CoinDesk published an article by partner Preston Byrne about the U.S. Securities and Exchange Commission's (SEC) first non-fungible token (NFT) action.
In the Aug. 29 article, Byrne argued that developers of new digital asset products needed to be mindful that regulatory regimes are more interested in the economic substance of cryptocurrency products than the specific data structures used by them.
"I cannot recall something that was labeled as a non-fungible token being treated as a security by U.S. regulators previously," he wrote. "According to the U.S. Securities and Exchange Commission, this case is the first. With that in mind, it's important to revisit first principles on selling crypto-critters in the United States. One thing which I see a lot of, all the time, is when developers start out with something that is unregulated and gradually mission-creep their way into something regulated."
On Aug. 28, the SEC settled enforcement charges against a Los Angeles-based media and entertainment company Impact Theory for conducting an unregistered offering of NFTs. Impact Theory raised approximately $30 million from hundreds of investors through the offering.
The SEC order found that Impact Theory encouraged potential investors to view the purchase of its NFT as an investment into the business, stating that investors would profit from their purchases if Impact Theory was successful in its efforts.
Without admitting or denying the SEC's findings, Impact Theory agreed to a cease-and-desist order finding that it violated registration provisions of the Securities Act of 1933 and ordering it to pay a combined total of more than $6.1 million in disgorgement, prejudgment interest, and a civil penalty.
"Designing a basic protocol application and the act of hashing a proof-of-work genesis block is not, generally speaking, a regulated activity anywhere in the world." Byrne wrote. "It is the stuff protocol engineers do afterwards such as creating incentives to use the chain and bring in new users (items five through seven on the above framework)."
It bears reminding, he wrote, that the Howey Test, the gauge the SEC uses to determine whether something is an investment contract that can be regulated as a security, "embodies a flexible, rather than static, principle."
The test is designed to look towards the substance of the transaction or sale or offering and not how it is labeled when determining whether something is or isn't a security.
"The NFT space, which is relatively new, is no different," Byrne wrote. "If a non-fungible token is sold in exchange for an investment of money in a common enterprise, with an expectation of profit arising from the efforts of a promoter or a third party, it is just as liable to be a security as a fungible token sold in the same manner and with the same expectations."
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