SEC becomes defendant in NFT classification lawsuit

Law professor and filmmaker Brian Frye and composer Jonathon Mann have filed a lawsuit against the U.S. Securities and Exchange Commission.

Lawyers argue that the Seconds approach to regulation threatens the livelihoods of artists and creators experimenting with NFTs.

What does the process say?

According to the documentthe plaintiffs want to determine whether NFT falls under the regulator’s jurisdiction. The lawyers asked the SEC to answer what actions could trigger the application of securities laws to the creation and sale of NFTs. The lawsuit also asks for information on how NFTs are registered before they can be sold.

“Two recent administrative actions issued by the SEC suggest that the SEC is getting into the art business by determining when art needs to be registered with the federal government before it can be sold.”

The authors of the brief compared non-fungible tokens to Taylor Swift concert tickets, which are often resold on the secondary market. Mann and Frye are in exactly the same position in this lawsuit. The lawyers argue that it would be absurd for the SEC to classify such tickets or collectibles as securities:

“They are artists and they want to create and sell their digital art, without the SEC investigating them or taking legal action.”

The SEC’s first lawsuit against NFTs

In 2021, media company Impact Theory launched the Founder’s Keys NFT collection. The company promoted the project from October to December 2021. The collection included tokens of three different rarity levels.

As a result, in August 2023, the SEC accused Impact Theory of promoting unregistered securities. The company used NFTs to attract investors, raising about $30 million. This was the regulator’s first case against NFTs.

The SEC believes that the company positioned the project as a business investment. In particular, it guaranteed holders high profits and promised broad prospects.

Thus, the regulator considered that the specified NFTs had the characteristics of an investment contract and, as a result, were classified as securities. By promoting the collection, the company violated federal laws in this sector.

Impact Theory agreed to pay a $6.1 million fine without admitting or denying guilt. Additionally, they decided to destroy the tokens and their mentions from websites and social media.

What is considered a security according to the SEC

Commodity Futures Trading Commission considers cryptocurrency a commodity. The regulator proposes to apply the tax regime developed for goods to cryptocurrency and consider the actions of issuers as producers of goods. However, no rule in the US would require issuers to register tokens as goods.

When assessing the status of cryptocurrencies, the SEC resorts to the Howey test.

The regulator sees the new financial instrument as having security features and believes that cryptocurrency falls within its legislative scope.

According to the SEC, all tokens, in one way or another, fall under several criteria designated by the agency: pre-sale or fundraising, promises to improve the project through continued business development and marketing, and the use of social networks to demonstrate the project’s capabilities and advantages.

However, no arbitration body has been able to resolve the dispute between the two American regulators, so each agency works according to its own view of the situation.

Traders are losing interest in NFTs, unlike regulators

Despite regulators’ interest in non-fungible tokens, the hype surrounding NFTs continues to wane. In July, sales volume in the NFT sector reached $395.5 million, according to CryptoSlam. This is a new low since November 2023.

The NFT industry has been on a downward trend for a long time. Sales volume and the number of unique buyers and sellers have been steadily declining since March 2024.

Source: CryptoSlam

Additionally, sales volume fell 45% in Q2 2024 compared to Q1 — $2.2 billion versus $4.1 billion.

The decline in July began in the middle of the month. At the same time, in early July, there were signs of recovery in sales volume after a significant drop in June. At the same time, July became the third largest month in terms of transaction volume in 2023.

During this period, 9.9 million transactions were recorded, compared to 5.7 million in June. However, this can hardly be a positive sign, as the average sale price in July hit a new low since September 2023 — $39.56.

What Threatens NFT: SEC or Falling Interest

According to the latest lawsuit against the SEC, the status of non-fungible tokens is yet to be determined. However, the regulator is attracting less interest in this area due to the waning excitement around NFTs.

Either way, the SEC’s approach to regulation threatens NFTs, which were initially conceived as an element of creativity across the blockchain and cryptocurrency space.

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