The Anatomy of NFTs from a Shariah Perspective

Introduction to NFTs

NFT is short for Non-Fungible Tokens. An NFT is a secure, blockchain-based certificate that represents an entitlement its owner has to a (usually) digital or physical asset (e.g. artwork) or licence and permit for something[1]. NFTs are indivisible and can store significant amounts of data, including unique information, which is what makes a particular token non-fungible, and is stored in a Smart Contract, a computer code that automatically executes upon the occurrence of a set of preconditions[2]. As such, an NFT is essentially metadata about an asset which is added to a blockchain. This means that, while an asset is used to encode the NFT to make a unique representation of that asset, the NFT is not usually – unless there are terms to the contrary in the smart contract encoded in the NFT or in any associated terms of sale – the actual asset itself. In the case of digital assets, an NFT generally contains a link to the asset being represented, which can be stored on a blockchain or off-chain, such as on a website. The commercial value of an NFT is in its ability to prove ownership and authenticity of the asset which it represents.

Purchasing ownership of an NFT representing a work in which copyright subsists does not, unless stated otherwise, grant the new owner of the NFT ownership of the copyright in the underlying work. Copyright ownership initially vests in the work’s author. What is observed and what is expected in the NFT marketplaces is that the copyright owner will grant the NFT owner a license to make certain uses of the work[3]. It is possible to vary this position by contract. Copyright to the underlying asset (or property rights where the underlying asset is a physical asset) can be transferred if specifically agreed (and validly transferred). Smart contracts, which govern the NFT, can be coded to specify that certain proprietary rights, including copyright, are transferred on sale of the NFT. In addition, standard terms and conditions, contracts for sale, deeds of assignment or licences, expressly setting out how rights to the underlying asset are dealt with, can apply to the sale of an NFT.

Potential NFT Composition

When it comes to the underlying asset – whether physical or digital – the NFT does not always transfer copyright and propriety rights of the underlying. As such, the sale of an NFT can potentially have the following scenarios:

  1. The sale of all rights of the underlying asset, including propriety rights, copyright, and rights of disposal of the underlying, as well as ownership and economic rights of the NFT itself.
  2. The sale of some rights connected to the underlying asset but not proprietary rights and copyright. In addition to that, the ownership and economic rights connected to the NFT itself.

The terms and conditions are pre-determined by the creator of NFT and may include benefits for buyers such as:

  • Outright ownership of the asset (digital or physical transfer included)
  • Exclusive access to the digital location where the asset is hosted (creative works, e.g. picture, audio, poem, tweet, GIF)
  • Resale right
  • Access to receive a percentage of bounty from a further resale[4]

The Anatomy of a Digital Asset from a Shariah Perspective

Being digital does not disregard it from being an asset in Shariah, as the driving factor in being Māl (property) – and therefore a valid asset – is the ability to benefit from the asset in a reasonable manner. The Hanafi jurists defined Māl in several ways such as:

  • Māl is what human instinct inclines towards and it is capable of being stored and accessible at the time of necessity (Ibn Abidin).
  • Māl is that which has been created for the benefit of humans. Māl brings with it scarcity and stinginess (al-Haskafi).
  • Māl is that which is normally desired and can be stored up to the time of need (Majallah).

The emphasis on Māl being stored and retrievable all goes back to two premises:

1. The ability to transfer something from the seller to the buyer such that the buyer can use the asset without any impediment and at their free will; It is not something which is dependent on the supply of the seller, as is the case of services, nor something dependent on the grant or permission of the seller, as is the case of rights. The Hanafis made a distinction between property, services, and rights, in that they perceived property (Māl) to be only that which was absolutely transferred with no further input or involvement from the seller thereafter. Services (Manfa’ah) require the service provision by the service provider or the leased asset continuously for the purchaser to benefit from the service. Rights (Huqūq) are in essence permits and concessions which are granted by the grantor of the right, and nothing is transferred per se, rather the subscriber is given a concession and benefit to use, but the overall power and ability to restrict in future is retained with the grantor.

As such, the Hanafi jurists did not permit the sale of all rights independently, as they are not something which can be transferred by sale to the counterparty, and therefore could not fall under the purview of a sale in Shariah, which required the exchange of two properties. And since rights could not be transferred and exclusively retained by the counterparty, the rights could not be stored independently and retrieved for use at will, this ultimately negated them from being Māl. As time passed and society developed, the use of rights and their subsequent trading initiated. People began to deem certain rights as transferrable goods. A social understanding and recognition among people of the existence of these rights and their utility increased. An understanding of rights as something intangible yet exchangeable and transferable was developed. This phenomenon was witnessed, recorded and upheld by social convention (Urf) to such an extent that a person could claim and demand for such rights in the court of law and it would be upheld by the courts. Urf allowed the recognition of these rights as property, their reporting and settling in case of dispute. The ability to record these rights in a orderly fashion which was recognised by the people gave them the ability to be ‘stored’ and be ‘retrievable’.

