction of NFT Technology Development

To understand the NFT token, we want to understand the flow of the ERC standard leading to ERC-20, ERC-721, and ERC-1155. While ERC-20 is a replaceable asset and ERC-721 is a non-fungible asset, ERC-1155 is a protocol that enables exchange  of fungible ERC-20 and non-fungible ERC-721 tokens.

1) ERC-20 vs. ERC-721 Code Level Difference

The significant difference between ERC-20 and ERC-721 is said to be the difference in the “factor” with which each standard deals. ERC-20 mainly deals with the token amount, and ERC-721 mainly deals with the ID and owner of the token.

ERC-20 focuses on the amount of tokens, and ERC-721 focuses on token ID and ownership, as seen from the minting, transferring, and burning functions.

2) Advantages and Limitations of ERC-721

• Advantages

NFTs do not put digital assets under the control of platform operators but provide ownership of assets to token holders. As an example, in the case of traditional games, items users obtain by investing their time and money have utility and value only within the service. When the service terminates, the assets disappear. However, in the case of NFTs, all digital assets are stored on the blockchain rather than inside the game. It means users can manage transactions and transmissions of digital assets even if the service does not exist.

• Limitations

NFT cannot prevent or control the copying of digital content. Moreover, with a limited ecosystem on a given platform, if the usability of digital assets is limited to the platform, it is difficult to give much meaning to NFT ownership.

3) ERC20 + ERC721 = ERC-1155

The most well-known NFT standard is ERC-721, but a recently improved standard is ERC-1155. ERC-1155 can be seen as combining the features of ERC-20 and ERC-721. ERC-1155 uses the “atomic swap,”6 which exchanges different coins without going through a cryptocurrency exchange, and processes fewer transactions than ERC-20 and ERC-721. In addition, it includes a multi-transmission function that sends any desired quantity to one or more recipients in one transaction. When using this function, the fee paid is about sixty percent of those for ERC-20 and ERC-721 transactions.

4) Strong Point of ERC-1155

The features of ERC-1155 are useful for application in games. However, for replaceable items (goods), one must apply ERC-20 and ERC-721 for non-replaceable items, so two separate transactions must be made to process tokens complying with these two types of standards.

However, there are both fungible  and non-fungible items in most games. Therefore, if ERC-1155 is used, items and goods that are non-substitutable can also be judged to be substitutable, and both items can be combined for a simple transaction. ERC-1155 produces various items according to the situation, and it is also possible to provide substitutability by having a unique index or treating it as a group according to the purpose of each item.

2. Application of NFT technology

When issuing NFTs, some values need to be set. For example, when using the tool provided by Atomic Hub, aNFT market platform, it is necessary to set values and orders.

When issuing NFTs for digital assets, the first step is generating the issuance number. The issuance number is generated according to the asset’s unique ID and creation order. The second is uploading an image file to be displayed as a NFT when entering the  asset’s  detailed  information.  Then,  a  hash  value  will  be  generated through a distributed storage system, known as the Inter-Planetary File System (IPFS). The final step is tocheck that the visualized digital asset is available directly by entering the hash value into the IPFS address (ipfs.io/ipfs/hash value input).

When creating a collection, the asset creator can set the commission rate to generate profits continuously whenever owners sell the asset. In addition, the issuance amount, transmission, and incineration functions can be easily set through the template ID and used for additional issuance.

Fig. 11: NFT Issuance Setting Value

Source: AtomicHub

3. Structure for Each NFT Type

Like the technological elements constituting the NFT, there are various technologies required to tokenize digital assets. The four essential technologies needed are a decentralized mainnet that supports smart contracts, a wallet for secondary users to send and receive NFT tokens, a trading platform that can trade NFT tokens, and finally, a distributed storage system that stores digital contents.

1) Mainnet

Ethereum, Flow, and Wax are the current leading networks in the NFT market. All three platforms provide users with the ability to buy or sell NFTs. In addition, some of these platforms also provide tools for users to issue NFTs and trade immediately. Meanwhile, Binance Smart Chain (BSC) attracts attention as a mainnet to be used frequently in the NFT market. If the growth in deposit size of Binance Coin (BNB), which at one point was ranked 5th by market capitalization, is maintained, there is a possibility that it will overtake Ethereum in the NFT ecosystem based on its enormous user power.

