So, your brand is ready to launch an NFT1 collection, and you are moving through your due diligence checklist before greenlighting the drop. You've considered intellectual property, securities, and various technical issues. Your marketing department assures you "privacy" isn't an issue because NFTs reside in "Web 3.02" where everything is open, decentralized, and anonymous.
Good to go? Well, not quite.
While NFTs offer the promise of Web 3.0, most of the ecosystem—including the websites where NFTs are bought and sold and the platforms where NFT communities engage—still exists on "Web 2.03." As a result, NFT drops rely on a "Web 2.5" ecosystem (as we like to call it) where data collection and monetization rule and a plethora of privacy laws, rules, and regulations apply.
This article proposes that there are five steps in dropping an NFT collection, and examines the privacy and data protection issues brands must consider through each of these five steps.
Step 1: Generating Hype
Before dropping an NFT collection (or "project"), most brands try to build excitement around the drop. A brand typically starts by setting up a website and/or Discord4 server dedicated to the NFT drop. The brand then announces the NFT drop using Twitter, and often embeds a URL in its brand profile or tweets that links to the brand's Discord server and/or website.
This process of generating hype inherently involves the collection and processing of personal information. Tweets, comments, IP addresses, and other device identifiers constitute or may include personal information under various privacy laws. Tweets and comments are particularly identifiable, as they relate to specific user accounts. In addition, the URL itself may collect personal information.
Where a brand uses its own website to promote an NFT collection, it should consider the functionality of the website. If a brand deploys cookies, pixels, or other tracking technologies on the website (or in emails or ads for the website), including for purposes of analytics or targeted advertising, the brand must address privacy obligations relating to data collected through those tracking technologies. Likewise, if a brand offers an email sign-up through the website,1 the brand must determine whether email addresses will be used solely for the purpose of sending email updates regarding the NFT project or for broader purposes such as creating hashed audiences for targeted advertising. Hashed audiences and targeted advertising require additional disclosures and evaluation of user rights, including opt-outs under comprehensive state privacy laws.
And, of course, if an NFT project is meant to be available or advertised worldwide, a brand must consider global data protection issues, including potential applicability of the European Union's General Data Protection Regulation ("GDPR") and related data transfer obligations7.
1: Example of an email sign-up on an NFT website.
Step 2: Developing a Discord Community
In conjunction with generating hype, brands frequently use Discord to develop a sense of community around their NFT project and engage with users. A brand may open text and voice channels to the public and converse with users on topics related (and unrelated) to the NFT project. In addition to opening channels, a brand may organize game nights, art or meme contests,2 loyalty programs, sweepstakes, or other events on Discord where, by participating, users can win NFTs, cryptocurrency, or the opportunity to add their digital wallet address to a list (often referred to as a "whitelist," "guestlist," or "allow-list") granting early access to NFT minting.
Brands should be extra careful regarding the security of user data collected through Discord. We've heard of Discord moderators soliciting digital wallet addresses as part of an event, storing the addresses within a list on Google Forms or an unsecured spreadsheet, and posting the entire list to their Discord server to let users confirm whether they are on a whitelist. As digital wallet addresses may constitute personal information under applicable law (more on that below), posting these lists in the clear on Discord could constitute a security incident and trigger data breach obligations in certain jurisdictions.
2: Example of a contest advertised on Discord where users must provide a digital wallet address to receive a (digital asset) prize.
Step 3: Setting Up and Maintaining a Digital Wallet
Next, in order to drop an NFT collection or receive any sale proceeds in cryptocurrency, a brand must either set up its own digital wallet or entrust a third party to manage its digital assets. As part of that process, the brand must decide who will open the wallet. The brand should associate any custodial digital wallet that it opens with a brand account rather than an employee's own account, as the employee may have individual privacy rights under the law.
Importantly, a brand must consider how the wallet's private keys (i.e., the code to the safe) will be protected. While digital wallets are generally considered secure, a wallet is only as secure as the wallet's private keys, also known as a user's "seed phrase," "secret phrase," or "recovery phrase." Any seed phrase stored online, on a computer, or in an electronic password manager is susceptible to being stolen. Once a bad actor has access to a brand's seed phrase, it can transfer all the assets in the brand's digital wallet to a new wallet the brand doesn't control. The nature of blockchain technology makes these transactions irreversible.
Brands should be aware of the tactics used by bad actors to gain access to digital wallets. Most attackers rely on phishing schemes where the attacker gains access to an online account which ultimately leads them to a digital wallet. Discord, Twitter, and Instagram are particularly vulnerable to attack. We've seen many instances where an attacker gains access to an NFT issuer's Discord10, Twitter11, or Instagram12 3 account, tweets or posts an announcement through the account of a new NFT drop along with a malicious link, and gains access to the private keys of those users who click on the link (whether through a vulnerability on the user's device or where the user provides their private keys as part of connecting their wallet to the attacker's website in the belief they will receive an NFT). We're also aware of at least one instance where an attacker gained access to an iCloud account13 and discovered the backup data included his seed phrase. These scams have resulted in wallet holders losing millions of dollars in assets and cryptocurrency. Where a brand falls victim to an attack, the brand could face significant liability as well as damage to its goodwill.
Accordingly, brands must take appropriate measures to prevent and timely respond to such attacks. Even basic measures such as employee training and limiting access on a "need to know basis" help protect not only the brand, but also potential NFT purchasers who interact with the brand.
