Coinbase, Uniswap, Robinhood, Kraken, and Consensys are the names the digital asset industry has grown used to watching receive the dreaded Wells Notices from the United States Securities and Exchange Commission. These companies are exchanges offering a wide range of tokens on their platforms, many of which are clearly investment vehicles with the promise of future profits thanks to the work of centralized teams. It would make sense for some of the offerings on these platforms to fall under the category of security.
But, last week, a new and unexpected name joined the list: OpenSea, the largest online NFT marketplace. And now hundreds of thousands of online artists feel as if they are under attack. But it is likely the true artists don’t need to worry. An NFT project for the sake of art is likely not the type of project the SEC has on its radar.
Most NFTs are not securities
The move by the SEC came as a major surprise, as most NFTs are clearly not securities—they’re just art people buy and sell. And there is a long history of people—indeed, investors—buying art that the SEC does not regulate as a security. And so, the precedent for going after OpenSea is thin.
Heretofore, NFTs have generally been viewed as a consumer product, not a financial product, stripping the SEC of any regulatory authority. Sure, there are some exceptions—such as fractionalized ownership in ventures—though OpenSea did try and keep projects promising returns off the platform.
Despite the facts, the SEC is considering a case against the NFT marketplace.
The facts are on the side of OpenSea and NFT artists
The facts of any case against OpenSea are that the platform generally allows users to buy and sell art, not securities.
There would be no precedent for the SEC to go after NFT artists. In fact, any and all of the facts speak against categorizing art in any shape or form as a security. It doesn’t make sense. Everyone knows individuals and entities buy and sell art that is not regulated as a security. Online NFTs, in most cases, follow this model.
Therefore, as far as most of the projects on OpenSea go, the SEC won’t have a leg upon which to stand when it comes to any potential legislation.
Instead, the SEC’s focus will be on NFTs promoted as investments and also offer some future profits due to the efforts of an NFT collection’s founders rather than pure artists just trying to sell their art online in a new and exciting way.
SEC precedent vs. NFTs similar to token precedents
In past SEC cases against the NFT industry, the SEC has established a clear pattern. How the NFTs had been promoted was at the heart of the case, as well as the promise of future profits thanks to the work of the NFT collection’s team.
Just like during the ICO days, when many projects made bold promises without working on tech, many non-NFT projects functioned as vaporware or vehicles by which founders attempted to raise investments. Instead of innovation, many projects were based on hype and hype alone, especially around the potential resale value of the project, which the SEC sees as a red flag.
NFT projects with royalty schemes, revenue distribution, and similar are the ones the SEC is likely after. For that reason, most NFT artists can breathe a sigh of relief, leave the fight to OpenSea lawyers, and get back to creating.
Those who are attempting more complicated NFT structures must now play a waiting game. Indeed, if there is to be a benefit of the SEC’s Wells Notice to OpenSea, it will long at least be for the possibility of regulatory clarity in the realm of NFTs.
Could Operation Choke Point 2.0 and the SEC’s focus on OpenSea and Custodia push the crypto industry into a corner?
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SEC strikes the crypto industry again…
As the U.S. approaches the upcoming presidential elections, the crypto industry once again finds itself at a crossroads.
With Democratic candidate Kamala Harris viewed by many as a potential ally, the current administration, led by SEC Chair Gary Gensler—appointed by President Joe Biden—has ramped up its regulatory actions, now setting its sights on the non-fungible token market.
On Aug. 28, the SEC issued a Wells notice to OpenSea, the largest NFT marketplace, signaling its intent to take enforcement action against the platform.
A Wells notice is a formal communication from the SEC indicating that the agency is considering enforcement action against a company or individual, and it provides them an opportunity to respond before a final decision is made.
According to OpenSea’s CEO, Devin Finzer, the SEC contends that certain NFTs on the platform may be classified as securities—a claim that could have stark repercussions for the entire NFT space.
OpenSea has received a Wells notice from the SEC threatening to sue us because they believe NFTs on our platform are securities.
We’re shocked the SEC would make such a sweeping move against creators and artists. But we’re ready to stand up and fight.
This notice arrived just a day after former President Donald Trump, who has positioned himself to be pro-crypto, launched his fourth collection of digital trading card NFTs, which included unique perks like pieces of his debate suit and exclusive experiences at Trump National Golf Club.