Representative NFT Platform for Each Mainnet

A. Ethereum

There are three main reasons why Ethereum is the most used platform for NFT services. First, Ethereum is the second-largest decentralized network after Bitcoin. Second, Ethereum has a smart contract function installed to provide a certain amount of money to the original owner whenever the NFT’s owner changes. Lastly, it is relatively stable regarding references, e.g. as seen in the establishment of ERC standards and CryptoKitties, the first NFT service issued on Ethereum.

Representative Project: OpenSea

OpenSea is a decentralized platform that allows users to trade NFT tokens in various ways, such as through Peer-to-Peer (P2P) transactions and auctions.

Since it is a decentralized platform, the original owners store the NFT tokens in their decentralized wallets, and OpenSea provides implementing transactions using smart contracts. Therefore users can freely trade in OpenSea, and by using tools provided in the platform, they can issue and trade their own NFTs very easily.

However, the Ethereum transaction fee (known as the gas fee) for creating and selling NFTs is high as of this writing. There is a possibility that the elevated cost of the gas fee will be improved when "EIP-1559," which features an improvement plan for the gas fee, is introduced in the future.

Fig. 12: Ethereum-based representation of NFTs - OpenSea

Source : OpenSea

Fig. 13: Transaction Cost when Uploading Art on OpenSea

Source : MetaMask

B. Flow

The Flow mainnet is the mainnet launched in 2017 by Dapper Labs, a blockchain company that released the CryptoKitties game that adopted the Ethereum ERC-721 standard. 

CryptoKitties game characters have stimulated people's desire to collect via their irreplaceable features, gaining explosive popularity. Unfortunately, due to this craze, CryptoKitties transaction volumes at one point accounted for more than 20% of all Ethereum transactions, creating a massive load on the network. Eventually, gas prices soared, causing inconvenience to users for a long time.

Based on that experience, Dapper Labs opened its blockchain network Flow mainnet. Flow has presented a vision to provide a pleasant user experience to more users by addressing the problems experienced in the Ethereum network.

Flow has the advantageous capacity to process a large number of transactions in a short period very reliably. By allowing five different nodes to handle tasks usually performed by a single miner or validator, redundant work is significantly reduced, and efficiency is improved. In addition, transaction fees are low compared to Ethereum’s.

Representative Project: NBA Top Shot

Dapper Labs became a leader of NFT platforms with the release of NBA Top Shot.

Fig. 14: NBA Top Shot

Source : NBA Top Shot

NBA Top Shot is considered the first project that brought NFTs to the mainstream public and helped bring about the NFT boom. The mere fact that Dapper Labs combined NBA culture and card collecting culture digitally was sufficient to raise hype to a frenzy. In addition, a popular user UI/UX, interoperability with other games, and, most importantly, payment in dollars (which remains the essential fiat currency), are considered significant success factors.

With the project’s exponential growth over a short period of time, some imperfections have emerged. Its stability, which was an advantage of Flow, collapsed because it could not handle the sudden increase in traffic. Also, service response and manual withdrawal still cause many inconveniences.

Nevertheless, Top Shot has proven its enduring popularity by continuously maintaining the user pool with a constant supply of new content tailored to users' content consumption speed. 

C. WAX

WAX is an acronym for Worldwide Asset Exchange, a blockchain-based online asset trading project. It started with EOSIO and recently announced its mainnet cloud wallet. However, the reason why WAX received attention is largely due to the accessibility of the its platform. 

WAX Cloud Wallet allows users to create and log in to a wallet directly through social logins such as Google, Facebook, Twitter, and KakaoTalk, without going through complicated processes such as generating a separate private key. In addition, because it is a forked chain based on EOS, it has an advantage over Ethereum in terms of speed and relatively low maintenance costs.

Currently, WAX shows remarkable growth with the growing interest in Alien Worlds (a mining game) and Atomic Market. These two DApps account for 70% of NFT activity on the Wax blockchain.

