American restaurant Flyfish Club has signed a settlement agreement with the U.S. SEC regarding an “unregistered offering of crypto asset securities.”

Flyfish Club will pay a fine of $750,000. According to the SEC ruling, between August 2021 and May 2022, Flyfish Club sold around 1,600 NFTs to investors. These tokens were supposed to become an exclusive means of obtaining membership in the club.

According to the regulator, the project earned $14.8 million, and the capital was planned to finance the construction and launch of a private restaurant, Flyfish Club, intended only for club members. In addition, 42% of investors bought several NFTs, although only one token is needed to become a club member.

“Flyfish engaged in significant marketing efforts that promoted the NFTs as investments and led investors to expect profits from Flyfish’s efforts.”

Why the SEC is interested

The regulator argues that these NFTs fall under federal securities laws because token holders can resell them at a higher price and earn passive income by renting them out.

Based on these findings, the agency said Flyfish Club violated Sections 5(a) and 5(c) of the Securities Act of 1933 by failing to register the collectible tokens as securities. The SEC’s order requires Flyfish Club to pay a civil penalty of $750,000 and destroy all NFTs in the company’s possession within ten days.

However, not all SEC officials agree with the agency’s actions. Former SEC representatives Hester Peirce and Mark Uyeda insist that Flyfish Club’s NFTs are utility tokens, not securities. They were created to provide access to exclusive dining offers and not as speculative investment vehicles. Peirce and Uyeda are concerned that the SEC’s intervention could negatively impact NFT holders by making them even more difficult to transfer and resell.

“Leaving crypto to be addressed in an endless series of misguided and overreaching cases has been and continues to be a consequential mistake.”

The commissioners emphasized that NFTs are a new tool for chefs and artists to monetize their talents and provide unique experiences that overly restrictive regulatory interpretations shouldn’t stifle.

SEC scares NFT industry

In August, the SEC threatened to sue OpenSea, arguing that the collectible tokens traded on OpenSea are securities.

OpenSea CEO Devin Finzer reacted to the SEC’s Wells notice, calling it “regulatory saber-rattling” that’s venturing into “uncharted territory”. He feared it could backfire and cause creators of NFTs to stop making digital art.

Finzer said the company would defend the rights of digital artists and promised to set aside $5 million to cover legal costs for any NFT developers who might receive a similar notice from the regulator.

Politicizing the SEC’s approach

The SEC, meanwhile, continues to face criticism from the crypto community and U.S. lawmakers. In 2022, the agency first turned its attention to NFTs, accusing a Los Angeles-based media company of selling unregistered securities through NFTs. The case ended in a $6 million settlement.

In the wake of the harassment, the U.S. House Subcommittee on Digital Assets, Fintech, and Inclusion said it would hold a hearing titled “Dazed and Confused: Breaking Down the SEC’s Politicized Approach to Digital Assets.”

Subcommittee said SEC Chairman Gary Gensler “prioritized and pursued an enforcement and regulatory agenda to the detriment of the digital asset ecosystem” during his tenure on the panel.

“During Chair Gensler’s tenure, the SEC has not released guidance on how the SEC determines whether a digital asset meets the definition of a security. Rather, Chair Gensler and the SEC have publicly opined.”

They cited inconsistencies with SEC Chair’s position on digital assets as securities under the Howey test and disagreements among commissioners.

Former SEC Commissioner Dan Gallagher and former agency lawyer Michael Liftick are expected to testify at the hearing on Sep. 18.

Coinbase joins the fight against the SEC

In September, Coinbase founded the legal advocacy group Stand With Crypto and launched a Legal Defense Fund to protect NFT projects.

On Sep. 13, Stand With Crypto announced a $6 million fund backed by venture giant a16z and NFT marketplace OpenSea.

Leading law firms back the fund: Fenwick & West LLP, Goodwin Procter LLP, and Latham & Watkins LLP will provide critical legal resources to those working in the blockchain and NFT space. According to the statement, a16z contributed $1 million to the Creator Legal Defense Fund, while OpenSea donated $5 million.

Law professor and filmmaker Brian Frye and songwriter Jonathon Mann have filed a lawsuit against the U.S. Securities and Exchange Commission.

The lawyers argue that the SEC’s approach to regulation threatens the livelihoods of artists and creators experimenting with NFTs.

What the lawsuit says

According to the document, the plaintiffs want to determine whether NFT falls under the regulator’s jurisdiction. The lawyers asked the SEC to answer what actions could lead to applying securities laws to create and sell NFTs. The lawsuit also asks for information about registering NFTs before they can be sold.

“Two recent administrative actions launched by the SEC suggest that the SEC is getting into the art business, determining when art needs to be registered with the federal government before it can be sold.”

The document’s authors compared non-fungible tokens to Taylor Swift concert tickets, 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 the SEC investigating them or filing a lawsuit.”

The SEC’s first lawsuit against NFTs

In 2021, the media company Impact Theory released 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 accused Impact Theory of promoting securities without registration. The company used NFTs to attract investors, raising about $30 million. This was the regulator’s first case against NFTs.

The SEC believes the company positioned the project as an investment in business. In particular, it guaranteed holders high profits and promised extensive prospects.

Thus, the regulator considered that the specified NFTs had the features of an investment contract and, as a result, were classified 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. In addition, they decided to destroy the tokens and their mentions from websites and social networks.

What is considered securities according to the SEC

The Commodity Futures Trading Commission considers cryptocurrency a commodity. The regulator proposes to apply the tax regime developed for goods to cryptocurrency and to regard the actions of issuers as producers of goods. However, no rules in the U.S. would oblige issuers to register tokens as goods.

When assessing the status of cryptocurrencies, the SEC appeals to the Howey test.

The regulator sees the new financial instrument as having security characteristics and believes cryptocurrency falls within its legislative field.

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 ongoing business and marketing development, and the use of social networks to demonstrate the project’s capabilities and advantages.

However, no arbitration body could resolve the dispute between two American regulators, so each agency works by its vision of the situation.

Traders are losing interest in NFTs, unlike regulators

Despite the regulators’ interest in non-fungible tokens, the excitement around NFTs continues to decline. Thus, in July, the volume of sales in the NFT sector amounted to $395.5 million, according to CryptoSlam. This is a new minimum since November 2023.

The NFT sector has been in a downward trend for a long time. Sales volume and the number of unique buyers and sellers have been steadily falling since March 2024.

In addition, sales volume fell by 45% in Q2 2024 compared to Q1 — $2.2 billion against $4.1 billion.

The decline in July began in the middle of the month. At the same time, in early July, there were signs of a 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 can hardly be a positive sign since the average sale price in July reached a new minimum since September 2023 — $39.56.

What threatens NFT: SEC or a decline in interest

According to the latest lawsuit against the SEC, the status of non-fungible tokens remains to be determined. However, the regulator is attracting less interest in this area due to the waning excitement 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.