August 28, 2024 | Seattle, WA.
Background: SEC issues Wells notice against OpenSea
Today, the U.S. Securities and Exchange Commission (SEC) issued a Wells notice against OpenSea, a leading platform for nonfungible tokens (NFTs). The notice, which typically precedes formal charges, suggests that the SEC may classify NFTs as securities, a move that has significant implications for the broader digital art and crypto industries.
OpenSea’s CEO, Devin Finzer, expressed shock at the SEC's stance, arguing that such a classification misinterprets the law and threatens to stifle innovation by placing undue legal pressure on countless online artists and creators. In response, OpenSea has committed $5 million to support the legal defense of NFT creators and developers who might face similar regulatory scrutiny.
This development is part of a broader SEC initiative to bring the crypto industry under its regulatory umbrella, with several prominent firms like Coinbase, Binance, and Kraken already engaged in legal battles with the commission. The SEC's actions have prompted concerns within the industry about the lack of regulatory clarity and the potential for innovation to be hampered by overreach.
The ongoing legal challenges have led some crypto companies to consider relocating outside the U.S. Meanwhile, SEC Chair Gary Gensler has consistently argued that much of the crypto industry already falls under the SEC's jurisdiction and that these lawsuits are necessary to ensure compliance. The controversy surrounding the SEC’s approach to crypto regulation has even entered the political arena, with figures like Donald Trump vowing to remove Gensler if elected, despite the president's limited power over the independent agency.
Could NFTs on OpenSea be considered securities?
While we do not believe NFTs are inherently securities, the way they are used on platforms like OpenSea could make them appear as such under the Howey Test, underscoring the nuanced nature of this ongoing debate.
Here are the four prongs of the Howie Test from a 1946 Supreme Court case, SEC v. W.J. Howey Co., which set a precedent for criteria to identify securities. All four criteria must be met to be considered a security.
Investment of Money: There is an investment of money or another form of capital.
Common Enterprise: The investment is in a common enterprise, meaning that the investors' fortunes are linked to those of the promoter or other investors.
Expectation of Profits: The investors expect profits from the investment.
Efforts of Others: The profits come primarily from the efforts of a third party or promoter rather than the investors' efforts.
Investment of Money: Yes
As most NFTs are sold, there is an Investment of Money, satisfying the first criteria. In the State of Washington, NFTs are taxed and therefore considered a product or item. Clearly items can be purchased that are not securities. Regarding the Howie Test, an Investment of Money is being made when purchasing an NFT on OpenSea. Common Enterprise: Not likely, but maybe
NFT Avatar collections commonly in quantities of 10,000 which were sold or promoted on OpenSea may fall into the Common Enterprise criteria, though could be argued that it does not fall into the criteria. The Common Enterprise was never between the consumer and OpenSea, though OpenSea did benefit from sales of the NFT and if prices went up. NFT avatar collections did the promoting and coordinated with investors. The SEC may hold the position that providing the platform for the Common Enterprise to take place holds OpenSea accountable.
Expectation of Profits: Yes, but was it from OpenSea?
NFTs were heavily promoted by projects and influencers as a means to make money. Whether on Twitter, Clubhouse, or Instagram, NFT projects would shill their collections and most would mention purchasing secondary on OpenSa as it was the most active NFT marketplace. OpenSea earned fees on every sale of an NFT project benefiting from the profits of the NFT, but OpenSea was not the one promoting the Expectation of Profits, it was the projects or influencers doing so. as with the Common Enterprise, the case would need to be made that since OpenSea had the platform where the Expectation of Profits occurred they are then liable.
Efforts of Others: Yes
NFTs sold on OpenSea went up in value based on the promotion, scarcity, and hype around the collection from projects and influencers. OpenSea could be considered to satisfy the criteria of Efforts of Others as they provided the platform, promoted certain projects on home pages and landing pages, and incentivized sales by offering royalties to sellers.
Howie Test Conclusion
Are NFTs on OpenSea a security? No, but we can see why the SEC could see them as such.
Niftmint's position on NFTs
At Niftmint, our position is clear: NFTs, by their nature, are not securities—just as a simple piece of paper isn't. However, the way an NFT or a piece of paper is used can determine its classification.
If an NFT is created to represent an investment, carries an expectation of profit in a common enterprise, or its value is dependent on the efforts of others, it could potentially be considered a security under U.S. securities law.At Niftmint, we have always maintained, with confirmation from our legal counsel, that NFTs are simply digital assets—programmable and more secure than standard digital content items. We use NFTs as infrastructure for creating digital twins of physical products and as mechanisms for authentication and loyalty, not for speculation or trading.
Niftmint believes every product will have a tokenized digital twin and is building the infrastructure layer to make it readily accessible for Brands and Consumers, without forcing them to own cryptocurrency or use cryptocurrency wallets as Niftmint manages on their behalf as a technology service.
The world continues to become more digital, while Brands offer more digital products and consumers ask for more digital products. Tokenizing real-world assets in commerce, which is creating digital products of physical products, is the most secure and complete means for Brands to offer digital products to their consumers. When you tokenize a product you can place all the key information about that product into the digital token's metadata. Key information can include authentication, warranty, service plans, rewards, loyalty, and insurance, which can all be programmable. Read our past Blog Post on NFTs are Worthless, so why are we building NFT Technology?
Unlike the speculative use cases of NFTs that became popular in 2020 and 2021, our focus has always been on the practical application of tokenizing real-world assets in commerce. This stance has remained unchanged and was the same stance we had during the NFT bull market three years ago. The SEC's recent Wells Notice to OpenSea does not affect our operations, as our use of NFTs is fundamentally different.