Representative Project: MLB TOPPS

Fig. 15: MLB TOPPS Baseball Card NFT Collection Market

Source : AtomicHub

MLB TOPPS also has received much attention as it has a large fan base. Some services used MLB licenses, such as the MLB Crypto Baseball game released in 2018 and digital player tokens, but neither of them was widespread. With the NFT craze, MLB TOPPS attracted a large user base and led to the incredible growth of Atomic Hub, WAX's market platform.

D. Binance Smart Chain

Binance launched Binance Smart Chain to solve the scalability problem, which is the most significant limitation of the existing Binance Chain. Unlike Binance Chain, Binance Smart Chain boasts smart contract functionality and compatibility with the Ethereum Virtual Machine (EVM)7.

Fig. 16: Binance NFT Marketplace

Source : Binance

Binance Smart Chain has several advantages over Ethereum. First, the transaction fees on Binance Smart Chain are about 20 times cheaper as of this writing than those of Ethereum. Therefore, it dramatically reduces the burden on users and improves accessibility. Second, it boasts relatively fast performance using a consensus mechanism similar to Ethereum 2.0's proof-of-stake scheme. Finally, both Binance Chain and Binance Smart Chain have features for cross-chain transactions. Thus, within one platform, users can use the cross-chain function between Binance Chain (BEP2) and Binance Smart Chain (BEP20). Based on these advantages, Binance Smart Chain is providing attractive services to both developers and users.

Binance has announced the launch of the NFT Marketplace in June 2021. Binance NFT Marketplace shares the same account system with Binance.com, allowing users to utilize the platform within a single Binance ecosystem. The influx of users is essential for the prospect of the new launch service, and since the existing Binance user base is significant around the world, it is worth paying attention to Binance's new NFT platform.

2) Wallet

A virtual asset wallet is an indispensable direct means for individuals to use NFT services. In general, decentralized NFTs connect digital asset tokens directly from personal wallets to NFT services, and in many cases, allow individuals to control funds such as direct withdrawals. It is common for many NFT services to support decentralized wallets such as MetaMask and Trust Wallet in their services.

In the case of the WAX wallet, WAX enhances user accessibility by linking various existing social media accounts to enable login.

Fig. 17: Login page of WAX Cloud Wallet 

Source : Wax Cloud Wallet

3) Marketplace

Within the NFT ecosystem, the marketplace and NFT issuance protocols are the starting stages of market formation. Then aggregators like OpenSea allow consumers to purchase NFTs on the their platforms.

Fig. 18: NFT Marketplace

Source: Hankyung Business

Recently, the issuance market and the distribution market are growing together, and in general, commissions are set at an average of 8.3% for direct sales and 2.2% for secondary sales. In addition, these marketplaces typically run on-chain, so not only are they efficient, but their fees are known to be about one-third that of spot marketplaces.

4) Distributed storage system (ex. IPFS)

It is difficult to store all digital contents in just one block due to the limited block storage space of the blockchain. Currently, the block capacity of one Ethereum is less than 1 MB, and each block usually contains 16 to 17 transactions. Therefore, it is almost impossible to store the entire digital content in a block.

A service that has emerged in response to this is a distributed storage system called Inter-Planetary File System, or IPFS. This system distributes digital content and stores it outside. The identification key value that can identify these distributed contents is stored as a hash value inside the NFT so that digital contents can be viewed anytime, anywhere, with only the identification key value.

Consequently, even if a given NFT is purchased, it is difficult to see that the owner of NFT owns the original digital content itself. Therefore, the owner needs to confirm that ownership may not be permanent depending on the service content of the solution provider.

4. Element technology and devices of NFT services

1) Investor Protection Device – Self-Operated Whitelist

To verify the authenticity of a luxury product, we must prove it with a warranty or receipt from the seller or obtain an appraisal from an expert. However, since a NFT token is a data element on the blockchain, verification by the creator or a centralized institution with public trust is required. In other words, if a platform or verification organization operates a whitelist and has a procedure to verify the content uploaded with the original author, consumers will be able to transact with more confidence.

