IRS and SEC are Eager to Put Regulations Down in the World of NFT

IRS

IRSThe head of the SEC has shown an eagerness for NFT to register with the agency!

According to a recent report, the SEC is now targeting certain NFT uses. According to the report, the SEC is probing whether NFTs are being utilized to raise money like traditional securities. The SEC has reportedly sent subpoenas related to the investigation and is particularly interested in information about fractional NFTs. Fractionalization allows multiple people to hold (and trade) a share of an asset. Each share is represented by an NFT that represents a fraction of the ownership of or revenue rights associated with the asset. In some cases, this may meet the Howey test, which is one of the primary tests the SEC uses to assess whether a digital asset is a security.

Securities issues are just one potential legal concern. Each different NFT model can present unique legal issues. They strongly encourage companies who plan to enter into the NFT space to seek competent legal advice early in the planning phase to obtain a comprehensive legal review. Spending an hour or so upfront to vet the legal issues can avoid subpoenas and legal issues down the road.

With regulatory bodies and enforcement agencies in the U.S. paying close attention to the world of cryptocurrencies, digital assets, and the crimes committed within these spheres, it certainly looks like it might be.

The FBI charged a former OpenSea employee with insider trading; the founders of the now infamous Frosties NFT project were arrested for making off with US$1.3 million in a rug pull; and Le Anh Tuan, the founder of the doomed Baller Ape Club NFT project and community, charged with conspiracy to commit wire fraud, in addition to conspiracy to commit international money laundering. A recent report by The Federal Trade Commission notes that, since 2021, “46,000 people have reported losing over $1 billion in crypto to scams.”

NFT is a token created on the blockchain that records ownership of a particular digital object. However, its legal standing is somewhat more complicated. Understanding their legal standing and nature, and in particular, the rights they confer unto their owner is of prime importance in dealing with issues like copyright and taxation. The newness of NFTs and the complex nature of financial and regulatory law means that there is little clarity. The issue is further complicated by the fact that ownership of an NFT does not confer a distinctive and set group of rights: what rights the purchase of particular NFT grants depends upon the underlying smart contract. Thus, buying an NFT of a work of digital art may only grant the owner limited rights such as the right to non-commercial uses. In many cases, the owner of the digital asset might be entitled to royalties on all future sales. Most NFT sales only convey a license. For copyright and commercial use, separate contracts will have to be entered into. Essentially, there are three issues that arise in the context of NFT ownership, which this work will touch upon in order: first, that the rights so conferred are not fixed and depend upon the underlying contract, second that a sale of an NFT is the sale of an entry on a blockchain additive ledger and not necessarily the work itself and third, that an NFT may be created by anyone (not necessarily the creator of the digital work).

 

The Securities and Exchange Commission

The SEC has watched these developments closely, listening and contributing to conversations on the nature of securities laws, and how they might or might not apply to these new technologies. But the agency is somewhat divided on its role in regulating the space. While the head of the SEC, Chair Gary Gensler, has shown an eagerness for crypto exchanges to register with the agency, a diversity of internal opinions exists about how the agency should approach the challenge.

“We’ve not been affording people a lot of time to comment on rule [proposals and changes], so I have concerns about those short time frames,” SEC Commissioner Hester Peirce said to not now, who notes that the views she expresses are her own and not necessarily of the agency or her colleagues. Commissioner Peirce believes that a collaborative and iterative process of rule-building is likely the best way to create new regulatory frameworks for crypto and NFT exchanges and other Web3 entities. Still, that’s not quite the stance the SEC has adopted.