NFTs are securities and that’s great
Everyone in the non-fungible token (NFT) market is terrified that the US Securities and Exchange Commission (SEC) will decide that NFTs are securities and regulate them. They should get over it. Of course, NFTs are securities. That’s what makes them so powerful and promising.
Instead of avoiding SEC regulation, the NFT industry should embrace this categorization. That is inevitable and desirable, especially because once the SEC understands how the NFT market works, it will likely be regulated with a light touch.
I hope that got your attention. Let me explain by analogy.
Brian Frye is a law professor at the University of Kentucky and a conceptual artist who works with NFTs. This article is part of Crypto 2023.
The art market has always been a securities market, we just couldn’t see it, because objects got in the way. The art market is the market for “art as investment”. Most people think that when you buy a piece of art, you are buying an object. Error. You are really buying an entry in an artist’s catalog raisonné, the list of all the works of art attributed to that artist by the art market.
This ledger entry is usually accompanied by a physical token, usually a dirty canvas or bulky lock. It does not matter what is represented, because only the general ledger entry has valuables. You can tell this is true because if the connection between the ledger entry and the object is broken, the object is worthless, even if it hasn’t physically changed. In other words, the object only enables the sale of the ledger entry, like a bearer bond.
The NFT market works in exactly the same way, it just eliminates the object and allows collectors to trade ledger entries directly, rather than by proxy. That’s great, of course, because it’s much cheaper and more efficient than trading fragile, expensive items. It used to be that collectors exchanged receipts for paintings stored in a Swiss art estate. Now they can trade NFTs instead, what a relief.
But eliminating the art object forces us to contend with the nature of both NFT and the art market. I refer to NFTs as “uncanny” tokens, because as Freud observed, they represent the return of the repressed, as the known becomes unknown. Why are so many NFTs and the NFT market experiencing unease? Because they take the art and the art market, which everyone thought they understood and make it look weird. Why would collectors spend $1 million on a digital receipt? The same reason they spend $1 million on a dirty canvas: they hope to sell it for more.
See also: The art world underestimates the power of NFTs
So, what are you actually buying when you buy a piece of art or an NFT? A fractional interest in the commercial goodwill associated with an artist, or rather, a share of the artist’s “influence”. If the artist becomes an art star, their influence will increase and you will be able to sell your artwork or NFT at a profit. But if their star fades, your artwork or NFT is worthless, just like any other failed investment.
We live in a shock economy
Is an investment in artwork or NFTs a security? Of course. The Supreme Court’s well-known Howey test states that an investment is a security the SEC can regulate if it is an investment of money in a joint venture with the expectation of profit based on the efforts of others. Every investment in artwork or NFTs is an investment in an artist’s career, with the expectation (or at least hope) of profit, by virtue of the artist becoming famous. It couldn’t be more obvious that art and NFT collectors are buying a security interest in an artist’s career.
Light touch
OK, so can the SEC regulate the art market and the NFT market? Of course it can. But it won’t, or at least probably won’t, regulate the asset class very heavily. Everyone says the key question is whether an investment “is” a value. But that’s stupid. The Howey test is hopelessly expansive – anything can be a certainty if you squint a bit. The real question—the important question—is whether the SEC wants to regulate an investment.
The SEC does not want to regulate the art market, and I suspect that the SEC will soon find that it does not want to regulate the NFT market either.
Why come? Well, because the SEC is in the business of regulating things it thinks “look like” securities. Historically, the SEC regulated the kinds of things it had always regulated (like stocks and bonds) and has avoided regulating new things itself (if they would fit the definition of a security). This is especially true when these things that would be new to the SEC have been around for a long time, like the art market.
Of course, the SEC has been making noises about regulating NFTs. I suspect that it will soon regret most of what it has said and begin to back down, because the agency does not have much to offer the NFT market. And if it starts regulating the NFT market, it will be hard to explain why it doesn’t regulate the art market as well.
My best guess is that the SEC will leave well enough alone, regulate a few tokens that are most similar to stocks, and then back off.
See also: The Different Types of NFTs: A Simple Guide
But wait. That’s where it gets cool. Because if the NFT market is really a securities market with influence, the potential is enormous. We live in an influence economy, where people value nothing more than fame. Celebrities are the vehicle through which people understand their own lives and the world around them. They generate enormous amounts of social capital by making the world meaningful to consumers.
And yet celebrities can only capture a tiny fraction of the social value they generate. Kim Kardashian may be a billionaire, but she’s leaving many more billions on the table in social value she can’t claim.
NFTs can change all that by enabling celebrities to secure their fame. What if Kim Kardashian could sell NFTs that effectively represent a fractional interest in her influence? People who think she will become even more famous in the future can speculate on how famous she will be, and people who think she is a flash in the pan can shorten her impact.
The bottom line is that it would give celebrities—even writers—access to the capital markets they’ve never had before. It could transform the market for knowledge goods by enabling authors to sell investments in their project, rather than expensive copies.
We live in a world of digital abundance, yet unrealized. Maybe NFTs can help us get to the promised land.