How is the platform protecting users in the absence of an official verification body?

Fig. 19: Randomly Created Collection

The above picture is a screen capture upon randomly creating a Hexlant collection before receiving whitelist certification. Platform users are unsure whether this collection was issued based on the original underlying asset or a digital asset uploaded by the original author.

Fig. 20: MLB Topps Collection

The picture above is of the MLB Topps collection. When comparing it with fig.19, there is a V mark next to the collection name with whitelist verification.

Fig. 21: Hexlant NFT Market Listing

The platform notifies the user of the danger by displaying a warning pop-up as shown below when a collection is registered for sale that is not on the whitelist.

Fig. 22: AtomicHub Whitelist Requirement

Source: https://wax.atomichub.io/faq

Each platform operates an independent whitelist, but for accurate verification and free trade that is not focused on one platform, an entity that can perform the role of official confirmation seems to be needed. Alternatively, it is necessary to specify the guidelines to be applied by each community.

2) NFT DAO

DAO (Decentralized Autonomous Organization) refers to a decentralized autonomous organization. DAOs run without a central authority, subject to organizational rules enforced by code running on the blockchain. DAOs may also issue governance tokens representing their fund management or the DAO's membership, voters, or ownership. A form of DAO exists in NFT as well.

A. Rarible

Rarible, a community-owned NFT marketplace, leverages its branding token (RARI) to power its community-operated platform model as a decentralized autonomous organization.

The RARI token is a utility token that underpins the DAO implementation. It cannot be purchased on the platform and can only be acquired through platform activities such as buying and selling art or collectibles. This kind of activity is called “marketplace liquidity mining.”

Participants can propose platform upgrades with RARI, and as a community, have the right to decide on system updates that modify existing protocols and participate in community-based platform management. RARI can also be used to curate content for platform marketing.

B. Mintable

The Mintable DAO feature is operated by an NFT that does not have an ERC-20 token. DAO is implemented by each voter having a personal NFT (MINT). MINT holds the number of votes held by each individual.

Whenever a transaction occurs in Mintable, buyers and sellers are given voting rights in their NFTs. Therefore, the more users use the platform, the more say users have in governance.

Voters can trade MINT tokens in all NFT markets such as OpenC, Mintable, and Larible and obtain MINT through Yield Farming.

C. Flamingo 

Through voting, Flamingo decides to support the NFT community, including commissions provided to artists, marketing curating, and investment. For membership, if users donate 60 Ether on a first-come, first-served basis, users will receive 1% Flamingo interest, which means 1% of Flamingo voting rights and proceeds.

The concept that NFTs fully execute DAOs without ERC-20 tokens is groundbreaking. Exciting developments are expected as new concepts and combinations emerge, such as yield farming.

5. Technical Issues and Accidents

1) A NFT does not prove ownership of the original

The purchase of NFT tokens does not necessarily imply ownership of the original because copyright is not required nor linked to the act of issuing NFTs for specific works of art. The problem caused is that even if the issuer is not the actual owner of the asset, there is room for issuing NFT tokens without consent, and the issuer can trade those tokens.

2) Digitization Limits on Physical Assets

The permanence of digital assets converted to NFTs means long-term storage of data. However, there are some costs for NFT data to last forever. Off-chain solutions such as IPFS can store data, but guidance needs to be set as to who is responsible for maintaining the price of non-chain NFT data and how long it lasts.

3) Original File Identification and Data Loss

Most of the original data of NFTs recorded on the blockchain, such as image files, videos, and sound sources, are stored in IPFS and become part of the NFT internal hash value as metadata in the form of URLs. Hence, there are concerns about the possibility of data loss if the URL or IPFS gateway where the original data exists is interrupted.

4) Security Incident

In March, NFT exchange Nifty Gateway suffered a theft in which some of the user accounts were hacked due to a centralized exchange that trades NFTs. Since Nifty Gateway assigns an address to each user through membership registration and the key is managed by a centralized entity, hackers can steal all NFTs held by those centralized platforms if they hack an account. If the account has 2FA enabled, it would be possible to check in advance when logging in or to make a transaction, but the inactivated accounts could not prevent hacking. Accordingly, a safe storage custody method specialized for NFTs is required. There may be more growth opportunities in the market for fiduciary services.

