Is the SEC Coming for Your NFT Project?
Web3 leaders, take note: The SEC's recent moves against NFT projects marks a significant pivot in how the U.S. regulates NFTs. Here’s what you need to know.
I've studied the regulatory orders so you don’t have to. Here's what you need to know.
Let's dive in👇
PS: Catch a list of top reads on NFT regulation at the bottom.
The Two Cases
Impact Theory 🖼️
Key SEC Claims:
Profit Expectation: Impact Theory promised NFT buyers “tremendous value,” insinuating profit.
Quote from the order: “If you’re paying 1.5 [ETH], you’re going to get some massive amount more than that. So no one is going to walk away saying, ‘Oh man, I don’t think I got value here.’”
“Its like investing 10k with a 300k upside, for a small risk.”
Business Funding: The firm used sale proceeds to finance operations.
Resale Royalties: It enabled NFT trading on secondary markets, collecting a 10% royalty.
Stoner Cats 🐱
Key SEC Claims:
Profit Expectation and Business Funding: Stoner Cats led buyers to expect rising NFT values if the related web series succeeded.
Unlimited Purchasing: No limit existed on how many NFTs one could buy, although one sufficed for project access.
Resale Royalties: It enabled trading of NFTs on secondary markets, earning royalty fees (2.5%), and therefore profiting of the value appreciation of its NFTs.
This was a key statement from Gurbir S. Grewal, Director of the SEC’s Division of Enforcement:
“Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security.”
Why This Matters
This is the first time the SEC has enforced NFT projects – a category of digital assets that has avoided the eye of the regulators up to now (at least in the US).
Reading through the case shows that this could potentially apply to a lot of other NFT projects too.
This pushes the entire NFT space into murky waters.
Unanswered questions include:
Are NFTs securities (and therefore subject to SEC regulations)?
Are NFTs collectibles or investments?
Should NFT issuers disclose more information on their projects and how they plan to use the proceeds from sales?
The SEC appears to be gearing up for more aggressive oversight, nearly doubling its staff overseeing crypto assets, including NFTs.
In October last year, Bored Ape and Crypto Punk IP holder Yuga Labs faced an SEC probe over unregistered offerings.
Not Everyone Agrees with the SEC
Prominent dissenters, such as SEC commissioners Peirce and Uyeda, argue that the SEC's actions are unjust and stifle creativity and innovation, comparing Stoner Cats NFTs to Star Wars collectibles sold in the 1970s.
Others say that while Impact Theory was an obvious example of dressing an NFT as an investment contract, Stoner Cats were clearly collectibles. Or that the SEC considered facts that aren’t relevant to securities law.
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Considerations for Brands
The SEC introduced a new layer of complexity and uncertainty for US-based NFT projects, on top of an already messy regulatory landscape.1
For now, potential red flags from the SEC’s perspective include:
NFTs sold through initial offerings (= paid mints) and/or come with revenue rights and/or promises of profitable returns
Pre-sales for undeveloped projects and/or use of sales or royalty revenues for business funding
Fractionalization – i.e. splitting an NFT into shares
Most importantly, brands should be careful with their messaging and the “economic reality” of the project to avoid any insinuation of profit.
If you're based outside the U.S., the SEC's actions may still matter to you as a global brand.
And before I forget: I'm not a legal expert, just an observer. Consult a professional for legal advice.
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Top Reads on NFT Regulation:
SEC Press Release, Impact Theory. Link
SEC Press Release, Stoner Cats. Link
Statement on Stoner Cats by Commissioners Peirce and Uyeda. Link
SEC Enforcements Against NFTs – Are You Next?, By James Gatto. Link
SEC charges Stoner Cats in latest move against NFTs, By Financial Times. Link
NFTs: US Policies and Priorities in 2023. By Daniel Castro. Link
NFT Regulatory Issues – a 2022 Review and 2023 Preview. By James Gatto. Link
All You Need to Know About Global NFT Financial Regulations. By DAppRadar. Link
The regulatory considerations of NFTs in the United States. By Cointelegraph. Link
Non-fungible token (NFT) – Swiss legal and regulatory considerations. By Reichlin Hess. Link
SEC Orders with key parts highlighted:
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This is partly due to the number of different regulators with potential oversight over NFTs in the US: the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), the Office of Foreign Assets Control (OFAC), as well as a number of other regulators.
Also, NFT regulation extends beyond securities law to include intellectual property, taxes, anti-money laundering, etc.