Monday, May 17, 2021

Minting Golden Tickets: What Ancient Wisdom Tells Us about Selling NFTs

By now, even if you don’t know how an NFT works, you probably at least know what an NFT is. “NFT” stands for “non-fungible token.” NFTs are NBA video highlights, MLB trading cards, cats, Garbage Pail Kids, and — yes, you guessed it — NFTs are possibly even “securities” as defined under the Securities Act of 1933. (Bear with me.)

Under the hood, NFTs are cryptographically encrypted digital assets that are “minted” and publicly identifiable on a blockchain network. In its simplest form, each NFT grants a non-exclusive license to use or display digital content for non-commercial purposes. An NFT can generate huge revenues. Amidst the recent crypto-craze, for example, NBA Top Shot has amassed nearly $570 million all-time sales (according to CryptoSlam).

Because almost every celebrity and public figure is developing NFTs, the market is becoming more competitive. NFT developers are manufacturing new and creative ways to make NFTs more appealing — something beyond a hanging on a digital wall. The goal is to transcend NFTs from the digital world and create real world utility and purpose.

For example, in March 2021, rock band Kings of Leon released their latest album, When You See Yourself, as part of an NFT offering called “NFT Yourself.” Each NFT grants typical licenses to various exclusive versions of the album as well as digital artwork. But a small handful of NFTs contain something more: a golden ticket. Lifetime access to front-row seats at any Kings of Leon concert in the world! 

Now, had this been an NFT of the 2008 Kings of Leon album, Only by the Night (of “Use Somebody and “Sex on Fire” acclaim), this NFT might have gone platinum. Be that as it may, the 2021 album generated just $2 million in NFT sales. By comparison, NBA Top Shot averages around $2 million per day in NFT sales. 


The Kings of Leon golden ticket NFT won’t even go down in history as the second best golden ticket idea, let alone the first best golden ticket idea. Yet, it nevertheless validates the transcendence of NFTs, and is cause for excitement.

Maybe now you are intrigued. Perhaps you are thinking of ways you can use NFTs in your business to generate some extra revenue and ride the wave to see where it takes you. You might even be thinking of some perks you can package in your NFT that would really entice people to buy. Be careful.

Despite the novelty of NFTs, the regulatory framework that dissects NFTs is not so novel. To the IRS, the FTC, and the SEC, NFTs are not unlike other digital assets like Bitcoin and other cryptocurrencies, which somehow fit into ancient wisdom bestowed unto such regulators at various times in the early 1900s. NFTs are and will continue to be, at least for the time being, viewed through a similar lens.

Whether or not you are an entrepreneur and reading this, if you are interested in NFTs, you should at least be curious about how each regulator is likely to treat NFTs. If you are a business owner, you should be uniquely concerned with how the SEC is likely to treat the NFTs you mint. For the SEC, NFTs are viewed through the lens of the “Howey test.” (If “Howey” sounds familiar to you, you either went to law school or you followed the SEC’s obliteration of initial coin offerings (ICOs) a few years ago.)

The Securities Act defines “security” as what you would think to be a security: stocks, bonds, and options. But there is under the definition a catch-all that lives, breathes, and rears its ugly head every so often. The “investment contract.” The U.S. Supreme Court in the 1946 case SEC v. W.J. Howey, informed that an investment contract exists if there is an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.

So, your NFT is an “investment contract,” who cares? The Securities Act imposes certain registration and disclosure requirements on any offering of securities, including investment contracts. If your NFT is an investment contract, any sale of your NFT must be registered with the SEC or be exempt from registration. Otherwise, you will be subject to hefty fines and, in some cases, criminal penalties. A critical point: your ignorance to these laws and your lack of intent to offer a security do not matter to the SEC.

Though some within the SEC itself — for example, Commissioner Hester Peirce (aka “Crypto Mom”) — find the application of the Howey test to digital assets to be “complicated,” the SEC’s track record at least gives insight on the issues you should consider and the characteristics of NFTs you should be wary of when minting and selling NFTs. Seller beware of:

  1. Promising investment returns, appreciation of value, or liquidity of an NFT or the underlying asset of an NFT
  2. Selling equity interests, profit rights, royalty interests, or dividend rights to the underlying asset of an NFT (for example, your company or a product of your company)
  3. Providing continued services to drive the value of an NFT, including creating or influencing a secondary market for the NFT
  4. Selling fractional interests to a single NFT
  5. Hiring promoters and other sponsors, especially Floyd Mayweather or DJ Khaled, to drive the value of an NFT

Essentially, if you currently do, have done, or desire to do any of the above, contact a lawyer to discuss whether the SEC’s regulations apply and, if so, whether an exemption may be available. NFTs are new and exciting. Everyone is rushing to sell the first “_____” NFT (fill in the blank: housemoviewine allocationPicasso etc.). What are some ways you can use NFTs in your business? Will you be the first to offer a particular NFT of that kind?

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