Luxury lawyers Maria Luigia Franceschelli and Ghada Qaisi Audi examine the viability of digital and ‘phygital’ asset strategies in an evolving luxury world
NFTs have triggered tremendous interest among brands for the past few years. The concept of owning a digital object that can be sold, traded or taken somewhere else was not possible before the advent of cryptography, blockchain and related innovations such as NFTs. But do all the rules and logic of the physical world apply? What is the current status of the NFT market and how can past experience and future possibilities guide brands in managing the risks connected to the constantly evolving uses of this technology?
NFT stands for non-fungible token, a unique piece of code where ownership is written and recorded on a blockchain and purchased using a digital wallet like Metamask, using crypto or fiat currency. They can be bought and sold through marketplaces such as OpenSea or Rarible, or a brand’s own. Each token represents rights to a unique digital asset or collectible such as an avatar, wearable, skin or digital artwork. Many luxury brands were drawn to NFTs as tradeable assets and as new business models, a classic example being the sale of a digital asset to provide a customer with access to a physical item.
Current state of the market
When exploring the use of new technologies in the era of Web3 and the metaverse, and as a more social, immersive and sophisticated version of the internet continues to emerge, what should brands take into consideration when including NFTs within their digital strategies?
The NFT market is currently experiencing a crisis, with NFT prices decreasing significantly and a notable decline in the number of daily active visitors on marketplaces compared to previous years. This downward trend closely correlates with the volatility of the cryptocurrency market.
The question is: are brands worried about this crisis? Apparently not. Many brands are launching new experiences in the metaverse, including NFTs, while other brands that were already advanced players within the space bolstered their investments in NFT projects.
One reason is because the market value created by NFTs is relatively small compared to a brand’s overall business. Indeed, the revenues made by brands from the sale of NFTs appears unremarkable compared to that made from the sale of standard goods.
A second reason is that the technology behind NFTs unlocks powerful additional utilities for the holder beyond the ‘tradable assets’ business model. NFTs have a number of useful brand engagement capabilities due to their potential to target new consumers, engage their existing communities and increase brand awareness.
Brands that understand the future utility and potential for mass adoption, and are building new infrastructure or are utilising these new technologies for improved customer experience, have accelerated their digital transformation. This underscores the longevity of blockchain technology beyond the current overall negative market sentiment towards digital assets. In this context, the luxury and fashion industry has witnessed a remarkable surge in the popularity of ‘phygital’ projects where the convergence of digital and physical experiences offers exciting opportunities for engagement, creativity and community building.
TARO ISHIDA luxury footwear startup brand phygital case study
Luxury shoe company TARO ISHIDA launched its digital flagship retail concept just before the start of the global pandemic. The use of digital channels by luxury brands skyrocketed due to the pandemic and accelerated digital transformation across industries. To meet the expectations of luxury shoppers seeking personalised, high-touch experiences and who traditionally prefer to shop for luxury women’s footwear in stores, TARO ISHIDA devised a phygital strategy.
As a luxury start-up brand, TARO ISHIDA’s journey of exploring the use of NFTs began as a way to cost-effectively combat counterfeiting. Among the many practical uses, it includes embedding near-field communication (NFC) tags into the footwear product and having an NFT digital twin. This enables clients to scan the shoes using a mobile phone to authenticate the purchase and be assured of its value as an original.
Not only was creating value for customers at the forefront of its phygital strategy, but also fostering continued avenues for direct interaction with customers beyond a sales transaction. This connection provides customers with a feeling of care, value and importance, while also creating post-sale touchpoints that enhance brand loyalty and engagement with its customers.
NFT integration offers significant potential to offer clients access to personalised digital experiences, such as cryptocurrency payment gateways and after-sales services, but also for circular economy, supply chain and ESG transparency. As the future of NFTs unfolds, TARO ISHIDA is closely examining customisable digital experiences and the manner in which the realms of physical and digital interaction with the product continue to merge. Moreover, any technology innovations must align with the brand’s DNA and provide unique, exclusive experiences for its customers.
For luxury brands in particular, the strategic use of phygital offerings should first take into consideration the end user’s experience and the target demographic of the consumer. For example, tech-savvy, phygital natives may be more inclined to interact with the brand in the digital world versus a brand’s client base from older generations. Second, a brand should take into consideration the user-friendliness of the application? Luxury consumers demand seamless and uncomplicated brand engagement. Third, functionality does not always equate to allure. Among the most important questions to ask here are a) does using this tool create desire for the product? And b) is the interface sufficiently user friendly for a luxury brand’s discerning clientele?
