The US Securities and Exchange Commission (SEC) recently labelled a non-fungible token (NFT) as a security, marking the first time this has happened. According to Preston Byrne, a columnist and partner of Brown Rudnick’s Digital Commerce Group, “Designing a basic protocol application and the act of hashing a proof-of-work genesis block is not, generally speaking, a regulated activity anywhere in the world. It is the stuff protocol engineers do afterwards such as creating incentives to use the chain and bring in new users (items five through seven on the above framework).”
The SEC’s recent case against Impact Theory, an L.A.-based entertainment company, is an example of how powerful cryptocurrency tech can be. The SEC summarised that Impact Theory sold NFTs, condensed those proceeds into a single wallet and used the funding to pay vendors and service providers. The SEC also noted that Impact Theory publicly stated that it would deliver ‘tremendous value’ to KeyNFT purchasers.
The Howey Test, which the SEC uses to determine whether something is an investment contract that can be regulated as a security, “embodies a flexible, rather than static, principle.” The test looks towards the substance of the transaction or sale or offering and not how it is labelled when determining whether something is or isn’t a security.
Byrne advises that “Just as an unstoppable blockchain app ignores the law, the unstoppable law ignores the blockchain. Labels and choice of data structures are part of the regulatory puzzle but are not dispositive. Substance is.”