OpenSea isn’t alone in facing the SEC’s scrutiny. In April, decentralized exchange Uniswap (UNI) also received a Wells notice, with the SEC alleging that it was operating as an unregistered securities broker.
Other major players like Coinbase, Kraken, and Robinhood have faced similar actions in the past.
These moves indicate that Operation Choke Point 2.0—believed to be a Biden administration strategy to sever the crypto industry’s ties with traditional banking services—is still in full force. What’s really happening?
Dissecting the OpenSea saga
In his tweet, Finzer expressed deep concern over the SEC’s approach, describing it as a “sweeping move against creators and artists.”
According to Finzer, the SEC alleges that the sale of NFTs on OpenSea broke securities laws because NFTs are considered securities, and those transactions constituted sales of unregistered securities.
The CEO pointed out that this action could stifle innovation across the NFT space, potentially affecting hundreds of thousands of online artists and creatives. The crux of Finzer’s argument is that NFTs are fundamentally different from financial securities.
Finzer mentioned, “NFTs are fundamentally creative goods: art, collectibles, video game items, domain names, event tickets, and more,” arguing that they should not be regulated in the same way as traditional financial instruments.
OpenSea contests the regulator’s allegations, asserting that they do not apply and that the platform is “ready to stand up and fight.”
From student artists finding full-time careers selling their digital art to indie game developers creating open markets for their in-game items, NFTs have enabled new opportunities that would be at risk if the SEC’s actions continue unchecked.
As Finzer mentioned, “it would be a terrible outcome if creators stopped making digital art because of regulatory saber-rattling.”
Finzer also drew attention to ongoing legal battles that echo OpenSea’s plight. He referenced the lawsuit filed against the SEC by musician Jonathan Mann and conceptual artist Brian Frye, who feared that the sale of their art and music could be classified as unregistered securities offerings.
To combat the SEC’s latest move, OpenSea has pledged $5 million to support NFT creators and developers who might find themselves in similar legal battles.
Regulatory ambiguity surrounding NFTs
When it comes to NFTs in the U.S., the regulatory environment is still murky. This lack of clear rules has created confusion and uncertainty, not just for creators and buyers, but also for platforms facilitating NFT transactions.
Currently, there isn’t a specific law in the U.S. that governs NFTs. Instead, regulators like the SEC attempt to fit NFTs under existing laws, which were primarily designed for traditional financial products.
The big question regulators are asking is: are NFTs securities? If they are, they would fall under strict SEC regulations, similar to stocks or bonds. But this is where things get tricky.
According to the Howey Test, a legal standard used by the SEC to determine whether something is a security, an asset is considered a security if it involves an investment of money in a common enterprise with an expectation of profit derived from the efforts of others.
This test was originally designed for traditional investments, but now the SEC is applying it to NFTs, which are often bought for reasons other than profit, such as collecting or supporting an artist.
The main problem with applying existing regulations to NFTs is that they don’t account for the market’s diversity and complexity.
NFTs can represent anything from digital art to in-game items, each with its own unique characteristics and value proposition. Applying a one-size-fits-all regulatory approach could stifle innovation and limit the potential of NFTs.
For example, if all NFTs are classified as securities, platforms would need to comply with the same regulations as stock exchanges, which could be incredibly costly and complicated.
Smaller creators and developers might find it impossible to meet these requirements, potentially pushing them out of the market entirely. This could limit the diversity and creativity that have made NFTs so popular.
Moreover, there’s a global aspect to consider. The U.S. is just one part of the global NFT market, and over-regulation in the U.S. could push NFT activities to other countries with more favorable regulations.
The SEC’s recent actions, including the Wells notice sent to OpenSea, signal a more aggressive approach to regulating the NFT space. By potentially classifying certain NFTs as securities, the SEC is attempting to extend its regulatory reach, which could increase costs for users and reduce the number of new NFTs entering the market.
Ripple effects across the industry
The ongoing crackdown under Operation Choke Point 2.0 is sending shockwaves not only through the NFT market but across the entire crypto industry.
A clear example of this is the recent restructuring at Custodia Bank, a small yet influential financial institution based in Wyoming that serves crypto companies.
Custodia Bank, once a key provider of banking services to crypto businesses, recently announced the layoff of nine out of its 36 employees, as reported by Fox Business. This difficult decision was made to preserve capital as the bank battles the Federal Reserve in court.
