Unfortunately there is no clear answer to this question at this time due to a lack of regulatory guidance and no such guidance forthcoming in the near future due to the slow movement of and disputed control over NFTs by various regulators. Put ten attorneys in a room and there will be 10 different opinions on what NFTs are.
What we do know to a near certainty is the NFTs can act as securities, as intellectual property, as commodities, as personal property, as currency, and as debt, financial, and/or legal instruments, among other new uses. Basically the uses of NFTs are as limitless as the minter’s imagination.
To be a security, a given NFT must meet the Howey test which would basically mean that an NFT would be an instrument that grants some type of passive equity to a purchaser in a common enterprise with a central management body upon which the success of the enterprise depends. This is entirely possible if an NFT comes with the expectation of passive profit, whether in the form of capital gains or staking/dividends, and the specific project the NFT is issued by has centralized management.
Most NFTs, in fact the vast majority, do not involve any kind of joint venture. Basically the NFT is minted, sold and that is the end of the transaction. Whether it’s a picture, in-game item, audio, film, or any copyrighted creative work, the buyer gets the item he/she paid for transferred to his/her wallet, usually without the actual legal title called ‘copyright’ (this topic addressed in a separate post), and the parties move on their separate ways. There is no further collaboration or joint venture, partnership, or enterprise involved. The NFT may gain or lose value of its own separate market value/demand and may be sold, used, or given away by the new owner depending on the future market price of that NFT. In this case it is relatively clear the NFT would not be a security.
A case where an NFT may be deemed a security is when it is sold and there will continue to be an ongoing relationship between the minter/issuer and the new NFT owner. The issuer/minter may have a business operation which is issuing NFTs to raise funds for operations as a start-up or ongoing concern with the intent of granting buyers a profit stake in the venture. In this case the purchaser is very likely making an investment in the NFT with an expectation of profit as a result of the significant labors or efforts employed by the issuer/minter. There may be ongoing passive dividend-like distributions and the price of the NFT may fluctuate. But if the NFT is connected to a business venture and any profits are not derived from the active involvement of the purchaser then it is probably such an NFT may be deemed a security by state or federal regulators.
In case such an NFT is in fact a security then its sale without registration or an exemption from registration may be deemed an illegal sale of unregistered securities. In the event a business wants to raise funds from investors to be used in the start-up’s operations then it is important to comply with federal and state law. The most common exemption from registration would be Rule 506c of Reg D which permits sale of unregistered securities to accredited investors only. The newly increased limit of 10mn for rule 504 is not recommended for a number of reasons, the main one being the potential liability of selling securities to non-accredited investors. Furthermore, NFTs sold under a Reg D offering would be ‘restricted’ from sale for twelve months.
If you have questions as to whether your NFT platform or venture is issuing securities don’t hesitate to reach out for a consultation with BELENKY LAW FIRM PLLC using the contact form at the top of the site.