NFTs—The Next Crowdfunding?
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NFTs—The Next Crowdfunding?

Brownstein Client Alert, Jan. 20, 2022

NFTs are one of the hottest new technology trends of this year. An NFT—or Non-Fungible Token—is a digital certificate, typically encrypted and verifiable on the blockchain. Few have escaped the NFT headlines over the last few months: A Lebron James NFT listed on the NBA Top Shot platform sold for $230,000, almost as much as the average family home.1 This was quickly outdone by the Bored Ape Yacht Club NFTs, which sold for 75 ether, or more than $300,000.2 Which then followed with the eye-watering $69 million NFT off “EVERDAYS: The First 5000 Days,” a digital image from the artist Beeple. Searches for “NFTs” now exceed those for “Bitcoin” and “Etherum,” and NFTs have demonstrated more stable value than cryptocurrencies.

With such hype, more and more companies are looking at NFTs as a way to raise money. An NFT can be made or (“minted”) from almost anything: a digital image of a sneaker, an athlete, or even of this very article. The beauty of the NFT is its very adaptability and the fact that it allows for the authenticated transfer of ownership of a unique good on the blockchain. But before considering a NFT offering, companies should consider potential legal requirements that limit the use of NFTs for fundraising.
 

NFTs Could Be Considered a Security

The U.S. Securities and Exchange Commission (“SEC”) regulates securities and requires the registration of a security with the commission before it can be publicly traded. To determine whether an investment falls within the definition of a security, the SEC will often consider whether it meets the definition of an “investment contract.” The seminal U.S. Supreme Court case, SEC v. Howey, employs the following factors to make this determination:
 

  • An investment of money
  • In a common enterprise
  • With the expectation of profits
  • To come solely from the efforts of others.

SEC v. Howey, 328 U. S. 293, 301 (1946).

As applied to NFTs, if the NFT itself is similar in use to an art piece, it looks less like a security and more like an collectors asset. Where NFTs may cross over to the SEC’s jurisdiction is when the issuers of the NFT market the NFT as an investment that is likely to appreciate. For example, if a sneaker company releases 100 limited edition NFTs of a certain popular sneaker collection, let’s call this the “Air NFTs” and then tells the purchasers they can expect that the Air NFTs will become even more valuable over time because there are only 100 such tokens, and the Sneaker Company intends to use the funds generated to launch even more sneakers, this token starts to look more like a security. If this company were to further tell purchasers that they could expect to trade these tokens on a secondary market for profit, the sneaker company would be hard-pressed to avoid having to register the token as a security.

Fractionalized NFTs, “F-Nfts” and NFT baskets are also gaining in popularity. Such products allow users to invest in a limited percentage of one NFT, and may facilitate the acquisition of interests of multiple NFTs. Platforms like Fractional, Niftex, and DAOfi allow individuals to purchase and trade F-NFTs the same way an investor could trade stocks on Robinhood or a collector could trade baseball cards on eBay.

As a result, companies that release NFTs to raise money to manufacture, produce or release certain items or content should consult with a securities lawyer as to whether the NFT is running afoul of U.S. securities laws and regulations. As SEC Commissioner Hester Peirce recently advised, “The definition of security can be pretty broad,” and cautioned “you better be careful you’re not creating something that’s an investment product….”3


1 Lyle Daly, “Average House Price by State in 2021,” The Ascent: A Motly Fool Service, (Aug. 5, 2021), https://www.fool.com/the-ascent/research/average-house-price-state/; Dijo Songco, “Lakers Star LeBron James Breaks Blockchain With Record-Breaking $230,000 Sale on NBA Top Shot,” Clutch Points (Aug. 25, 2021), https://clutchpoints.com/lakers-lebron-james-breaks-nba-top-shot-record-with-230000-sale/.

2 Daniel Van Boom, “How a $300k Bored Ape Yacht Club NFT was Accidently Sold for $3k” CNET (Jan. 9, 2022), https://www.cnet.com/news/how-a-300k-bored-ape-yacht-club-nft-was-accidentally-sold-for-3k/.

3 Sophie Kiderlin, “The SEC’s ‘Crypto Mom’ Hester Peirce Says Selling Fractionalized NFTs Could Be Illegal,” Business Insider (March 26, 2021), https://markets.businessinsider.com/news/currencies/sec-crypto-mom-hester-peirce-selling-nft-fragments-illegal-2021-3
 

This document is intended to provide you with general information regarding NFTs. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. The information in this article is accurate as of the publication date. Because the law in this area is changing rapidly, and insights are not automatically updated, continued accuracy cannot be guaranteed.

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