With the massive explosion in interest in the use of non-fungible tokens (“NFTs”), purveyors are always looking for new avenues and areas to utilize NFTs. NFTs are being integrated into many different facets of commerce. Nonetheless, it is important to consider several regulatory issues before “jumping into the deep end” with an NFT offering.
Initially, NFTs’ typically represent an underlying digital asset, including, but not limited to, digital art, videos, characters, items, or even a plot of virtual land. Certain “rights” to these digital assets are granted to a third party when a NFT is acquired. The basket of rights acquired by the NFT holder varies, rather than when a singular piece of acquired property is made. The NFT issuer provides the scope of the acquired rights, and then that is designed and transferred or sold. The basket of rights may not include all the appropriate rights necessary to provide the NFT holder with the ability to use the intellectual property or other certain economic rights.
As a result, it is imperative for NFT sponsors to: (i) consider the NFT rights to grant; and (ii) what rights those are. Similarly, the NFT issuer must be concerned about their own intellectual property as well as any licensing. NFTs must integrate intellectual property rights with licenses, and determine if there is an ability to pass said rights to third parties. For example, the NFT issuer should consider: (a) the NFT rights granted to acquirers; (b) NFT restrictive uses; (c) penalties; and (d) liability protections. Such an assessment will definitively set the basis for the NFT.
Additionally, the offering and sale of NFTs may also implicate federal, state, and foreign securities laws. These laws may apply to NFTs, blockchain technologies, cryptocurrencies, and tokens. Since NFTs may be customized, the approach may implicate applicable state and federal securities regulations. In the United States, certain NFTs have been found to be “investment contracts,” and deemed to be “securities” by the various securities regulators. In particular, the United States Securities and Exchange Commission has used the four-part test first developed in the United States Supreme Court’s landmark decision in SEC v. Howey, as a basis for determining if the NFT is an “investment contract.” To be considered an investment contract, the NFT must involve: (1) an investment of money in a (2) common enterprise with (3) an expectation of profit (4) primarily derived from the effort of others. The Howey test is fact dependent, and depends upon the manner of distribution and marketing of tokens, actions taken by the creator of the NFTs, and expectations of the NFT purchasers. Thus, economic rights, including, but not limited to, revenue sharing or entitlements to future tokens or other expectations for appreciation of value may rise to a security. Additionally, NFTs may also be subject to commodities or money transmissions laws.
Further, there are also tax issues relating to the initial creation, sale, re-sale, and NFT exchanges for other NFTs, among other things.
In short, issuers should seek out seasoned securities counsel before the NFT creation to address these issues.