Early signs of NFTs REGULATION? A recent SEC petition seeks to use a 1930 law to recognize NFTs as securities, therefore classifying platforms as exchanges/brokers by the SEC.
Although cryptocurrencies are still mostly unregulated, the NFT market may feel the SEC’s hands way quicker, as a great market boom is still ahead of us – will the regulators try to put their claws in before it happens? Or perhaps install order to an overly-wild market?
New SEC petition for NFT regulation was revealed in an interview with Brock Pierce.
A recent petition to the Security & Exchange Commission (SEC) asked for some clarification around Non-Fungible Tokens (NFTs), hoping to resolve any uncertainty the might hinder the juggernaut bullet train of NFT projects, art, collectibles, media, gaming, and so on barreling toward a bright future with a new form of digital ownership.
The petition notes a securities law from the 1930s that could possibly “provide a crude mechanism for the regulation of NFTs.” The petition then refers to the SEC’s Howey guidance to address the issue of whether NFTs should be considered securities — which would cause all platforms selling and trading NFTs to be classified as exchanges or broker-dealers by the SEC.
The petition suggests a compromise, suggesting that NFTs that relate to an existing asset “…should not be deemed a security.”
That compromise would still bring some rain to the NFT parade. It would make platforms that include tokenization like Bitclout effectively unlicensed dealers of unregulated securities. It could also impact fractional ownership of real-world assets, such as ARTCEL’s recent share-based sale of a blue-chip art portfolio which includes Banksy & Nina Chanel and will be exhibited in the HOFA gallery.
The hype around NFTs has brought them mainstream awareness that rivals the mighty Bitcoin. Now we wait for the new SEC Chairman Gary Gensler, who is reputed to have a considerable understanding of blockchain and digital assets, to consider this request for regulatory clarification.
Ex-Presidential candidate, entrepreneur, and star investor and promoter, Brock Pierce has an unparalleled track record in the crypto world, having raised more than $5 billion for the companies he has founded. He is currently Chairman of the Bitcoin Foundation and co-founder of EOS Alliance, Block.one, Blockchain Capital, Tether, and Mastercoin (the first ICO).
Pierce took some time to share his thoughts on NFT regulation in an exclusive interview with Benzinga. From his perspective of experience around new and emerging digital technologies, he thinks regulation is both inevitable and desirable.
“Any of the actions from the SEC to regulate the NFT Space are an important part of the overall development of the space. Moves that the SEC takes serve to validate all the growth and innovation that is happening around NFTs. The hope is always that they regulate lightly and try to be open-minded and learn from the technologists and entrepreneurs in the space — the hope is that they don’t just come in and shut everything down,” Pierce said.
When asked if new SEC policies on NFTs could create a “regulatory brick wall” for projects, Pierce felt that a lack of regulation — and the uncertainty around it — is a greater barrier.
“I think that worries about regulation and uncertainty do more to stifle innovation and discourage risk-taking. The innovators will always find ways to work with the regulations, and work around regulations until the new regulations are created,” Pierce said.
Although fractional ownership seems a likely target for SEC regulation, Pierce believes the impact will ultimately be positive.
“It was a threat in the sense that we do not know yet what is, or should be allowed, in fractional ownership of NFTs. So, some guidance from regulatory bodies could be extremely helpful in showing us how the market should develop,” Pierce said. “I do think that the ideas around fractional ownership are leading us towards novel ways that people can own collectively and collectively buy things. I think that’s an important development in every sector, not just in NFTs.”
Pierce thinks that the SEC will provide guidance as much as possible, but with a realistic eye on their ability to enforce the new regulations. So, whatever guidelines are passed are likely to impact the big platforms, not the small NFT creators.
“The regulators usually target what they can go after. So, the same way that regulators will go after centralized exchanges, and force them to adhere to certain regulations, the regulators are most likely to go after centralized platforms that have companies and funding behind them,” Pierce said. “Will the SEC force artists to register with the SEC? I don’t know how they would go about implementation.”
Regulation Driving Growth in NFTs?
As Louis Pasteur once said, “Fortune favors the prepared mind.” Speaking to the projects and legal leaders in the crypto space, the tone is both cautious and optimistic as they prepare for the inevitable regulatory shifts.
Dan Wasyluk, CEO of Blockchain Foundry and Syscoin Co-founder said that they have anticipated changes in regulation and developed in preparation, having recently launched Syscoin 4.2 LUX, an upgrade billed as “the next generation of blockchain tech for NFTs”.
