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Are NFTs Considered Securities?

The Mona Lisa painting by Italian artist Leonardo da Vinci currently hangs at the Louvre Museum in Paris. While it is not for sale, it still comes as no surprise that the timeless masterpiece is valued at a staggering $870 million as of 2021.

For such an iconic and famous painting that have endured several generations, that kind of eye-watering amount seems just about right to quantify its worth.

However, it’s a completely different story when early last year, a digital artwork in the form of a non-fungible token or NFT called Everydays – The First 5000 Days sold for an eye-popping US$69.3 million at Christie’s Auction.

It got everyone talking about NFTs, and while the rest is not yet history as we speak because NFTs are still gaining ground all over the world, it was definitely a catalyst that made people actually look at the fundamental value that NFTs bring to the table.

Non-Fungible Tokens Explained

So what exactly are non-fungible tokens?

At its core, non-fungible tokens are blockchain-based proofs of ownership over one-of-a-kind assets. What this simply means is that all the corresponding historical and transactional data of these unique assets are stored on a digital ledger called the blockchain, making one’s ownership over them virtually impossible to tamper with.

One classic example of an NFT is the Nyan Cat GIF that was sold as a one-of-a-kind crypto art for an astonishing US$580,000. That’s right – it’s a GIF that you can view a million times on the Internet, share as many times as you want, and even save and post on your own page.

So you might ask -why would anyone pay half a million bucks for its NFT?

One word – ownership (and whatever rights that come with it).

To put things into perspective, let’s go back to the Mona Lisa painting. You can take a picture of it and even make a thousand copies of that picture, but at the end of the day, that doesn’t mean you own the actual painting – which is basically the same scenario of you sharing the Nyan Cat GIF without buying its NFT.

NFTs have made it possible for people to own assets and have indubitable proofs of ownership over those assets because of blockchain. The implication of this is that as an owner, you can exercise all kinds of rights over the said assets, including the right to receive royalties, rent them out, or sell them anytime you want, among others – regardless of the blockchain platform that you got them.

Right now, there are already many kinds of NFTs on the market, and they can range from in-game assets, digital arts, collectables, metaverse properties, and many more.

Another interesting NFT example that’s worth noting is the NFT collection created by crypto artist Josie. Two pieces of her crypto art called “Choose #4” and “Choose #5” look identical but are entirely different and unique NFT masterpieces stored on the blockchain. So yes, uniqueness is not only skin-deep when it comes to NFTs.

Can NFTs Be Considered Securities?

Considering the growing adoption of non-fungible tokens and how they are revolutionizing our concept of ownership over both virtual and real-world assets, it is inevitable that the question of whether or not they can be considered as securities would pop up down the line.

In an op-ed by Merav Ozair of Coindesk, she explained that there is no straightforward answer when it comes to treating NFTs as securities and that applying one encompassing rule for all NFTs may stifle innovation or impede global economic growth.

Ozair also pointed out that innovation is evolving and the utilization of NFTs are boundless and hence should be examined use case by use case.

“If the purpose of the fractionalization of the physical painting is to create shares to be traded in a secondary market and provide liquidity, then, in this case, these “factions” will fall under securities laws,” Ozair discussed in her article. “Thus, fractionalizing an NFT to provide trading and liquidity, utilizing a wrapped fungible token to represent the fractionalization of the NFT, will be classified as security.”

This is a sentiment well-echoed across the industry. In a different article by the law firm Dentons, they explained that whether or not a token is a security is a question of fact and is to be determined on a case-by-case basis.

Referencing the guidelines set by the Canadian Securities Administrators, the Denton article explained that an offering of tokens may involve the distribution of securities if it satisfies any of the following criteria:

  1. the offering involves the distribution of an investment contract;
  2. the offering and/or the tokens issued are securities under one or more of the other enumerated branches of the definition of security; or
  3. the tokens may be security that are not covered by the non-exclusive list of enumerated categories of securities

In the first category, the Howey Test comes into play, wherein the non-fungible token can be considered a security if it involves:

  1. An investment of money
  2. In a common enterprise
  3. With the expectation of profit
  4. To be derived from the efforts of others

At the end of the day, there is no categorical answer on whether or not NFTs are considered securities due to the various types and limitless possibilities it presents – it all depends on their utilities the purpose of their issuance.