At the core of this legal battle is Custodia’s pursuit of a master account with the Fed—a crucial asset that would grant the bank access to the central bank’s liquidity facilities and payment services.
Without this account, Custodia is forced to operate through other institutions that do have master accounts, leading to much higher operational costs.
Banking regulators have become increasingly cautious about allowing traditional banks to engage with crypto firms. This heightened scrutiny has made many traditional banks hesitant to maintain relationships with crypto companies, contributing to a growing sense of isolation within the industry.
Despite assurances from government officials, including Deputy Treasury Secretary Wally Adeyemo, that there is no coordinated effort to exclude the crypto industry from the broader financial system, the experiences of industry participants suggest otherwise.
Custodia Bank itself has faced this harsh reality, with two of its partner institutions terminating their relationships, leaving it even more vulnerable as it fights for survival.
The crackdown under Operation Choke Point 2.0 reflects the real-world impact of regulatory pressure on the crypto industry. Even a small, state-chartered bank like Custodia, which plays a critical role for businesses lacking other banking options, is struggling to stay afloat.
Social media backlash
The SEC’s recent move against OpenSea has sparked a wave of frustration and anger across social media, with many users expressing disbelief and concern over what they perceive as a heavy-handed approach to regulating the NFT market.
One of the most angered critics highlighted the absurdity of labeling NFTs as securities. The user questioned whether the SEC would also start classifying “paintings” or “Beanie Babies” as securities, sarcastically asking if “eBay” might be next on the SEC’s list.
Ridiculous to claim NFTs in general are securities. Are paintings securities now? Beanie Babies? Is the SEC coming after eBay next? Seriously silly. You could surely make an NFT that was a security, but you can make slips of paper into securities too (“stock certificates”).
Another user expressed disbelief at the SEC’s continued actions against the crypto industry, lamenting the agency’s measures as a direct assault on innovation.
Wow. The SEC continues to take measures against innovation.
The frustration isn’t limited to the SEC’s actions alone; it extends to the political sphere as well. One user even voiced their disillusionment with the Democratic Party.
Crypto for Harris my ass. Don’t vote Dems if you want crypto and american innovation.
Drawing a historical parallel, another user pointed out that in 1976, the SEC ruled that art galleries did not need to register as securities dealers, even when promoting and selling art as investments.
In 1976, the SEC ruled that art galleries, even when promoting and selling to buyers that had investment motives, didn’t need to register with the SEC.
The tweet wryly notes the inconsistency in the SEC’s stance, suggesting that while “galleries” were deemed acceptable, “NFT marketplaces” are not.
The growing chorus of voices on social media reflects a deepening divide between the crypto community and regulatory bodies like the SEC.
As these discussions continue, the debate over how to regulate digital assets is far from over, with many in the industry calling for more clarity and fairness.
Stablecoins have grown to become an over $160 billion market. Yet, regulatory uncertainty across the globe threatens their future. We have seen the digital asset industry invest in effective lobbying campaigns. More of that is needed.
Numerous threats remain to the stablecoin market. For instance, regulators could reel in the market by mandating changes to issuer business models. As Tether (USDT) makes clear on its transparency page, stablecoins are not precisely backed by dollars. Instead, a pool of assets earning a little more than 5% for stablecoin issuers back the world’s first popular real-world asset. Issuers generally do not pass any of the yields they earn to holders.
Tightening the regulatory belts
Stablecoin sponsors argue this is why stablecoins are not securities and face a comparatively light regulatory regime compared to most tokens with centralized teams. However, stablecoins’ existence as a currency and a lightly regulated financial instrument could be coming to an end. While Donald J. Trump promises to allow the expansion of stablecoins in the United States, the European Union and Switzerland are exploring legislation that could undermine stablecoins.
Questions remain over the future of stablecoins, which differ from many digital assets due to major stablecoins’ dependence upon central issuers.
Even though stablecoins don’t produce profit for holders, they could still be considered a security. In fact, a February 2024 New York federal court ruling determined a stablecoin may become a security when combined with a yield.
Stablecoins have an issuer who profits off the stablecoin: companies like Tether, Circle, Coinbase, etc. In addition, Circle uses BlackRock as a “primary asset manager of USDC cash reserves.” Moreover, securitized bonds exist today with negative nominal coupons despite investors having no reasonable expectation of profit.
