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Securities Update on NFTs

* co-authored by Elizabeth L. Carter, Esq., Managing Attorney

The non-fungible token (NFT) space has continued to evolve since our last article, with new platforms offering more NFT capabilities for creators, as well as the surge in theft. As a recap, an NFT is a unique and one of a kind asset. NFTs are bought and sold using digital tokens on various online platforms or marketplaces such as Ethereum, Binance Smart Chain, and Tron. Lastly, NFTs can be virtual representations of real or intangible items including, but not limited to, art, music, collectibles, and virtual land. This is what makes NFTs so attractive.

NFT Programs & Functionality Updates
Like many companies right now, Visa has recently announced a new program that it is launching for artists who are interested in NFTs. This program is in partnership with retired professional baseball player Micah Johnson who is also an NFT artist. Visa and Micah will introduce artists to the NFT community as well as its financial benefits. Adobe is another company that is getting involved in the NFT space. Adobe Photoshop is releasing Content Credentials which will allow NFT sellers the ability to link their Adobe ID with their cryptocurrency (crypto) wallet. A crypto wallet allows users to store, send, and purchase crypto on a blockchain. This Adobe update will make authentication of NFTs easier by showing a verified certificate of the NFT’s original owner. Authentication is very important within the NFT space as plagiarism has become a growing concern. Hopefully, the Adobe functionality will address some of these authentication concerns.

NFT Theft
Many NFT artists and creators are experiencing theft in addition to authentication issues. This includes people creating NFTs for work that they do not own nor possess a copyright. For instance, there was a scandal back in September where someone created a fake NFT supposedly by a famous artist named Banksy and sold it for $300,000. Luckily, the buyer was able to recover the money after the fraud was discovered. There are several reports of fraudulent individuals taking artwork they do not own, converting it into an NFT, and selling it without the original artist’s consent. It is often hard to track down the NFT thieves because they hide behind anonymous online accounts.
Likewise, there is a service called Tokenized Tweets that essentially encourages people to tokenize their favorite tweets. As a result, people begin to profit off of someone else’s content without permission - whether intentional or not. However, this is a genuine threat to many artists who later find out their art has been misappropriated and created as an NFT. Once the creator of the NFT has identified the theft or misappropriation it is still difficult to regain possession. This is because once an NFT is uploaded to the blockchain it may only be removed through a process called “burning.” Burning is when the NFT is sent by the owner to an inaccessible web address but will remain on the blockchain forever.
Due to the nature of the blockchain, stealing NFTs is relatively easy. All that a thief has to do is obtain a crypto wallet, set up an online profile on an online NFT marketplace, and upload the NFT with details, name and a price online. In order to get a stolen NFT taken down from an NFT marketplace, the original owner has to contact the host of the online marketplace and request the removal. Still, some artists are becoming more proactive at quickly tokenizing their art before others can in order to avoid a theft altogether.

7 Steps to Adopting NFTs for a Business
Visa also released a report on how to best utilize NFTs for businesses called “NFTs: Engaging Today’s Fans in Crypto and Commerce.” The report begins by discussing cryptocurrencies and defining NFTs. The report then moves on to describe ways that NFTs can be used to increase fan and customer engagement for sports teams, leagues, collectors, and businesses.
Visa’s report also lists seven steps that businesses can use when venturing into the world of NFTs. The first step is for a business to identify a “use case''. A “use case” determines how the business will use NFTs, such as for collectibles, art, gaming, loyalty programs, and discounts. Second, a business has to decide which blockchain to use for the NFTs. Blockchain is a technology that allows for cryptocurrencies to exist by recording and storing information.
An example of a blockchain is Ethereum. However, there are many other blockchains that are beginning to support NFTs such as Foundation, NBA Top Shot, and Sandbox. Third, a business has to get its NFT “minted” or created. A minted NFT will be represented by a token on the blockchain and includes the name, description and other details of the digital asset.
Fourth, a business has to decide how to store the NFT on the blockchain through the use of centralized or decentralized storage. Centralized storage is where a user’s files and other information are stored on one server such as the “cloud”--software and services that run on the internet. Decentralized storage spreads user data across multiple nodes (computers) on a network so that there is no central point of error (one place for issues) unlike centralized storage. Fifth, businesses must be able to securely and efficiently access and store the NFTs using their crypto wallets.
Sixth, the business has to determine how to distribute its NFT to consumers through the use of a number of methods: (1) an open marketplace, (2) a crypto native marketplace, and (3) a closed marketplace. An open marketplace is a place where anyone can buy and sell NFTs. Crypto native marketplaces require that sellers be approved by them. A closed marketplace is where a platform uses its own storefront to sell the NFT on behalf of the seller. Lastly, the business should research new opportunities to better engage consumers using NFTs.

Securities Regulations Update
On October 6, 2021, the Securities Exchange Commission (SEC)’s Chairman Gary Gensler discussed the securities implications of NFTs and cryptocurrencies during his testimony with the House Committee on Financial Services. Chairman Gensler stated that cryptocurrencies may actually be securities, depending on the “facts and circumstances.” In fact, the SEC will no longer take the broad “Howey Test” approach for determining whether securities laws will be implicated in cryptocurrency transactions.
Under this approach, the SEC determined that where a NFT is fractionalized or sold and the buyer has an expectation of profit from this purchase, then the NFT would be considered a security under the Howey test. This approach also led the SEC to formally conclude that cryptocurrencies like Bitcoin are not securities. Now fast forward months later, the SEC is not so broad with their approach. Instead, Gensler informed that the SEC will begin overseeing these transactions through a narrow lense. Still, Gensler acknowledged that it will take federal legislation to fully regulate NFTs, cryptocurrencies, and other digital assets.
Currently, there are no new SEC regulations governing NFTs, cryptocurrencies, or other digital assets. However, based on Gensler’s sentiments, it can be presumed that creators, artists, and businesses alike should be on the lookout for new rules in the very near future. Last month the SEC charged BitConnect, a global crypto lending company, in a $2 billion fraud scheme. BitConnect is accused of issuing fraudulent and unregistered securities through investments in its "Lending Program." The SEC mandates that BitConnect ceases activity, repays investors, and pays fines of an undisclosed amount due to these violations. Additionally, a crypto mining company called Marathon Digital Holdings Inc. was recently subpoenaed by the SEC for possible securities laws violations. After disclosing this information in a quarterly filing, the shares fell from $55.40 to $20.52.
For further reading on the intersections of NFTs, cryptocurrencies, and securities, please check out our other blog article. If you are a business interested in utilizing NFTs or a creator who wants to tokenize your art, feel free to schedule a consultation with us to learn about your securities legal requirements.

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