Any digital asset, including non-fungible tokens (NFTs), can be classified by securities regulators as a “security.” But this begs the question of whether or not a prospective buyer is potentially subjecting themselves to a country’s securities law simply by buying and selling NFTs.
The industry-wide expansion into the metaverse has opened the doors to associating and integrating digital assets into new virtual worlds, making it even more likely that these assets will eventually become commercialized and potentially subject to these securities laws.
So, what do countries around the world have to say about NFT transactions and their characterization as a “registered” security?
Given the ongoing education NFTs are currently bringing to both the fintech and legal landscapes, the answer isn’t entirely clear yet on where regulators across the world officially stand — but some, including the U.S., U.K, Hong Kong, and China, are already exploring the question.
The United States and NFT securities
Remember, the U.S. follows the landmark 1946 U.S. Supreme Court case of Howey, which sets forth four four elements that help determine whether or not a cryptocurrency or digital asset such as an NFT is considered a “security” or “investment contract” — they are: (1) investment of money, (2) into a common enterprise, (3) where there is an expectation of profits, and (4) profits received from efforts of third parties.
While the regulation of digital assets is primarily housed under federal law with the U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), each state has its own securities law, which may have different or additional requirements to that of federal law.
In April, securities regulators in the states of Texas and Alabama issued cease and desist orders to Cyprus-based virtual casino developer, Sand Vegas Casino Club, to stop selling NFTs, alleging it was illegally offering unregistered securities.
By and through its Gambler Ape NFTs — a virtual gambling character — Sand Vegas promoted to buyers that purchasing an NFT would provide certain benefits, including a share of any profits generated by the casinos Sand Vegas created.
According to Sand Vegas, the proceeds generated from its NFT sales were to be used to create virtual casinos throughout the metaverse. However, regulators in both states found several “forgotten” steps that the online casino developer failed to take in efforts of marketing its NFTs to consumers and prospective investors, including:
- Failing to disclose the actual address of Sand Vegas;
- Failing to disclose all of Sand Vegas’ business partners and officers, in addition to their backgrounds and qualifications for due diligence;
- Using a logo that closely resembled an established trademark belonging to another Las Vegas-based gaming company, which creates a high likelihood of consumer confusion;
- Failing to disclose that company principals would be entitled to receive a 10% royalty on the sales of all NFTs listed on OpenSea;
- Failing to state the associated risks with operating a casino; and
- Failing to state the associated risks when buying, selling, and/or trading NFTs
Later that month, OpenSea delisted Sands Vegas from its marketplace in response to the cease and desist orders.
The industry is currently working through pending bipartisan legislation introduced back in June by U.S. Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) that would better clarify the roles the SEC and CFTC play in the overall regulation of digital assets, including cryptocurrencies and NFTs.
NFTs in the United Kingdom
In May, the British Web3 community achieved a crucial legal milestone after its High Court of Justice ruled that NFTs represent “private property” in the United Kingdom.
Giving rise to the Court’s decision was the February theft of two NFTs stolen from the highly-acclaimed Boss Beauties project — a female-led global initiative that creates opportunities for girls and women through cutting-edge collaborations.
In March, Women in Blockchain Talks Founder Lavinia Osbourne alleged that two Boss Beauties NFTs were stolen from her online wallet.
However, the High Court cautioned that this “private property” status does not extend to the actual underlying content that the NFT represents, providing the necessary protections for the underlying work of the original authors.
While this was a major step forward in the further development of how NFTs are treated in the U.K., the major takeaway is how courts in the U.K. can issue injunctions against individual accounts on NFT marketplaces like Ozone Networks and OpenSea, in instances where NFTs are alleged to have been stolen, resulting in the freezing of an account’s assets until more information is collected.
However, since the U.K. and the U.S. govern with the same copyright laws, there’s no overwhelming “big picture” take on distinguishing how the U.S. and the U.K. views of original works of authorship under copyright law differ.
On Sunday, June 10, Hong Kong lawmakers introduced new legislation that seeks to introduce a new licensing regime for crypto service providers as it relates to the region’s anti-money laundering (AML) policies.
The proposed legislation will require entities working with crypto projects that want to launch a trading platform to obtain a license from the Hong Kong Securities and Futures Commission (SFC), among other stipulations.
In June, the SFC issued its first round of guidance on how investors should approach the purchase and sale of NFTs, speaking to the heightened risks they bring through illiquid secondary markets, volatility, opaque pricing, hacking, and fraud.
The news release stated that any NFT issuers in Hong Kong or those targeting potential investors must obtain a license from the SFC if their NFT is a “collective investment scheme” (CIS) or a fractionalized token.
It further clarifies what a “CIS” is, breaking it down into four elements, which include “projects that enable participants to receive profits, income, or other returns,” further clarifying that NFTs that do not fall under those categories will not be regulated.
In April, China laid out its stance on NFTs, wherein its Banking, Securities, and Internet Finance associations issued a set of guidelines for how NFT projects will be treated by China’s Internet Financial Association, the China Banking Association, and the China Securities Association.
The guidelines specifically state that:
- The underlying assets of NFTs should not include bonds, insurance, securities, precious metals, or other financial assets.
- Platforms should not provide centralized exchanges for NFTs.
- NFTs should not be transacted in cryptocurrencies.
- Platforms should impose real-name identity checks on and store transaction records of customers to eliminate money laundering.
- Entities should not directly or indirectly provide financial support to NFT investments.
Despite China’s stringent crackdown on cryptocurrency, it has recognized the value NFTs bring to the space, distinguishing market hype and potential for fraud from actual value added.
The bottom line on global NFT policies
The current landscape shows that regulators domestic and abroad will continue to examine NFTs based on the specific qualities and characteristics they are marketed under, and are prepared to apply existing securities law and policies to every project that starts to gain traction.
Andrew Rossow is an attorney and journalist who focuses on fintech and intellectual property law.
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