NFT Regulation Is Incredibly Complex… So You Might As Well Stop Misusing The Term
I got just about the amount of pushback that I was expecting on my last piece on NFTs. It was foreseeable that many would feel uneasy about the fact that “NFT” collectibles are intrinsically fungible. And, of course, I get why some might feel like that! Having the super-hyped, sensationalized NFT tag removed from the (valuable?) artwork you just purchased must hurt.
However, let us be real, and maybe rigorous, even if just for a second: Do you think that, in the real world, we should attach very the same laws and rules to a) a token representing ownership of a whole house, b) several tokens representing pieces of ownership of the said house, and c) tokens representing ownership of pictures of the house? That cannot be good for maybe any of the owners of said tokens.
This time around, I want to take an amateur look at how the regulatory processes behind NFTs might look like and what the advances in that direction are at the moment. Hopefully, thanks to this, we’ll arrive at a point where we can start drawing some conclusions!
From the ridiculously basic to the Supreme Court
The obvious mockery point surrounding art NFTs is that you can right-click any piece and click “Save”. This raises the issue that your “receipt” showing that you paid 2 ETH for a magnificent drooling monkey is the actual valuable piece you own… which we might call a step back from the traditional art world.
A second, tangential mockery point, which grew in prominence thanks to Twitter’s latest announcement about integrating NFT features, is that it’s just as easy to showcase your NFTs as it is to showcase your plagiarized NFTs. Because, well, they look the same.
Copyright laws do already apply to NFTs, and issues have surfaced where NFTs were issued by individuals that did not have the copyright to the work. They might even put them up as their Twitter profile picture. Copyright law works just as you would expect it would, so selling or buying copyrighted work from someone who does not have rights may entitle an artist to statutory damages on a significantly higher sum than just the transaction.
However, it isn’t as easy to regulate NFT copyright. All the usual challenges for regulators that relate to cryptocurrencies also apply to NFTs: This means jurisdictional issues, dealing with decentralized systems (which cannot be controlled by any single individual or by the state), plus the inherent anonymity of most NFT minting and trading platforms, etc. A nightmare if you want to get any legal procedure done.
Another prime target for NFT regulations is the hindrance of money laundering activities through the NFT market, similar to how the physical art market is used for such intents. One of NFTs’ (and cryptoassets in general) fundamental characteristics, anonymity, works very much in favor of money laundering activities. Even though transactions are recorded in a public ledger, buyers can erase their steps if they are careful enough. Moreover, for the apparent unpredictability of the pricing of those assets, large amounts of money can be laundered through just a few transactions. This is more likely than not to lead regulators to eventually require and analyze Terms and Conditions for NFT sales.
Looking at current regulation to see how and why this can’t work
The United Kingdom is one good place to start illustrating how NFTs do not really fit existing frameworks.
In the UK, there is already regulation that establishes three categories of cryptoassets: The first is unregulated tokens (which honestly sounds like a “we’re not trying”), meaning cryptocurrencies such as Bitcoin and Ether. Then there’s also E-Money tokens (basically, digital cash) and Security Tokens, which I think need no description. It’s been discussed that the authorities will try to intervene and fine issuers of NFTs if they do not comply with the existing requirements. However, genuinely non-fungible NFTs are highly unlikely to fall under these categories.
So, if you’re the British authorities, do you go around fining everyone, or try to fit your regulations to every specific case?
The FATF (Financial Assets Task Force) has recently changed one of its draft regulation guidelines’ wording regarding virtual assets from “assets that are fungible” to “assets that are convertible and interchangeable”. This indicates that it’s likely that they consider NFTs as warranting regulation from financial regulators worldwide.
The other side of the world doesn’t know what to do either. The most advanced talks in the US have arrived to a sense that NFTs are not very likely to be classified as securities because they are not necessarily bought as an investment with expected returns from other entities’ or people’s efforts. The famous Howey Test would mean that these tokens cannot meet the definition of financial securities.
However, to make things worse, an argument can be made that there are some cases in which NFTs can function very similarly to securities. NFTs that represent ownership of real objects or physical property (or even stock NFTs, if such a thing is possible), for instance, are very similar to securities.
A petition to the United States Securities and Exchange Commission (SEC) written in April 2021 by Arkonis Capital has generated some discussions on this topic. The SEC has not ever acted against an NFT creator or operator of an NFT sale or creation platform, but still, there is a particular need to distinguish which NFTs are regulated in which way.
We need to draw lines, and that means breaking a few eggs
I’ve proposed the name LEFTs (Limited-Edition Fungible Tokens) to describe collectibles issued as “NFTs”. Given the need for clear definitions that can be used in legal frameworks around the world, I think it’s important to specify that there could be Utility LEFTs and Security LEFTs, each of them regulated in a different way. This, of course, aside from true NFTs.
This is just one of the many distinctions that we need to start drawing, and I obviously don’t have the answers to all of the questions that remain in the air: “How do we avoid money laundering?”, “How do we enforce copyright law?” and “Can we integrate NFT receipts in legal frameworks as proof of ownership?” are just some of them.
Whichever way regulations go, I’m sure most users wouldn’t like their cryptopunks treated as securities by their governments. And, perhaps, the simplest best thing we can start doing as a community is calling out people and companies misusing the term “NFT” for profit and attention.
