Blockchain and NFTs are smart, but can they revolutionise the fashion industry?

25 Jan 2022 , 8:13pm

Lawyers Cindy Yang, Kelly Bonner, Fiona Rodgers and Michelle Ray-Jones from the Multilaw network discuss sustainability and luxury pirates in the digital age

Following the worldwide disruption in retail due to COVID-19, sales of luxury goods are expected to grow as much as 25% in 2022. Much of this growth has been driven by e-commerce, with online sales totalling 23% of all luxury sales in 2020. Meanwhile, consumer sustainability demands have driven growth in luxury resale or rental markets, now worth an estimated $36 billion, while brands have expanded their reach into the brave new digital territory of the metaverse – the overlapping digital spaces in which we increasingly work, play, and consume.

Yet luxury’s digital embrace has been hampered by a concomitant rise in counterfeit goods in the physical and digital worlds. In 2019, Harvard Business Review reported that fake luxury goods accounted for 60% to 70% of the $4.5 trillion total global trade in counterfeit goods sold annually.  And in 2016, the Organisation for Economic Co-operation and Development (OECD) recorded that counterfeit luxury goods accounted for approximately one quarter of the estimated $1.2 trillion total global trade in luxury goods.

Since the pandemic, these figures have worsened, with brand protection agencies reporting a 56% increase in online counterfeit sales in the first six months of 2020.

Additionally, there has been an increase in the number of cease-and-desist letters and takedown notices sent to non-fungible token (NFT) creators and platforms in response to the rise of unauthorised NFTs.

The damage goes beyond lost sales. Counterfeit products can tarnish a brand’s reputation and degrade consumer trust. Further, counterfeits produced in unregulated environments can pose risks to customer health and safety, while detracting from brands’ public commitments to sustainability and Corporate Social Responsibility (CSR).

Increasingly, luxury brands have turned to the latest advances in blockchain, nanotechnology, and the internet of things (IoT), to authenticate their products, combat increasingly sophisticated counterfeiters and guarantee supply chain transparency. Yet these digital solutions can also pose unique risks for transparency, privacy, and cybersecurity.

Blockchain and the metaverse

Although the concept behind blockchains may appear inscrutable, the technology is as intrinsically straightforward as its name suggests.

A blockchain is a form of database or ledger that stores information in blocks, whereby the verified blocks are connected to one another in a chain. When new data is entered, it will have to be verified and then can be connected to the existing blocks in chronological order. Each block holds important encrypted information, such as a time stamp, the cryptographic transaction identifier (or “hash”) of the previous block in the chain, and the data of the transaction. After the information has been entered into the block, the technology ensures that this information stays in the block indefinitely and cannot be changed, deleted, or modified. Any attempt to alter information contained in the existing blocks can be easily detected. As a result, transparency and traceability are safeguarded, and anyone can verify the authenticity of the information.

Blockchain technology may be used in conjunction with QR codes, smart labels, near-field communication (NFC) tags, and/or radio frequency identification (RFID) tags. These devices facilitate the transmission of data from the code, label, or tag to a smartphone or reader device. Blockchains can also be generated for use with real-life physical products, like handbags or shoes. When placed onto these products, the devices act as a link between the physical item and the digital ledger which contains data, such as the product’s source and ownership history. When consumers scan the QR codes/tags with their smartphones or with NFC/RFID readers, the data is instantly revealed, providing them with access to relevant information that can assist in making purchasing decisions or verifying the product’s authenticity.

Blockchain technology also inspired innovations in value creation and transfer. Some of those innovations include cryptocurrencies, stablecoins, decentralised finance (DeFi) and NFTs. NFTs are verifiable, one-of-a-kind, and non-interchangeable digital assets. The unique identifiers provided by creating – or “minting” – NFTs allow potential buyers to digitally track and trace a physical or digital product’s ownership history and authenticity.

As luxury brands turn to digital strategies to protect brand value, NFTs have emerged as luxury goods themselves, generating millions of dollars in brand value.

According to a recent blue-sky analysis by Morgan Stanley, while NFTs in the form of luxury collectables account for less than 1% of all NFT transactions in 2021, the report estimates that luxury NFTs could become a $25 billion business by 2030, representing 10% of the luxury market.

Yet as NFTs become increasingly important for protecting (and generating) brand value, they also pose challenges on issues of authenticity, ownership, and Intellectual Property (IP) protection. For example, a proliferation of unauthorised NFTs – or incorporating a brand’s trademarks and/or trade dress – creates the risk for potential trademark dilution, particularly in the metaverse where digital iterations of luxury goods often outstrip the value of physical products, or could be used to promote counterfeit physical goods.

