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 SEC's approach to regulation threatens the livelihoods of artists and creators experimenting with nfts.

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What the lawsuit says

According The documentThe plaintiffs want to determine whether nfts fall under the regulator's jurisdiction. The lawyers asked the SEC to respond to what actions could lead to the application of securities laws to create and sell nfts. The lawsuit also asks for information about the registration of nfts before they can be sold.

“Two recent administrative actions launched by the SEC suggest that the SEC is entering the art business, determining when artworks must be registered with the federal government before they can be sold.”

The authors of the document 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 being investigated or sued by the SEC.”

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 charged Impact Theory with promoting unregistered securities. The company used nfts to attract investors and raised about $30 million. This was the regulator’s first case against nfts.

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The SEC believes that the company positioned the project as an investment in business. In particular, it guaranteed shareholders large profits and promised broad prospects.

The regulator thus considered that the nfts in question had the characteristics of an investment contract and, consequently, classified them as securities. By promoting the collection, the company violated federal laws in this industry.

Impact Theory agreed to pay a $6.1 million fine without admitting or denying guilt. It also decided to destroy the tokens and their mentions on websites and social media.

What is considered securities according to the SEC?

The Commodity Futures Trading Commission considers cryptocurrencies to be commodities. The regulator proposes to apply to cryptocurrencies the tax regime developed for goods and to consider the issuers' shares as producers of goods. However, in the US there are no rules that oblige issuers to register tokens as goods.

In assessing the status of cryptocurrencies, the SEC relies on the Howey test.

The regulator believes that the new financial instrument has security features and believes that cryptocurrencies fall 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 media to demonstrate the project's capabilities and advantages.

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

Traders are losing interest in nfts, unlike regulators

Despite regulators' interest in non-fungible tokens, enthusiasm for nfts continues to wane. In July, sales volume in the nft sector amounted to $395.5 million, according to CryptoSlam. This is a new low since November 2023.

The nft sector 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.

In addition, sales volume fell by 45% in the second quarter of 2024 compared to the first quarter: $2.2 billion versus $4.1 billion.

The July decline 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 cannot be a positive sign, as the average sale price in July reached a new low since September 2023: $39.56.

<h2 class="wp-block-heading" id="what-threatens-nft-sec-or-a-decline-in-interest”>What threatens nfts: the SEC or a drop in interest?

According to the latest lawsuit against the SEC, the status of non-fungible tokens is still to be determined. However, the regulator is showing less interest in this area due to the waning enthusiasm around nfts.

In any case, the SEC’s approach to regulation threatens nfts, which were initially conceived as an element of creativity in the entire blockchain and cryptocurrency space.