Should Bored Apes or other NFTs be regulated as securities?

Should a Bored Ape be considered a security similar to stock in Apple or Microsoft? TL;DR? No!

Winston Churchill, anticipating Securities and Exchange Commission Chairman Gary Gensler, once called “this world of sin and woe.” Now let’s add to the litany of woes the possibility of Bored Apes, CryptoPunks and many other non-fungible tokens (NFTs) being considered securities.

There are even some pro-crypto people out there who would like to treat NFTs as securities. They are, as we argue here, completely wrong when it comes to most (but not all) NFTs for both operational and legal reasons.

As two of our colleagues wrote in The national interest nearly a year ago, “Typical non-fungible tokens (NFTs) are no more securities than baseball cards. Some high-profile investors, such as Canadian entrepreneur Kevin O’Leary, are on record as seeing billions of dollars in potential NFT investments paralyzed until legislation or regulation makes it clear that ERC-721 tokens will not be treated as securities.”

Related: Throw Bored Apes in the trash

Federal regulatory and law enforcement agencies tend to be imprisoned by “strong priors,” referred to as “Maslow’s hammer” by psychologists: “If all you have is a hammer, everything looks like a nail.” To know:

• The US Commodity Futures Trading Commission considers blockchain-based assets as virtual goods.
• The SEC, under Gary “Genghis” Gensler, sees almost everything on the blockchain, except for Bitcoin (BTC), as a security.
• The US Treasury Department’s Financial Crimes Enforcement Network views crypto as money.
• The IRS recently said this: “The IRS intends to determine when an NFT is treated as a collectible using a ‘look-through analysis.’ During the look-through analysis, an NFT is treated as a collectible if the NFT’s associated right or asset falls under the definition of collectible in the Tax Act.”

As for the courts? In February, Judge Victor Marrero of the US District Court for the Southern District of New York (basically Manhattan, the Bronx and some adjacent counties) ruled in Friel v. Dapper Labs., Inc. that Dapper Labs’ NFTs, called “Moments”, may be securities. Although Marrero acknowledged that “not all NFTs” constituted securities, he added:

“It is the special arrangement that Dapper Labs offers Moments that creates the sufficient legal relationship between investor and promoter to establish an investment contract, and thus a security, under Howey. And the legal relationship is primarily derived from the plausible claims that Dapper Labs maintains private control over the Flow Blockchain, which substantially, if not entirely, dictates Moment’s use and value; that Dapper Labs designated Moments as a means for purchasers to obtain substantial profits through the low selling prices of packages and marketing of the substantial profits others had earned through sales on Dapper Labs’ proprietary Marketplace; and that without Dapper Lab’s essential efforts to sustain the Flow Blockchain and Marketplace, Moments would be worthless.”

All well and good – as long as it doesn’t open a cascade of predatory lawsuits against millions of NFT creators or owners, or spur the SEC to try to further expand its jurisdiction. The court’s well-reasoned decision, while more procedural than binding precedent, strongly suggests that most NFTs are not securities.

Brian Frye, a law professor and conceptual artist, has – oddly enough – playfully and publicly argued that NFTs (along with virtually everything else) is securities. Moreover, he celebrates such an outcome, and blandly claims that the SEC will regulate with a light touch.

Color us incredulous.

He also argues that because the Howey test “is hopelessly expansive,” works of art, such as Rembrandt’s, are also securities. This brought to mind a comment made by a New York State Supreme Court justice to the plaintiff’s attorney at a court hearing one of us attended nearly 40 years ago: “This is an argument that can only fool a lawyer.”

Related: Should Bored Ape buyers have a legal right to a refund?

NFTs add authenticity, originality, and uniqueness to what would otherwise be infinite (and thus, the value is determined by supply and demand, worthless) identical copies of, say, a piece of digital art. Most NFTs on OpenSea are works of art — from CryptoPunks and Beeple’s “Everydays” to Bored and Mutant Apes, plus countless works (80 million, per the Harvard Business School’s Digital Initiative).

As Marrero observed, if a creator treats the NFTs they provide more like a speculative investment than something to love, honor, and cherish, they can actually tap dance from the safe space of art into the minefield of securities. Stifling a thriving marketplace for a million artists by imposing unsustainable compliance costs would be absurd—and indeed tragic.

That said, as Gensler’s SEC seems to have little aversion to absurdity or tragedy, call the Capitol switchboard, ask for the office of crypto-friendly House Majority Whip Tom Emmer, and tell whoever answers to pass legislation defining NFT- is, unless specifically promoted as speculative. investments, clearly defined as non-securities and not subject to the SEC’s jurisdiction.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.