Additionally, NFTs provide purchasers with a digital certificate of ownership that can be bought and sold online, yet generally do not give the purchaser rights to the physical product, or any associated IP. This can lead to confusion among purchasers over the right to display, resell, or engage in commercial use of the NFT, resulting in unauthorised use and/or dissemination.

Finally, NFTs suffer from the same basic flaw as blockchain, in which “authenticity” depends on the integrity of the underlying information, and the transparency of supply chain participants.

Sustainability and transparency

The digital age and global pandemic have rendered it common practice for consumers to purchase fashion goods via online platforms, where they are unable to physically inspect products before payment. This has led brand owners to consider new identification methods that can handle the challenges presented by the sale of their goods through online marketplaces. Moreover, trust is considered one of the most important factors in consumer purchasing decisions, making transparency and sustainability two of the hottest topics in the fashion world. With an increasing number of reports in recent years of unethical labour practices, water pollution, overproduction and microplastics, the fashion industry has come under intense scrutiny.

While luxury brands must meet consumer demands for “fast fashion”, they must also commit to meeting specific ethical standards that are sustainable in the long-term. This poses a major challenge for the fashion industry.

The environmental and social footprint of a finished product can be immense. Often, fashion brands only have sight of those closest to them in the supply chain and even less control over how it operates. This is especially true for clothes production which is a hugely fragmented industry and often involves complex global supply chains. This means it can be difficult for luxury brands and retailers to monitor what materials end up in finished products and where and under what conditions the raw materials are sourced, and products made. To help overcome issues resulting from opaque and inefficient supply chains, fashion houses and retailers are turning to blockchain technologies.

For example, suppliers can use blockchain technology to store and share information regarding the source of the raw materials. This creates a permanent immutable record of all the materials used in production. Manufacturing information would usually be stored in an internal or analogue system, but by using the blockchain system, this manufacturing information can be easily accumulated and self-validated and – as the blockchain can be translated to a QR code or NFC and assigned to each product – it is accessible by anyone with a QR code or NFC reader. Simply by using a mobile phone to read the QR code or NFC, the complete history of the product can be traced, and consumers can understand the environmental and social impacts of the product.

In 2018, Danish designer Martine Jargland created the first product tracked by blockchain.. As a result of a partnership between A Transparent Company, Provenance and the London College of Fashion’s innovation agency, each step of the manufacturing process was tracked via blockchain through an app. This sparked the interest of other major fashion brands and retailers.

Benefits vs. challenges

Adopting blockchain can benefit luxury fashion brands and present many challenges. There are a variety of blockchain protocols and systems, each with their own rules and standards, vying for popular adoption in the fashion industry. Without standardisation or cooperation between key players, the fashion industry’s adoption of blockchain-based technologies can result in a plurality of incompatible, siloed systems with limited reach or benefit.

Fortunately, blockchain consortiums, such as the Aura Blockchain Consortium, and standard-setting organisations (SSOs) are addressing standardisation issues. However, in their quest for efficient standards, these consortiums and SSOs must share sensitive and confidential information between members/competitors, address standard-essential IP – and the licensing thereof – and tackle potential antitrust concerns.

There is also the cost of adopting blockchain to be considered. It is not cheap, and this makes it unfeasible for many smaller brands and retailers.

Then there is the issue of the perceived environmental impact of blockchain technology itself. Blockchain technology is coming under increasing scrutiny due to the generalisations made about the allegedly inherent energy intensive nature of the technology. This perception raises concerns about, and inhibits, the future uptake of blockchain. While this perception might be true for other types of application of blockchain technology such as cryptocurrency, blockchain technology is not the same across all applications. Consequently, it seems that the stigma attached to blockchain technology should be treated with caution and should not put off adoption in the fashion industry and reaping the benefits it provides.

Is blockchain the solution?

Blockchains can be used as a guarantee of authenticity and traceability and can be effectively integrated into the existing practices of fashion brands of various sizes. This technology can also be used by fashion brands to transparently demonstrate their supply chain to assure consumers of ethical and sustainable sourcing. While sophisticated tech solutions have shown tremendous promise in combating counterfeiting in the luxury space, brands should remain aware of the potential risks and legal pitfalls inherent in these solutions, and continue to deploy multi-pronged, real-world strategies to combat counterfeiting in the physical and digital world. These include implementing effective supply chain controls, maintaining strong IP protections, developing robust online monitoring programs, and collaborating with enforcement authorities to identify and prosecute counterfeiters.

The authors of this article are Duane Morris partner Cindy Yang (cyang@duanemorris.com) and associate Kelly Bonner (kabonner@duanemorris.com); senior associate Fiona Rogers (Fiona.rodgers@penningtonslaw.com) at Penningtons Manches Cooper; and
Tileke & Gibbins partner Michelle Ray-Jones (michelle.r@tilleke.com).

They are members of the global law firm network Multilaw - www.multilaw.com