“We know that regulators are currently looking at the NFT space and working on developing guidelines for the various use cases and forms (fractional and non-fractional) that NFTs can take. We believe it’s not a matter of if they will regulate NFTs, it’s just a matter of when. Blockchain Foundry has worked to develop NFT technology that will be able to comply with the evolving regulatory landscape these tokens operate within,” Wasyluk said.
Paige Mason, Managing Director at Guidepost Solutions, a global security, compliance, and investigations firm, and former contractor attorney in the Asset Forfeiture Money Laundering Section at the U.S. Department of Justice, provided some perspective on the regulatory precedent for NFTs.
“We aren’t operating in a complete vacuum with respect to potential regulatory implications because we do have the SEC’s Framework for Investment Contract Analysis of Digital Assets and the knowledge from the SEC’s historical enforcement approach to Initial Coin Offerings,” Mason said. “Not all NFTs are likely to be implicated in the current discussion around securities if there is no fractionalization taking place… I still think it’s too soon to tell whether the SEC’s regulation of NFTs used for fractional ownership will act as a brick wall… but I do think we will see more of a public push from the market to get specific guidance from the SEC instead of just enforcement actions.”
Robert Elwood, Co-Founder & Partner at Practus LLP, a tech-forward law firm, thinks that the SEC is likely to take a nuanced approach — regulating some NFTs as securities, but not necessarily all NFTs.
“The key question appears to be whether a particular NFT’s economic substance meets the definition of an “investment contract”. For example, if a particular NFT is primarily a means to document a unique piece of digital art, sports or media collectible, or something similar, effectively serving as a means of establishing provenance using a blockchain, that type of NFT is unlikely to be a security. On the other hand, an NFT that is intended to represent fractional ownership in an economic enterprise such as a company, then it would seem that such an NFT might well be regulated by the SEC,” Elwood said.
Overall, respondents viewed regulations as being potentially disruptive but ultimately positive for the future of NFTs.
“While many in the crypto space see regulations as detrimental, we view it as exactly the opposite. Regulations must strike a balance between enabling businesses and protecting consumers. Blockchains that have developed solutions for evolving in parallel with the regulatory landscape without forcing users to pay higher transaction fees will ultimately come out on top,” Wasyluk said.
Elwood believes that ultimately regulation will help open the way for institutional investors and greater growth in NFTs, but warns the transition could be complicated.
“It is important to note that an NFT that is treated as registered security will be subject to limitations on marketing and transfer, including things like hard forks. Certain parties would need to be registered as broker-dealers. In addition, there are a host of tax issues that would depend on an NFT’s status as a security, such as whether mutual funds holding them would pass certain income and assets tests,” Elwood said.
Frank Borger Gilligan, a securities attorney with Dickinson Wright, and the former top securities regulator for the State of Tennessee believes that new regulations will create greater clarity which will be positive for investors.
“I think what people want to see is clarity and certain assurances from the SEC. In my opinion, uncertainty as to whether or not something is a security and whether or not the SEC will seek enforcement action creates more of a barrier for projects. Some, but certainly not all, NFTs may be securities… SEC Commissioner Hester Peirce has already warned that fractionalized interests in NFTs could be considered securities. It’s important for everyone to know where the boundaries are and how to address them properly to assure regulatory compliance,” Gilligan said.
Gilligan speculated that it is possible that new regulations could cool the enthusiasm of some NFT projects, but he welcomes the change.
“In my opinion, more regulatory clarity will facilitate more long-term interest in and legitimacy of NFTs. In many ways, we can draw a comparison to ICOs – i.e., there were initially a lot of bad actors and celebrities who were unwittingly (maybe some wittingly) endorsing or promoting the sale of unregistered securities. With more regulation and clarity, the “frenzy” surrounding ICOs diminished, but that’s not a bad thing,” Gilligan said.
In mid-March, the digital artist Beeple caught the attention of the world by selling a single work of art as an NFT for over $69 million dollars. Since then, there have been nearly two months of unadulterated enthusiasm regarding NFTs.
It is wise to check the collective enthusiasm with a dose of regulatory reality — and although some crypto purists may balk at regulation on its face, ultimately this is a part of the maturation of NFTs as viable assets.
NFTs have provided a new form of individual and collective ownership which has helped capture the imagination of the public. All that attention is likely to put additional pressure on the need for regulation and that will inevitably lead to some disruptions to unprepared projects dealing in fractional sales and tokenization, but to the rest of the NFT-creating and NFT-buying world this is all just a necessary step in the mainstreaming process.