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Are NFTs Securities? | Investor Junkie



Are NFTs Securities? | Investor Junkie

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In 2020, NFT trading volume was a mere $21.7 million. In 2021, it exploded to $40 billion.

Many NFT buyers are just interested in supporting their favorite indie artists. And others may simply be filling their digital art galleries or claiming bragging rights for “owning” famous memes and gifs.

But a significant portion of NFT buyers are bonafide investors who see NFTs as the next gold rush of the digital age. And considering that the secondary NFT market reached $15 billion last year, many of them are getting rich.

When investors start flipping assets for massive gains, it begs the question: Are these assets securities? Should they be regulated? If not, what missteps would put NFT investors square in the SEC’s crosshairs?

Let’s investigate whether NFTs should be considered securities.

The Short Version

  • NFTs aren’t securities because they don’t pass the Howey test.
  • However, there are some cases where NFTs are awfully close to acting like securities.
  • While the SEC doesn’t consider NFTs securities right now, that could change in the future.

What Are NFTs?

NFTs, or non-fungible tokens, are unique data strings that live on a blockchain.

To understand NFTs, we first have to understand where they’re generated and stored: the blockchain.

Blockchains are like giant online ledgers of data. They can be added to and read but never edited. Think of a giant stone wall in the town square where people can chisel on essential data  but never erase their neighbor’s.

The Bitcoin blockchain was generated in early 2009 and still operates today. But it can only be used to store financial data. With Ethereum, users can store all kinds of data on its blockchain. It allows the storage of non-fungibles, i.e. one-of-a-kind strings of code.

The implications of storing unique data to a secure, decentralized blockchain are endless — we can keep medical records there, legal data, and of course, ownership of art. 

When you buy an NFT on OpenSea, you’re not buying a .JPG or even the copyright to use a specific piece of art. You’re just buying a string of data on the blockchain that says: “Chris owns NETFLIX 2087 by Beeple.”

In summary, NFTs are “certificates of ownership” stored on the Ethereum blockchain that certify that one particular person or group “owns” a digital piece of art.

Find out more >>> What Is an NFT? 

What Are Securities?

A security is a financial asset that can be traded. Stocks, bonds, options, futures, and banknotes are common securities examples.

Notably, all securities are fungible, meaning interchangeable. Your ten shares of AAPL are just as good as my 10 shares of AAPL. Like quarters and dollar bills, nothing functionally differentiates one share of AAPL from the next.

There are four different types of securities: Equity, debt, hybrid, and derivatives. 

Equity securities represent a partial ownership interest in an entity like a business. If that sounds a lot like stock, that’s because it is. Shares of stock are the most commonly cited example of equity security.

Debt securities represent loans with pre-established terms on the size, renewal date, and, of course, the interest rate. The most common example of a debt security is a bond. Like most debt securities, bonds entitle their holders to regular principal payments, plus interest.

Hybrid securities contain elements and characteristics of multiple types of securities. An oft-cited example of a hybrid security is the convertible bond, debt securities that can convert into a predetermined number of shares.

Derivatives are a security whose price derives from the value of an underlying asset. For example, when you purchase oil futures on NYMEX, you’re not buying the oil; you’re buying the right to buy the oil at a specific price later (well, technically, the obligation). Since the oil futures contract was based on today’s oil price, that makes it a classic example of a derivative.

So, Are NFTs Securities?

To find out if NFTs are securities, let’s go down the list.

  1. NFTs don’t meet the criteria for debt securities. They share virtually no DNA with a bond and don’t represent a loan made to or by the artist.
  2. By that logic, NFTs don’t fit the bill for hybrid securities either.
  3. How about derivatives? NFTs are too simple to be derivatives. They may be complex in concept, but they’re pretty straightforward as an asset. They’re just art pieces and don’t represent any other underlying asset.

That leaves us with equity securities. It might seem strange to compare shares of NVIDIA to a digital artwork of a cat in a cowboy hat. But stocks and NFTs share a surprising amount in common:

  • They both represent ownership
  • External market forces drive their values
  • They’re both expected to experience capital appreciation (in some cases), and,
  • Both are perceived as good “investments” by certain players

But at the same time, NFT collectors have been able to stave off regulators by repeating a simple defense: “Hey, man, they’re just art.”