6. Future Technical Challenges and Prospects

1) Creators and Copyright Protection

Relevant regulations and licensing are necessary to ensure the freedom and flexibility of creators. Furthermore, upon NFT issuance, an extensive authentication process and a tracking system for assets should be established.

2) NFT Platform Security Audit

A. Contract Security Audit

In the case of NFTs, assets are issued and traded based on a decentralized contract. During this process, if a bug occurs in the smart contract, there is a risk of asset theft. Therefore, security audits are required to ensure that asset creation is created with the correct metadata and ownership records and that asset transactions proceed with the accurate transfer of ownership.

B. Platform Security Audit

There are centralized and decentralized NFT platforms. Examples of representative services include centralized NBA Top Shot and decentralized OpenSea. In centralized services, NFT assets are often stored in a centralized wallet, which can be easily accessed when hackers try to hijack the user's account. Therefore, it is necessary to check whether 2FA or additional security procedures are in place.

IV. Current Status and Direction of Korea’s and International Legal Systems in the Field of NFTs

In the current situation where there is no specific law on NFTs internationally, possible issues that may arise in the future can be broadly classified into six categories.

1. Intellectual property

Owning an NFT does not imply or guarantee the ownership of copyrights in the underlying assets. The original author and the NFT issuer may be different. Distinctness of the creator and the issuer may raise questions, such as copyright theft, and duplicated issuance of NFTs based on the same underlying asset is possible.

Legal experts announced the interpretation that the solution could resolve issues within the existing legal principles. Experts argue that both acts of issuing and selling NFTs created with a forgery and with artworks without the original author’s consent constitute infringement on the original author’s copyright.

According to Korean law, copyright infringers can face up to five years in prison or a fine (Korean Copyright Act, Article 136, Paragraph 1, Item 1). In addition, they may be subject to claims for damages in a civil court (Article 125 of the Copyright Act), a request for destruction, and a request for the prohibition of reproduction and transmission (Article 123 of the Copyright Act).

Mina Song, a lawyer at the law firm Minwho,8 explained that there might be no remedy if the issuer infringed the original author’s rights claims that the transaction was made on a decentralized platform and has no right to delete the infringing work. She said that it is necessary to forcibly destroy relevant NFTs and introduce a coercive means to force the trade to be banned if the issuers post infringing works on an NFT trading platform.

2. Tax

Tax treatment differs depending on the characteristics of the underlying asset, but in cross-border NFT transactions, a detailed understanding is required. According to US IRS guidelines, virtual assets are capital assets, and taxpayers are required to file a tax return if they earn money from the sale, transfer, exchange, or acquisition of virtual assets. Therefore, similar to virtual assets, NFT trading may be subject to capital gains tax reporting obligations.

If users live in a specific country, such as India, or use IP, they may need to support related content from a decentralized platform. For example, one response is the Equalization Levy (EL) imposed by the Indian government on the online advertising revenue of foreign IT companies. In addition, withholding tax and Goods and Service Tax (GST) are tax items NFT traders and platform developers should consider.

3. Anti-Money Laundering Act

In March, the Financial Action Task Force (FATF) changed the definition of non-fungible tokens (NFTs) to convertible and interchangeable assets in a draft guideline. NFTs are also subject to anti-money laundering regulations because they can support money laundering and terrorist financing in secondary markets.

4. Stock

The NFT committee of the Japan Customs Brokers Association (JCBA) published NFT guidelines on April 26th. Depending on their design, NFTs may, however, fall under the definition of crypto assets, prepaid payment instruments, or money orders under the Payment Services Act (PSA) or the Banking Act or constitute securities within the meaning of the Financial Instruments and Exchange Act (FIEA).