3: Tweet from Bored Ape Yacht Club after its Instagram account was hacked on April 25, 2022, where the hacker allegedly stole nearly $2.5 million worth of NFTs.
Step 4: Dropping the NFT Collection
Once everything else is in place, a brand can proceed with dropping its NFT collection. Most brands choose to sell NFTs through their own websites, often microsites or splash pages, which are designed to be compatible with MetaMask or similar third-party digital wallet extensions. (We note that brands can alternatively drop their NFTs directly on marketplaces like OpenSea, which carries its own privacy considerations.) Users simply connect their digital wallets to the website for the opportunity to mint an NFT.4 When a user purchases a brand's NFT, a public entry is created on the applicable blockchain showing that a user's digital wallet address and the NFT collection's smart contract address (which typically points to the brand's digital wallet address as the deployer) sent cryptocurrency and NFTs to each other. Brands are responsible for any personal information they collect during this process.
One of the touted benefits of digital wallets is that they are supposed to be anonymous. Each wallet has a unique, random, and immutable "public" address that allows its user to receive cryptocurrencies. Because these addresses are long strings of alphanumeric characters, some brands may believe that the addresses should not be able to identify a wallet holder and therefore they do not need to consider privacy and data protection obligations. However, while a digital wallet address alone cannot identify a user, it could become identifiable and subject to privacy law by associating other pieces of information with it.
One possible way to identify the owner of a digital wallet address is through its transaction activity. Blockchains, which are distributed digital ledgers, store and publicly list all transactions and assets associated with each digital wallet and each NFT collection's smart contract address. Unlike information stored using other technologies, these transaction histories cannot be deleted or modified. Through a quick search,5 a brand (and third parties) can view all of the transactions and assets associated with a digital wallet (or smart contract address) and find out:
- when the wallet was opened
- what assets the wallet holds and has held;
- when assets were purchased and sold;
- from whom assets were purchased and to whom assets were sold; and
- whether any blockchain-based domain names (i.e., customized wallet addresses) are associated with the wallet (e.g., janedoe.eth)
Knowing several pieces of transaction activity, or even a single piece of transaction activity associated with outside information, could quickly make a digital wallet address identifiable to a brand. For example, as recently demonstrated by Jimmy Fallon,146 a digital wallet address could become identifiable where a brand knows that the digital wallet holds a specific NFT and the brand interacts with a user on Twitter, Discord, or LinkedIn using that NFT as an avatar or "PFP" (slang for profile picture). A digital wallet address could also become identifiable where a brand knows that the digital wallet holds a Proof of Attendance Protocol or "POAP" NFT, which certifies the holder attended a specific event, and the brand also has a list of those individuals who attended that event.
In addition, a digital wallet address could become identifiable based on associating the address with data collected through a brand's website. For example, a brand could collect the IP address of a user who visits the brand's website, and associate the IP address with a digital wallet address based on the time of a purchase. More directly, a brand could require a user to register an account in order to make a purchase and associate the account information with a digital wallet address. Brands that are particularly mindful of anti-money laundering and "Know Your Customer" (or "KYC") requirements have even required digital wallet owners to submit personal information such as photos of government issued IDs to purchase NFTs or use NFTs in their wallet to redeem physical assets.
Based on the above, regulators could consider digital wallet addresses to be personal information under privacy law and expect brands to treat them as such (this has yet to be tested in most jurisdictions). This means brands must provide disclosures and rights around digital wallet addresses (even if the brand cannot delete the immutable information from the blockchain).
We expect some brands may argue that digital wallet addresses are publicly available information and thus exempt from the definition of personal information in certain jurisdictions. However, brands should be careful when relying on this argument. Even if a digital wallet address itself is publicly available information, if a brand associates a digital wallet address with other information, the resulting combined information could be considered personal information. Earlier this year, the California Attorney General issued an opinion that inferences15 generated based on publicly available information are subject to the protections under California privacy law.
4: Example of a website with digital wallet integration.
5: Example of a scan through Etherscan.io showing some transaction activity of a digital wallet.
6: Jimmy Fallon and Paris Hilton compare their Bored Ape Yacht Club NFTs on The Tonight Show, allowing viewers to find and identify their digital wallets.
Step 5: Post Drop Utility
After a drop, a brand may continue to engage with its users and offer additional utility for NFT holders. For example, a brand may give NFT holders the ability to redeem physical goods or exclusive merchandise, attend invite-only events16 or meetups, or download or access exclusive content. To the extent these practices involve the collection or processing of personal information, a brand must continue to evaluate its obligations with respect to such processing.
There is a lot to consider when dropping an NFT collection, and privacy and data protection compliance should be a chief consideration. Failure to address privacy and data protection could lead to regulatory scrutiny and enforcement, damage to consumer trust and goodwill, and loss of valuable assets and revenue. As we move closer to Web 3.0, best practices and laws will evolve, and brands will need to stay up-to-date and nimble to address their obligations.
Now, the next time your marketing department assures you "privacy" isn't an issue, you'll be ready to kindly respond that it is an issue and direct them to this article.
This alert provides general coverage of its subject area. We provide it with the understanding that Frankfurt Kurnit Klein & Selz is not engaged herein in rendering legal advice, and shall not be liable for any damages resulting from any error, inaccuracy, or omission. Our attorneys practice law only in jurisdictions in which they are properly authorized to do so. We do not seek to represent clients in other jurisdictions.