Amazingly, this defense works. Although NFTs straddle the line between product and security, the SEC disqualifies them as securities (for now) because they fail the Howey Test.

Do NFTs Pass The Howey Test?

According to the SEC, for an asset to qualify as a security, the sale of that asset must pass the Howey test.

The Howey test finds its origins in the 1946 Supreme Court case SEC v. W.J. Howey Co. Back in the ’40s, the Howey Company was selling tracts of citrus groves to Florida residents, getting access back via lease, and selling fruit grown on the property for profit — which it then shared with the landowners.

Clearly, this leaseback arrangement involved an investing contract. But Howey failed to register the transactions with the SEC. The SEC established the Howey test to help future businesses avoid this mistake.

According to the Howey test, a transaction qualifies as an “investment contract” (and thus the asset exchanged is qualified as a security) if it includes three factors:

  1. An investment of money
  2. A common enterprise (i.e. shared goals between investors and those selling the asset)
  3. Reasonable expectation of profits derived from the efforts of others

The SEC has used the Howey test to classify certain ICOs (initial coin offerings a.k.a. IPOs for cryptos) as investment contracts, thus qualifying the underlying crypto as regulatable security.

Why NFTs Aren’t Securities

NFTs manage to scoot by because they fail to meet condition number three of the Howey test.

You see, unlike the founders of certain scam cryptos that I won’t mention, the creators of NFTs generally don’t call their products “investments.” They mint them, tweet about them to generate buzz, and sell them as products.

After that point, some of their NFTs might rise in value due to limited supply and high demand. But as far as the creator is concerned, they’re simply selling products, not investments. There’s no written expectation between buyer and seller that the price of the NFT is going to soar.

That’s a critical distinction because outright labeling your digital asset “a good investment” is a surefire way to invite regulatory scrutiny and get classified as a security.

In summary, NFTs may share a lot in common with stocks, but they’re not securities because they’re not sold with the expectation of profits. Capital gains aren’t part of an NFTs initial value proposition to buyers.

Instead, NFTs are marketed purely as art and collectibles. They can’t be classified as securities simply because their value increases.

Should NFT Investors be Worried About Regulation?

For now, NFTs investors shouldn’t be worried…but they should be wary. NFTs are already walking a fine line, as the SEC has regulated other digital assets. Here are just a few of the places where NFTs could misstep and slip into the crevasse of regulation:

Secondary Sales/Profit Redistribution

When Zoë Roth auctioned off her Disaster Girl NFT for $473,000, she included a contract term stating that each time it sold again, she’d get a share of that sale, too.

Such stipulations are becoming more common among artists looking to generate passive income from their NFT sales — and they’re also attracting SEC attention, implying a common enterprise and expected profits down the road.

The Secondary Market

NFTs are able to skirt regulatory scrutiny because creators do not market them as investments.

But what about the investors who buy them? What happens when they market them as suitable investments to attract other investors and artificially inflate values?

Secondary NFT sales reached $15 billion in 2021, begging the question: How long until a specific subpopulation of buyers, the investors, become too loud for regulators to ignore?

Corporate Marketing

Folks sometimes forget that Bitcoin started just like NFTs: a cool, new technology that was never intended to become an investment.

And yet, once values rose, marketplaces emerged to facilitate trade–and many of these marketplaces didn’t hesitate to market their wares as “investments.”

Bitcoin has managed to avoid becoming a security because it has no central leadership or authority.

But NFTs have clear paper trails leading back to their creators. So, if you one day mint an NFT on a website that markets your creation as an investment, the SEC might come for you both!

Partial Ownership AKA Fractionalization

Historically speaking, when you’re able to purchase a fractional share of an asset, that’s a clear sign to the SEC that it’s an investment vehicle.

After all, the “it’s just art and I like it” defense falls apart pretty quickly when you buy 1/826th of a painting.

Case in point, the company Masterworks, which sells partial ownership in physical art, must register their transactions with the SEC.

With NFT prices skyrocketing, how long before creators and investors do a “stock split” to attract more buyers?

The Bottom Line

The SEC may not regulate NFTs as securities today. But if the investing community isn’t careful, I sense that may eventually change.