Fig. 23: The guidelines of Japan Customs Brokers Association(JCBA) and  Blockchain Contents Association(BCA) legal and regulatory environment for NFTs 

Source: https://innovationlaw.jp/en/nft-market-and-guidelines

5. Sustainability

Even if items, collections, and assets are permanently preserved as records on the blockchain, people may doubt the preservation of value if the scope of use is limited to a specific platform. In addition, since data marked as NFTs are stored off-chain, it is unclear how to protect consumers from damage that could occur if NFTs become worthless or non-functional due to service changes or termination.

To solve this problem, the issuer can specify the operating period, or the buyer can choose the option of running an IPFS node to keep the data in the cloud. Alternatively, the developer can increase the growth rate by modularizing the ecosystem in issuance and transaction, auction and storage, and expandable platform through partnership. 

6. Ownership of game items

Games that Korea’s Game Rating and Administration Committee (GRAC) have not rated due to the application of NFT technology have recently been bypassing the open market using an autonomous review system. The reason for canceling the classification is the change that item ownership will bring.

The game company owns existing game items, and they give users the right to use games, characters, game items, and points according to the conditions set by the company. When the game companies apply NFT technology to such game items, the item’s ownership belongs to an individual, not the companies. Thus, those items become giveaways under the Game Industry Act. Some also pointed out that NFT game items may be traded on a trading platform or outside the game rather than inside the game, making it possible to convert them into cash, raising concerns about speculation.

In addition, NFT items are valued not only by ownership but also by the scarcity of details such as name, power level, game history, and advanced technology. For this reason, the act of a game company arbitrarily releasing an upgraded item or increasing the distribution quantity of an existing item directly or indirectly affects the value of items owned by an individual. Therefore, NBA Top Shot discloses the number of cards issued under the same conditions or requires inserting a code that locks the token from further increases in issuance when issuing NFT.

V. Ecosystem Analysis

The NFT ecosystem is divided into six parts: a platform that provides NFT development tools, a trading market that trades NFTs, such as art, collectibles, and game items, NFT market data sites, and NFT and DeFi combination projects that attempt to connect with finance, blockchain games, and metaverses.

Fig. 24: Current Status of Representative Projects of the NFT Ecosystem

Source: ZIMA RED, Nonfungible.com, The number of sales is as of May 26, 2021, at 10:00 am

VI. Conclusion

As a cashless society becomes a reality, people face a fundamental change in perceptions, which place value on digital data, not what is material. Just as means of transportation has changed with the development of the technology industry, the flow of value-added to payment method innovation and electronic data is a natural change. The advent of Bitcoin, CBDCs, and NFTs is further facilitating this flow.

NFTs, which provide uniqueness to digital data via blockchain, are just taking their first steps in a metaverse society where the boundaries between the real world and the virtual world are blurring. The keen interest in NFTs has expanded to the game industry, which provides a similar digital virtual environment, and the art industry, which values ownership and scarcity. 

The emergence of NFTs results from a combination of human’s various needs and the reflection of the present age. Relevant are the rise of the MZ generation who use games to communicate, the creators’ desire to share their work but not to be copied without permission, and the desire to form a bond by owning a collection related to favorite celebrities. 

As all assets become digital data and the public can operate in the virtual world as creators and consumers amidst changing perceptions regarding value, the size of the NFT market will continue to grow. If the Metaverse is defined as the point where the real world and the virtual world intersect and converge, NFTs will become deeply rooted in our lives. 

References 

• So Young Park(박소영), 등급분류 불가 NFT 게임, 자율심의로 우회 출시… 게임위 ‘아뿔사'뒷북 [Unclassified NFT Games Released Detour After Self-cencorship...Korea’s Game Rating and Administration Committee’s Blind Spot], IT조선[IT Chosun] (Apr. 1, 2021, 6:00AM), http://it.chosun.com/site/data/html_dir/2021/03/31/2021033102647.html.

• Ji Hyeon Ham(함지현), 엔진, 차세대 암호화폐 표준 ERC-1155 발표….블록체인 기반 게임에  특화’ [Enjin Announced The Next Generation of Cryptocurrencies Standard, ERC-1155….Specialized for Blockchain-Based Games], 전자신문[Electronic Times News] (Jun. 25, 2018), https://www.etnews.com/20180625000265?m=1.

