Since the meteoric rise of NFTs following the footsteps of ‘blue chip’ leaders like CryptoPunks, BAYC (Bored Ape Yacht Club), and NBA Top Shots, founding teams have found increasingly novel ways to draw attention from the crowded marketplace — some of which have attracted NFT marketplace scrutiny, most recently resulting in the ‘freeze’ of several high profile projects on popular NFT platform OpenSea.
Features including free NFT drops, community events, online merchandise, and metaverse creation are almost guaranteed to be on roadmaps of any NFT project, but one type of perk in particular has caught the NFT world by storm.
The success of NFT specific tokens generated from owning NFTs (CyberKongz and $BANANAs for instance) has quickly inspired other NFT teams to implement tokens as part of their ecosystem. This pattern has led to increased scrutiny from regulators not unlike ICOs and IDOs have seen in the recent years.
This blurred line between owning a token and owning a security is still yet to be defined by US regulators (governments abroad are taking different approaches ranging from zero tolerance to very favorable), with the Biden administration just gearing up to review cryptocurrency and associated Blockchain ecosystems in greater depth. Without clarifying statements from US government authorities, many NFT teams are referring to the Howey Test to help set precedent for incoming federal regulation.
The above summary is important for NFT founding teams to keep in mind.
Put simply:
- A token becomes a security the moment that expectation of profit is communicated by the issuer
- A token may not fit under the umbrella definition of a security if it is for a utility not associated with profit/revenue creation
As an example, CyberKongz gets around the Howey Test by explicitly stating that $BANANAs have no inherent value and are meant for ecosystem purchases, even if you can exchange the token for value in DeFi exchanges (~$90 per $BANANA at the time of this post). Whether or not that will pass the increased scrutiny of regulators is up in the air.
Other NFTs offering splits of NFT sales royalties and tokens with promises of financial return will likely continue to face delistings and crackdowns. FTX.US’s monstrous new NFT marketplace launch has come with some explicit statements on royalties:
‘We will try to support as many Solana NFT collections as we can. However, we will reject any NFT from a collection/project that distributes or advertises the distribution of royalties to NFT holders.’
Long story short — consult a lawyer if you are on a founding team. For retail NFT players, be careful. The hammer has not come down yet, and it may come down hard on founding teams first. But you are just as much in the crosshairs if you are on the other side of the token transaction.
Much love,
~DJinn