If and when the SEC starts regulating NFTs, I predict they’ll regulate all of them. They won’t cherry pick like they do with cryptos, since that would take too much work.

Do you think that the SEC should classify NFTs as securities and start taxing them? Let me know in the comments. I’m curious to hear your thoughts!

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Sushiswap developers propose to divert 100% of fees generated to Sushi’s multisig



Sushiswap developers propose to divert 100% of fees generated to Sushi’s multisig

  • Sushiswap developers have submitted a new governance proposal to the community.

  • The proposal seeks to divert 100% of fees generated on the platform to Sushi’s multisig.

  • The funds would be used for Sushi’s multisig for a year or until new tokenomics are implemented.

Sushiswap developers want to divert trading fees

Developers of the decentralised finance (DeFi) protocol, Sushiswap, have submitted a new proposal to the community. According to the proposal, 100% of the fees generated on the platform would be diverted to Sushi’s multisig for one year or until new tokenomics are implemented.

This latest cryptocurrency news comes as Sushiswap is currently facing a significant deficit in its treasury. The deficit threatens the protocol’s long-term operational viability. 

In his proposal, the Head Chef, Jared Gray, said;

“After reviewing expenditures, it’s clear that a significant deficit in the Treasury threatens Sushi’s operational viability, requiring an immediate remedy. In my original proposal, Sushi operated with an annual runway of 9M USD. However, after my detailed review, we reduced that requirement to 5M USD. We made the reduction possible by renegotiating infrastructure contracts, scaling back underperforming or superfluous dependencies, and instituting a budget freeze on non-critical personnel and infrastructure.”

Despite reducing the project’s annual runway requirement from $9 million to $5 million, the treasury still provides for only about 18 months of runway.

The developers are now proposing to set up Kanpai, a fee-diversion protocol. The proposal, if accepted, will lead to 100% of fees diverted to the Treasury multisig for one year or until the project’s new token distribution and reward schemes become active. 

Sushiswap’s fee-diversion solution is temporary

The developers pointed out that the proposal is a temporary solution to a long-term problem. The proposal was put in place because new tokenomics will take time to implement

The Head Chef said;

“Kanpai is a temporary solution to a long-term problem, and a new tokenomics proposal is on the horizon, which will help address the long-term value proposition of Sushi for stakeholders. Sushi must implement a holistic token model that allows the rebuilding of the Treasury and delivers value for all stakeholders while reducing the fiscal liability carried solely by the protocol.”

In addition to Kanpai, the Sushi team said it increased its funding by securing several multi-million dollar partner deals. 

However, the developers added that relying on business development deals is only part of a successful business model to secure Sushi’s future. In October, asset management firm GoldenTree invested $5.2 million in Sushiswap.

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Europe’s McGuinness pushes for global rules after FTX collapse



Europe's McGuinness pushes for global rules after FTX collapse

Mairead McGuinness, financial services commissioner for the European Union spoke to CNBC in Brussels.

Bloomberg | Bloomberg | Getty Images

BRUSSELS — Some market players are purposely avoiding regulation in the crypto space, the EU’s top regulator told CNBC as she called for a global approach to protect retail investors.

The European Union agreed in June on the Markets in Crypto-Assets (MiCA) regulation. This is meant to reduce risks for consumers buying crypto assets. In essence, the rules mean providers would become liable if they lose investors’ crypto-assets, but the regulation is only due to start 12 months from now.

“It will not come into effect for a year, but I think it’s already having an effect,” Mairead McGuinness, European commissioner for financial services, told CNBC Tuesday.

She said that firms in the crypto industry that want to be part of the regulated system — and therefore have the seal of approval from a regulatory authority — are “already acting in a way that our legislation is pointing.”

However, she added that some crypto players are choosing to, and are fundamentally against, stricter rules.

“Some of those who were involved in crypto, from the very outset, were doing it because they didn’t want to be part of the regulated, managed system. They want it to be separate from and in parallel to it. That’s a very dangerous path,” she said.

Recent crises in the crypto world have clearly exposed the risks for consumers. The recent collapse of FTX, an exchange once valued at more than $30 billion, and the crash of supposed “stablecoin” terraUSD both highlighted the risks associated with these assets.