• Baek Gyeom Kim(김백겸), 미술품 넘어 디지털 자산으로…달아오르는 ‘NFT 마켓 플레이스’ 경쟁 [From Art to Digital Assets… Raising Competition in ‘NFT Marketplace’], 매거진 한경[Magazine Hankyung] (Apr. 2, 2021, 7:01AM), https://magazine.hankyung.com/business/article/202103248263b.

• Sang Gyun Kim(김상균), 디지털 지구, 뜨는 것들의 세상 - 메타버스[Digital Earth, the World of Rising things - Metaverse] (2020).

• Ji Hyeon Lee(이지현), 암호화폐 다음은 NFT? 블록체인산업은 차세대 시장 NFT로 향한다[Next Cryptocurrency is NFT? Blockchain Industry is heading to NFT, the Next Generation Market], Kotra 해외시장뉴스[Kotra Foreign Market News] (May 6, 2021), 

  https://news.kotra.or.kr/user/globalBbs/kotranews/782/globalBbsDataView.do?setIdx=243&dataIdx=188333.

• Mina Song(송미나), 스타트업 법률상식 54 - NFT가 가져온 디지털 저작권 시대의 도래[Startup Common Sense in Law 54 - The advent of the digital copyright era brought by NFT], 디지털데일리 [Digital Daily] (Apr. 29, 2021, 4:38 PM), http://m.ddaily.co.kr/m/m_article/?no=213368.

• TokenPost(토큰포스트), NFT 두 번째 보고서 - 세상 모든 크리에이터를 위하여[NFT Report 2 - For All the Creators of the World], TokenPost.kr (May 13, 2021), https://www.tokenpost.kr/tp-report/2.

• Korea Creative Content Agency(한국콘텐츠진흥원), 글로벌 게임산업 트렌드 2021년 3+4월호[Global Game Industry Trend Issue of March and April 2021], Kocca.kr (Apr. 27, 2021), https://portal.issn.org/resource/ISSN/2636-0853#.

• JOIN:D(조인디), NFT 노리는 해커들, NFT 플랫폼 사용자 계정 해킹[Hackers targeting NFT, NFT Platform User Account Got Hacked], joind.io (last visited Jun. 25, 2021), https://joind.io/market/id/5881.

• Kyle Tut, Who Is Responsible for NFT Data?: Is Da Vinci Responsible for Maintaining the Mona Lisa, Medium (Apr. 6, 2020), https://medium.com/pinata/who-is-responsible-for-nft-data-99fb4e8147e4.

• Cyrus Ip, How Fractionalized NFTs Could Be The Next Frontier of Investing: Where is the NFT market headed, and has the bubble burst? Consider a world where any asset could be tokenized and sold fractionally to investors., Forkast (May 6, 2021), https://forkast.news/fractionalized-nft-investing-next-frontier.

• Grounded, The Revolution of NFT DAO: From DeFi to NFTs to NFT DAOs, the crypto space witnessed numerous innovations as projects adapt to new demand in the market. Medium (Nov. 3, 2020), https://medium.com/grounded-work/the-revolution-of-nft-dao-5684c2cc054.

• DaapRadar, Dapp Industry Overview: April 2021, DappRadar.com (May 5, 2021), https://dappradar.com/blog/dapp-industry-overview-april-2021.

• Ipsita Agarwalla&Meyyappan Nagappan, Taxing Non-Fungible Tokens (NFTS), The National Law Review (May 4, 2021), https://www.natlawreview.com/article/taxing-non-fungible-tokens-nfts.

• Japan Cryptoasset Business Association(一般社団法人日本暗号資産ビジネス協会), NFTビジネスに関するガイドライン[NFT Business Related Guideline], cryptocurrency-association.org (Apr. 26, 2021), https://cryptocurrency-association.org/dl/nft_guideline202104.pdf.

• So Saito&Shinpei Asano, NFTs: An Overview of the Current State in Japan, the Legal and Regulatory Environment, and the Latest Guidelines by the JCBA and BCA, So&Sato Innovative Lawyers (Apr. 27, 2021), https://innovationlaw.jp/en/nft-market-and-guidelines.