The Consumer & Retail Industry has been an early champion of the benefits of Web3 concepts like NFTs (non-fungible tokens) and the metaverse, helping retailers to drive sales and growth and supercharge brand awareness. NFTs and online gaming are forecast to account for around ten per cent of the luxury market by 2030 and to be worth more than EUR 50 billion in revenues.
The next stage of this evolution is the development of a new "Phygital" ecosystem; in other words, the fusion of digital assets with the physical world to create new, immersive technologies and products. The most relevant current example of this is the combining of NFTs with NFC Tags for luxury and fashion goods.
What is an NFC?
NFC is shorthand for Near Field Communication, a wireless communication technology which enables short-range data exchanges between devices that are near to each other. Unlike Wi-Fi or Bluetooth, NFC technology requires physical contact or close proximity to establish a connection, thus making it hard to intercept or hack.
An NFC Tag is programmed to provide a unique URL address, which serves as the NFC's Tag ID. This Tag ID is then attached to a product as a label, usually with anti-tamper protection, and can be read by a simple scanner or smart phone. This is similar to QR codes, which are widely used in the retail industry for mass produced goods, but unlike QR codes, each NFC Tag ID is unique and will not be duplicated between individual products. As with QR codes, NFC Tag ID URLs are public and visible and can be read and easily copied.
However, the critical underlying technology is based on a private encryption key which is encoded and hidden within the NFC chip. This private key is used, sometimes together with the Tag ID, in order to generate one-time authentication codes. This encryption technology is similar to that used in passports and bank cards and this element of the technology makes the NFC Tag unique and protects it from easily being duplicated.
NFTs combined with NFCs
The Luxury Fashion sector is now using NFC Tags in combination with NFTs in order to link physical objects with digital assets – hence the term "Phygital". NFTs have been around for about ten years and are regarded as the standard bearer for digital asset identification, but until recently have remained separate from real world assets and something of a niche interest, subject to a wide degree of scepticism over their true value.
NFC technology enables retailers to effectively pair a physical good with its NFT digital counterpart. Retailers register and create a profile on a suitable technology platform, insert information on the product in question and generate its equivalent in the form of an NFT. Each NFC Tag is connected to its own unique NFT via the private encryption key. The NFC Tag provides an encrypted, permanent record of ownership and transaction history of the individual product via blockchain technology. This will show the relevant authentication data such as provenance, time stamp, author information and so on, which is, in effect, certified on the blockchain.
Where can this technology be used?
There are a large number of luxury & fashion items that can benefit from this new technology:
- Clothing, shoes and accessories
- Handbags
- Jewellery, watches
- Beauty products, perfumes
- Works of art such as paintings
- Collectibles such as figurines, sports memorabilia, trading cards, coins and stamps
- Fine wine and premium collection spirits
- Gaming merchandise, collectible cards, in-game bonuses and assets
In April 2021, LVMH, Prada Group, OTB, Mercedes-Benz and Richemont created the Aura Blockchain Consortium, using NFTs to allow consumers to access the product history and proof of authenticity of luxury goods across the product life-cycle. In September 2022, Dolce & Gabbana sold nine NFTs in the form of dresses, suits, tiaras and crowns valued at more than EUR 6 million. Louis Vuitton created outfits for the League of Legends video game characters that players can purchase. Burberry, Valentino and Balenciaga have all partnered with gaming companies on in-game products.
The benefits
From a retailer's perspective, there are the obvious benefits of a new type of product and a new market for their existing products. Digitising real assets through NFTs allows the products to be listed and traded seamlessly online, whilst the product itself can remain safely stored in a custody warehouse or similar arrangement. This eliminates transport risk and the need for every buyer to arrange their own storage and security arrangements, which can be expensive for high-value items.
In addition, the product authentication and anti-counterfeiting aspects of the technology benefit both retailers and consumers, ensuring that they are purchasing legitimate products with a transparent record of ownership and traceable registration history. This could have huge benefits in the art world and with rare or highly valuable collectibles. The technology can also be used to assist high-end retailers with inventory checks and record-keeping.
Retailers can also utilise the technology to enhance their products by providing extra product information, exclusive digital experiences and special features. Luxury perfume brands have already started to create their own customised scents, using digital ingredients which the consumer can then register as an NFT limited edition physical perfume. Collectors can utilise the digital aspects to showcase their collections and even participate in digital auctions and decentralised sale and purchases. Football clubs are already starting to use NFC Tags on scarfs and football shirts which double as e-tickets and can also be linked to NFTs.
The themes across product ranges are common ones and of particular interest to the Luxury & Fashion sector, namely exclusive, collectible and limited edition items.
Legal issues
Inevitably, a large number of legal issues will arise. In relation to the use of new technologies in the Consumer & Retail industry more generally, we have already covered these in detail in our earlier article, which can be found here: https://www.whitecase.com/insight-alert/new-technologies-consumer-retail-industry-key-legal-issues-and-risks
With regards to Phygital assets, the position is particularly complex. NFTs themselves are digital assets with an owner, albeit one who may be anonymous. Ownership of the NFC Tag is more nuanced, because the physical product to which it is attached can change hands without any digital interaction. The question then arises as to how to structure things legally, so that ownership of the digital asset can be successfully paired with the physical product. And what happens if the two end up in the hands of different owners?
The legal landscape in this area is still developing and there are a number of alternative options. On a basic level, the physical and digital assets can be sold together as a single package, but capable of legal separation into separate ownership if one or the other is sold or transferred. Alternatively, the NFC Tag ID can store the ownership information of the NFT, but a subsequent change of ownership of the NFT will simply render that information in the NFC Tag ID out-of-date.
A more sophisticated option would be to link the details of the NFT ownership to the NFC, such that a registered change of ownership of one would automatically prompt a digital change ownership of the other. Of course, in practice, the new owner would still need to have physical possession of the product to which the NFC Tag is attached. However, without the up-to-date chain of digital ownership and authentication on the paired NFT, the resale value of the physical product may be adversely affected. It is possible to lock NFTs, such that the ownership cannot change without a direct confirmation from the NFC encrypted key, with such key either being stored with an authentication server or, alternatively, within the blockchain.
Ultimately, however, there is no digital "kill-switch" that will stop a physical product from being taken by or transferred to someone who is not the owner of the paired digital asset and it is inevitable that separation of digital from physical assets will occur in many cases. Ensuring that the custody obligation and rights transfer with the NFT is something that needs proper attention.
The mechanics of transferring legal ownership to physical assets varies across jurisdictions and asset types and it may not always be possible to transfer legal ownership with the NFT. Instead, the arrangement may need to be structured as a contractual right to receive ownership on eventual redemption of the NFT (i.e. title only passes on redemption).
Where the acquisition of an NFT conveys onto the owner a right to receive the underlying physical asset, retailers will need to be careful that this doesn't conflict with any local laws or regulations; for example, the distribution of alcohol to minors, the export of restricted art works overseas or the sale of restricted precious stones and gems. Retailers will also need to ensure they comply with relevant sanctions regimes and do not facilitate the transfer of assets to prohibited persons or persons residing in prohibited countries.
Conclusions
It looks like the Phygital world will continue to grow for retailers, especially for those most active in the Luxury & Fashion sector. Given the premium brand nature of this segment of the market, the potential upsides are significant and also offer a more mainstream market for NFTs in the future. The legal framework is largely playing catch-up in this space and will also continue to rapidly develop.
White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.
This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
© 2023 White & Case LLP