Legal issues and hot topics
The legal management of NFT projects could be complex, especially for phygital ones, as brands must not only oversee the digital sale of NFTs and related digital assets, but also ensure a seamless connection to the physical experience associated. In this landscape, they can leverage past experiences and previous case law to gain valuable insights that can guide them in the legal regulation of their projects and help with managing the risk.
Still, there are several questions that do not find a singular answer. And the uncertainty could have serious consequences for content creators and brands in terms of control of their assets. We want to red-flag three main risks:
- First is the definition of NFTs. While some cases have recognised NFTs as assets, there is no definitive consensus on whether they should be considered as such. This lack of clarity has implications for enforcing measures like injunctions, which typically apply to assets only.
- The application of the first sale doctrine to NFTs also remains an unresolved issue. In certain jurisdictions, it may be applicable to NFTs associated with digital objects, which can limit the control over resale or third-party usage.
- Instances involving stolen NFTs highlight the importance of providing adequate customer service and protection for NFT owners. While IP owners can take advantage of takedown procedures to halt the promotion of infringing NFTs, these actions may not entirely eliminate the NFT or the associated infringing content from the platforms where they are stored.
The increasing importance of terms and conditions
These issues and uncertainties are prompting brands to adopt meticulous regulation of their NFTs through appropriate agreements and smart contracts. This approach aims to significantly reduce the risk of losing control over both the digital asset and the associated physical experience while providing a more enforceable tool against potential misuse.
The terms and conditions (T&Cs) of sale of an NFT should comprehensively address not just all relevant aspects to cover the entire lifecycle of the NFTs and account for various variables, but also the risks just described. Typical clauses may include limitations on commercialisation; termination in case of misuse; right to update the T&Cs from time to time; redemption limitations; consequences of breach and enforcement.
Brands should also focus on resolving concerns regarding transparency and traceability which are being raised by purchasers. The demand for clarity is strong, especially on the rights granted to purchasers over the underlying digital assets. Brands should address this topic plainly in the T&Cs and make these available to purchasers in a way that allows for review and acceptance during the purchase and resale process. Concurrently, in the same way they educate customers about their physical products, brands should undertake the task of educating their consumers about their NFTs and their blockchain-based digital infrastructure. This should be done using simple language that is easily understandable to individuals without technical expertise.
Blockchain technology provides the ability for better verification of sustainability performance and of product ownership. The choice of which blockchain is an important one for luxury brands. With ‘network effect’ a major driver, the more users and applications, the more valuable the blockchain. With the addition of new blockchain companies dedicated to the luxury industry, such as the Aura Consortium and LUKSO, solutions for better verification, sustainability, traceability and product ownership will continue to emerge.
In an effort to support the market and ensure clarity for both buyers and content creators, several stakeholders have developed standardised licenses for NFTs. A good example is the “can’t be evil” license by a16z, which is directly incorporated into the NFTs’ smart contract on-chain.
Still, most brands employ their own licensing terms, particularly for phygital projects. This approach is recommended when the project is customised, and the rights granted to NFT purchasers extend beyond mere usage as a profile picture or in a wallet.
What’s the future for NFTs?
The NFT market presents significant opportunities for brands, and the mere sale of NFTs represents only a fraction of its potential. Brands are realising and unlocking the powerful utilities that NFTs provide for consumers ranging from educational resources, entry into communities and tickets to real-life events. Additional practical uses of NFTs for the luxury and fashion market include the capability to prove authenticity, track goods and fight counterfeits.
In this dynamic and ever-evolving market, the legal framework must continuously adapt to the latest trends to provide brands with sufficient protection. While agreements and smart contracts are valuable tools, brands must stay continuously informed about the legal aspects of this technology to avoid unforeseen challenges. Brands will be called upon to navigate the complexities. Conversely, the opportunity to educate consumers on any pitfalls strengthens brand engagement. Not all hyped trends endure. However, those that manage to persevere and achieve mass adoption will transition these tools into new standards that are seamlessly integrated into consumers’ everyday lives and shape the future of retail in subtle but significant ways.
Maria Luigia Franceschelli is a counsel at Hogan Lovells, based in Milan. She is a member of the global fashion and luxury team. The team, as part of the consumer group, advises many of the world’s most renowned fashion and luxury labels, from manufacturers to influential fashion houses. The global footprint and deep industry knowledge enable the firm to efficiently address any legal issues at a moment’s notice.
Ghada Qaisi Audi is CBDO and Co-CLO at TARO ISHIDA. She combined her luxury law, luxury retail and investment experience to become a luxury consumer goods brand co-founder. She is former general counsel of Seddiqi Holding (Dubai, UAE), the preeminent luxury watch and jewellery retailer in the Middle East. She frequently serves as an arbitrator and is an authority on complex luxury and fashion industry commercial disputes.