2. The second premise for anything to be deemed as Māl is for it to be storable and retrievable. This goes back to the idea that historically, only something tangible and corporeal could be transferred, received and possessed. The early Hanafi jurists alluded to the idea of Māl being something tangible. This idea is hinted in the manner they described and defined Māl. Imam al-Haskafi explicitly described Māl as something tangible. Of course, in earlier times, it was not conceivable for intangibles to be something storable nor retrievable, as such, intangibles were not deemed Māl. These jurists held this view because sales and exchanges are transactions which require a mutual transfer of wealth and property. How could something, which cannot be possessed or held, be exchanged? The jurists did not permit such exchanges as it would lead to one party losing and not gaining anything of substance. As such, Huqūq (rights) were deemed not to be Māl and therefore not retrievable nor storable. Storability simply refers to the idea that something can be retrieved for use later. Thus, thin air, an odour or scent, a passing thought in one’s mind are not ‘storable’. The early Hanafi jurists put this condition for Māl because only storable items could be retrieved and used, and the entire purpose of being defined as Māl was that something of benefit and value could be transferred and exchanged for the benefit of others.

Of course, in earlier times it was inconceivable to have incorporeal assets and intangibles as stored assets. There was no infrastructure to store, retrieve and use such intangibles. With the advancements in the world now, this is the norm and we have legal and regulatory frameworks to inform acceptable practice, accounting conventions to value intangible assets, and digital infrastructure to house such assets. The core function of Māl is to benefit. The great Hanafi jurist Ibn Abidin (d.1252 AH) described Māl as something ultimately “made for the benefit of people”. Many digital assets are stored digitally, they are accessible, retrievable at will and also give benefit depending on what they are, they are aspired by people and therefore, have all the hallmarks of Māl and can be deemed Māl. Of course, not everything intangible or digital will be Māl, some assets may well be rights or services, but that can be reviewed on a case-by-case basis.

The Sale of an NFT from a Shariah Perspective

If we simplify the sale of NFTs into two common scenarios, we can then present the subsequent Shariah perspectives:

  1. The sale of all rights of the underlying asset, including propriety rights, copyright, and rights of disposal of the underlying, as well as the ownership rights and economic rights of the NFT itself.

From a Shariah perspective, the consideration will depend on what is actually sold. As long as what the NFT represents is Halal and lawful, then a sale of an NFT which incorporates all rights to the underlying including proprietary rights, will be a typical sale of an asset, just that it is a digital asset. It will be deemed a sale of property (Māl) as the buyer receives all rights connected to the digital asset.

  1. The sale of some rights connected to the underlying asset but not proprietary rights and copyright.

From a Shariah perspective, this falls under the sale of rights. The token itself would be nothing more than a certificate and “paper” showing rights. As long as the NFT is lawful and the rights are lawful and acceptable in Shariah, this sale can also be valid. The classical jurists permitted the sale of rights which were subordinate (tabi’) to an asset. They give the example of the right of passage (Haqq al-Murur) in a path that people would sell along with a path and land. Thus, when an NFT transfers some rights only such as the right of exclusive access and personal use rights, it is similar to the sale of the right of passage[5]. In fact, the later jurists explicitly permitted the sale of the rights independently as it became an accepted norm and customary practice, which was then recognised legally and systemised[6].

A Word of Caution

Although the above discusses the nature of NFTs from a Shariah perspective, it is worth mentioning that NFTs must be something which are of value and have utility to be acceptable in Shariah. Selling junk and purchasing junk assets which have no genuine use cases and utility is not acceptable in Shariah. The very heart of a transaction is Māl; Māl means inclination and aspiration of people as it something which gives genuine and reasonable benefit to humans. This will be addressed thoroughly in a future article.

 

[1] https://www.taylorwessing.com/en/insights-and-events/insights/2021/05/nfts-a-question-of-ownership

[2] https://www.lawyer-monthly.com/2021/05/nfts-and-ip-law-who-owns-what/

[3] https://www.penningtonslaw.com/news-publications/latest-news/2021/non-fungible-tokens-legal-issues

[4] https://medium.datadriveninvestor.com/i-bought-an-nft-what-exactly-do-i-own-f1026d715377

[5] (المادَّةُ ٢١٦) يَصِحُّ بَيْعُ حَقِّ المُرُورِ وحَقِّ الشُّرْبِ والمَسِيلِ تَبَعًا لِلْأرْضِ والماءِ تَبَعًا لِقَنَواتِهِ. (مجلة الأحكام)

[6]  تَوْضِيحُ القُيُودِ – قِيلَ فِي المادَّةِ (تَبَعًا لِلْأرْضِ) لِأنَّهُ إذا بِيعَ حَقُّ المُرُورِ مُسْتَقِلًّا فالبَيْعُ غَيْرُ جائِزٍ عَلى رِوايَةٍ؛ لِأنَّ هَذِهِ الحُقُوقَ هِيَ مِن الحُقُوقِ المُجَرَّدَةِولِذَلِكَ عِبارَةُ (تَبَعًا لِلْأرْضِ) قَيْدٌ احْتِرازِيٌّ عَلى هَذِهِ الرِّوايَةِ وعَلى رِوايَةٍ أُخْرى بَيْعُ حَقِّ المُرُورِ مُسْتَقِلًّا جائِزٌ وهَذِهِ الرِّوايَةُ أحْرَزَتْ قَبُولَ عامَّةِ المَشايِخ (درر الحكام شرح مجلة الأحكام)