U.S. interest

The European Union has been stepping up rules in this space and has pushed for a global approach. In meetings last month, McGuinness discussed crypto regulation with her U.S. counterparts.

“What I found in the U.S. is huge interest in what we were doing here, and the markets and crypto assets legislation. And I believe there will be developments there,” she said.

In the wake of the downfall of FTX, some U.S. policymakers urged the Treasury to do more to tackle the risks for investors. The U.S. Treasury was not immediately available for comment when contacted by CNBC.

In the U.K., officials are reportedly working on a new plan to regulate crypto as well.

“We have seen events, let me put it like that, in this crypto space. Which maybe is a wake-up call for those who thought that investments would only increase in value,” McGuinness said.

She added that crypto is like climate change, in that it needed a global approach.

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New crypto wallet designed by iPod creator Tony Fadell



New crypto wallet designed by iPod creator Tony Fadell

The creator of the iPod, Tony Fadell, designed a new hardware wallet for people to store their cryptocurrency.

The product, created by French crypto asset security firm Ledger, launched at the company’s annual Ledger Op3n event Tuesday. Its launch comes at a time when trust in centralized crypto platforms is fading as a result of the collapse of Sam Bankman-Fried’s FTX.

It’s called Ledger Stax and resembles a small smartphone or credit card reader. Measuring 85 millimeters long and 54 millimeters wide, it’s roughly the same size as a credit card. It is also about 45 grams, weighing less than an iPhone. Users can deposit or exchange a range of tokens, including bitcoin, ether, cardano, solana and nonfungible tokens, or NFTs.

The Ledger Stax sports a black-and-white E-ink display, similar to that of Amazon’s Kindle e-readers. It also includes magnets, so that multiple devices can be stacked on top of each other, like a pile of books or cash — hence the name Stax. Users can connect it to their laptop through a USB cable or their phone via Bluetooth.

“Many Ledger owners have multiple devices, some store their NFTs, some store different crypto, some have multiple because they have different clients that they store for,” Fadell told CNBC in an interview.

The display also has a spine that curves around the edge, “so you can see what’s on each one, just like an old CD or cassette tape or book,” he said.

The iPod for crypto?

Initially, Fadell turned down working with the Ledger team on Stax. “This was not something I wanted to do,” he said. “When they first approached me I’m like, ‘I don’t want to do it. No thank you.’ I was interested in crypto, I had crypto at the time but I’ve basically got a lot of other things to do.”

The Ledger Stax is the latest hardware crypto wallet from French startup Ledger. It’s roughly the same size as a credit card and sports an E-ink display.

What is DeFi, and could it upend finance as we know it?

Ian Rogers, Ledger’s chief experience officer and a former executive at Apple and LVMH, said he’s confident about the mass market potential.

“There’s no question about the need for security and there’s no question that we lead increasingly online lives,” he told CNBC. “Instagram, Nike, Starbucks, Amazon — many companies are finding real life use cases for digital assets. And so I think that we will grow with that.”

Not your keys, not your crypto

After the recent collapse of FTX into insolvency, crypto holders have sought alternative means of storing their digital assets. One is via cold storage, where a user’s private key — the code they need to access their account — is kept on a device that’s not connected to the internet.

Since these wallets are offline, they’re less susceptible to hacks or failures. Ledger says that, to date, none of its devices have been hacked.

Ledger has seen a boost in sales as a result of fears around the contagion from the FTX collapse. Last week, BlockFi, a crypto lender, entered bankruptcy after revealing Alameda Research, Bankman-Fried’s trading firm, defaulted on $680 million worth of loans from the company.

November “will be our all-time high biggest month ever,” Pascal Gauthier, Ledger’s CEO, told CNBC. “All the news that you’ve seen since the beginning of the year, from Celsius all the way to FTX, has really pushed a lot of users towards self custody.”

Ledger has sold more than 5 million devices to date.

However, a sharp downturn in digital asset prices could spell trouble for the company with retail investors becoming more wary. Only 21% of Americans feel comfortable investing in cryptocurrency, according to Bankrate’s September survey. That’s down from 35% in 2021.

The Ledger Stax will compete with a slew of consumer gadgets this holiday shopping season, including Apple’s new iPhone 14, at a time when budgets are being constrained by rising inflation.

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