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Let’s dive in. Are NFT’s Securities?
The Howey test determines if an underlying asset is a security; NFTs would have to be determined on a case by case basis. With no legal precedent set for digital assets and very little insight given from the U.S. government on their plans for regulations, it’s currently impossible to definitively say.
With all the recent controversy surrounding crypto currency and regulation, it begs the question: are NFTs a security? With the digital asset market cap exceeding US$ 3 trillion dollars, investors have been passionate in encouraging or rejecting regulation.
If digital assets such as crypto currency or NFTs are considered securities, this will by definition mean they’re subject to regulation in the United States by the SEC (and related regulatory bodies in other nations). Since a key principle of crypto currency is that it’s decentralized (meaning there’s no central entity controlling it) many investors are heavily against regulation. Investors commonly argue regulation would defeat the purpose of decentralization in itself.
First, let’s start with what an NFT is. NFTs are non fungible tokens backed by and verified on the blockchain. This gives the owner of the NFT complete ownership of their token. This emerging technology is fascinating with many compelling use cases. Our professional research team dives more in depth about what an NFT is, which you can find here.
Next, let’s discuss what is a “security.” Simply put, a security in the world of finance is a tradable financial asset. In traditional finance, common securities include equities, bonds, ETFs and other financial instruments such as derivatives.
In order to be considered a security, the underlying asset must pass the “Howey Test”. This assessment tool is used to decide if an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.” The Howey Test tests for four elements to determine if it’s a security or not.
The first test: is there an investment of money? The second test: is there a common enterprise? The third test: is there an expectation of profit? Lastly, it tests if it is through the efforts of the promoter, or is there profits from a third party.
You can find a basic template for conducting the Howey test below.
Securities are regulated by the Securities and Exchange Commission, commonly referred to as the SEC. The SEC exists to protect investors through regulating securities and financial markets. This theoretically allows fair and efficient markets to come together, enabling investors to proceed with confidence given that the US government is involved in enforcing consequences for fraud or other financial crimes. Prior to the creation of the SEC, financial crimes such as insider trading were unfortunately not regulated. There was also no public auditing, resulting in accounting fraud being far more common than today.
So, are NFT’s considered securities? The answer is remarkably unclear due to a multitude of factors.
Why Are NFTs Not Securities?
In order to be considered a security, the underlying asset must pass the “Howey Test”. However, it is unclear if NFTs are considered a security or not. The answer is: maybe.
Securities entail regulation from the SEC, to which many digital asset investors are opposed. There is currently no legal precedent set for digital assets in the USA; there is also very little insight provided by the U.S. government on their plans for regulations making it impossible to say at this moment.
An NFT is simply non fungible tokens backed by and verified on the blockchain. The use cases are endless, and as a result many NFTs would – and of course some wouldn’t – pass the Howey Test.
Some NFTs are art from a photographer, while others provide utility and function as a ticket to exclusive events. Other NFTs are passive income vehicles, viable investments or even ponzi schemes. Due to the array of what an NFT project can be, there is an interpretation that suggests it would have to be regulated on a case-by-case basis.
Another common interpretation is that the very fact the US government has not taken action to date is cause enough to suggest the SEC and other regulatory bodies see NFTs as outside their purview. As noted earlier, this is a multi-trillion dollar market, and historically, the government has acted swiftly when it perceives abuses in emerging marketplaces. Proponents of this view point out that NFTs which – for example – function as a transferable ticket to an event and a lifelong memento are not materially different from today’s QR code-based digital tickets, which can be transferred and resold without SEC intervention.
Why Does It Matter If NFTs Are Deemed To Be A Security?
Since the SEC is yet to offer public guidance as to if an NFT is a security, influencers are currently being sued for their misleading financial claims. Were NFTs deemed to be a security, the SEC would undoubtedly intervene; NFTs would also be held under the same advertising and promotion laws as stocks.
Many in the public trust the financial guidance offered by influencers, incorrectly perceiving them to be reliable and vetted by relevant government agencies.
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