Securities or Not? The NFT Market and Potential SEC Regulation

by | Aug 11, 2021 | Blog | 0 comments

            In an economy that has witnessed increasing digitization of all sorts of assets, it is no surprise that non-fungible tokens, or NFTs, have gained attention across the investor spectrum. Yet much confusion still surrounds what NFTs are and why people are drawn to them. Put simply, NFTs are digital entries, recorded on a blockchain, that represent objects such as videos or works of art.[1] This makes NFTs similar to cryptocurrencies. But, unlike cryptocurrencies, NFTs are not interchangeable; no two tokens are identical. This factor ripens NFTs for an influx of market participants—both the token creators looking to monetize their assets and the investors speculating on the tokens’ value.  

            Though the dominant discourse on NFTs today centers on digital content and artwork, it is worth noting that NFTs can also represent ownership interests in physical assets.[2] Yet the former asset type is unique because NFTs serve a major need for many creators: they provide reach and facilitate demand. Indeed, NFTs enhance the free-flow of assets to wherever in the market they are valued most highly. For artists, specifically, they disintermediate parties (i.e., galleries) that formerly served gatekeeping functions and increased transaction costs. That these unique tokens are digital, and thus accessible on the blockchain, enhances liquidity by making them easily transferrable.

Potential SEC Regulation

            This year alone, NFT sales have exceeded $2.5 billion. And the SEC has noticed. Because it has never before contemplated digital assets as part of its regulatory framework, the SEC is taking its time before deciding what to make of NFTs.[3] The central issue is whether to treat them as securities, commodities, or something else altogether.

            This classification matters because a security is subject to substantial SEC regulation. For example, any exchange listing a security for purchase and sale by counterparties would theoretically be required to register with the SEC. Such a classification would undoubtedly have a chilling effect on liquidity in the NFT market. It would create a substantial barrier of entry to market facilitators who cannot comply with SEC registration requirements.

Courts have typically used the Howey test, established by the U.S. Supreme Court in 1946, to determine whether something warrants regulation as a security.[4] The test outlines four prongs—all of which must be satisfied—for a transaction to be considered an investment contract and thus rendered a security: the transaction (1) involves an investment of money; (2) has a common enterprise; (3) was made with a reasonable expectation of profits; and (4) is derived from the entrepreneurial or managerial efforts of others.[5]

            Many legal scholars have weighed in on the hypothetical application of Howey to NFTs, arguing that most NFTs bought and sold today would not be classified as securities under it because of the second-prong’s “common enterprise” requirement. The dynamics shift slightly when it comes to f-NFTs, or fractional non-fungible tokens.[6] An f-NFT is a fractional share of an NFT that can also be freely bought and sold. F-NFTs are revolutionary for their facilitation of access to the risk/reward tradeoffs of certain assets that have traditionally been out of reach for the average investor. Assuming that standard NFTs only fail for the second prong, it is hard to imagine the SEC foregoing regulation of f-NFTs, being as the fractional nature of the ownership interest seems to satisfy that prong.  

Stay Posted: Final Remarks

            The continued and rapid expansion of the NFT market dictates, no doubt, that the SEC needs to clarify its position on these issues in short order, lest these new investment instruments be used to lure in and swindle unsuspecting retail investors. SEC Commissioner Hester Price was clear this past March that the SEC will not hesitate to regulate the exchange of “securities.” But in the meantime, it seems that NFT creators and purchasers will enjoy scant oversight of their transactions.   

[1] Sharma, Rakesh. “Non-Fungible Token (NFT) Definition.” Investopedia, 8 Mar. 2021,

[2] Clark, Mitchell. “NFTs, explained I have questions about this emerging…um…art form? Platform?” The Verge, 11 Mar. 2021,

[3] “NFTs: Key U.S. Legal Considerations for and Emerging Asset Class” Jones Day, Apr. 2021,

[4] S.E.C. v. W.J. Howey Co., 328 U.S. 293 (1946)

[5] Id.

[6] Id. See also Anello, Robert. “Digital Art May Be Next In The SEC’s Crosshairs.” Forbes, 16 July 2021,