Circle argued in a September 2023 amicus curiae brief in a legal battle between Binance and the SEC that stablecoins are not securities simply because users don’t expect to profit. The SEC, however, argued in a case against Binance that BUSD, Binance’s stablecoin, has represented security “since its inception,” mostly leaning on the fact that it offers yield.
Indeed, Binance’s stablecoin places money into “profit-generating” opportunities. In addition, Binance promised “interest-like” payments to people in the US for “simply buying BUSD and deploying BUSD into yield programs.
The SEC approach
The SEC does not only rely on the Howey analysis. It could be argued, for instance, that stablecoins represent a share in an open-end company under the Investment Company Act of 1940, especially if the stablecoin looks like a money market fund, which have Net Asset Value of shares pegged 1:1 to the US dollar.
It is therefore not unreasonable to think the SEC might view a stablecoin backed by a bundle of assets as an asset backed security.
In the Binance case, the New York Department of Financial Services ordered Paxos to stop administering BUSD. A Paxos spokeswoman in 2023 said the company does not view their stablecoins as securities under Howey or Reves. Stablecoin sponsors argue that stablecoins do not meet the three-part Howey test of an investment contract and sponsors keep profits to themselves. They argue stablecoins preserve value and prevent losses, but do not create profit.
In a court of law, an SEC lawyer might argue that just because issuers keep all of the profit for themselves doesn’t mean stablecoins are non-securities. All it takes is for a judge to agree and make a ruling based on this argument. A stablecoin is, after all, a receipt for an off-chain asset. There are also secondary markets for stablecoins, as well as an issuer-investor relationship. Financial instruments representing underlying digital assets—such as the Bitcoin (BTC) ETF—are considered securities. So, why not stablecoins, as well?
Stablecoin proponents will have been wrong. For a stablecoin to constitute a security, the buyer of a security doesn’t necessarily need to expect to make or lose money by buying and selling a security. The crypto market would be upended since it operates based on the assumption that stablecoins are currencies and not securities.
Centralization, one more time
What’s more, the dominant stablecoin model is highly centralized, both adding to concerns these might be securities and putting the stablecoin and broader crypto market at risk for government interference.
US authorities—or any country authorities—could revoke stablecoin issuers’ access to the banking and financial system. If a USD stablecoins issuer is overseas, the US government could request foreign governments to disinclude such entities from their respective banking systems. Furthermore, US authorities could require stablecoin issuers to comply with anti-money laundering and know your customer procedures, as Swiss authorities have done with a recent guidance document.
If the digital asset industry exerts the influence it so clearly now has, then stablecoins can continue to proliferate and millions can reap the benefits of financial inclusion.
As it gained traction in the crypto industry, real estate tokenization is classified as a security in most jurisdictions with developed financial regulations, such as the United States, European Union, United Kingdom, Australia, and others. In this article, I focus on the limitations of tokenization-securitization and explore why the concept of tokenization should aim to digitize property rights instead of penetrating the very heart of land registries. In my previous article, I outlined the idea of the “title token” and the concept of the next-generation land registry—blockchain estate registry. Now, let us scrutinize the promise of securitization to illustrate why, without redesigning the system, the digital economy will not progress.
Securitization explained
Traditionally, real estate has been viewed as a valuable asset class but has presented challenges for smaller investors due to its illiquid nature and substantial upfront investment requirements. It is commonly believed that blockchain technology offers a promising solution through the tokenization of real estate. This widespread interpretation involves converting real-world assets into digital tokens tradable on a blockchain, thereby subdividing the asset into smaller, more manageable units. This approach purportedly makes investment more accessible and enhances the liquidity of real estate, as these tokens can be easily traded on secondary markets.
However, while such tokenization has garnered attention, a critical examination of its limitations is essential. The following scrutiny reveals the inadequacies of this model and underscores why a thorough redesign of the land system is imperative to ensure meaningful progress.
Essentially, such tokenization represents securitization. A typical scheme authorized by a financial regulator involves the creation of a special purpose vehicle (SPV), e.g., a corporation or a trust, where tokens represent shares or units, respectively. Rarely, when tokens represent neither of these, such security can fall under a larger category of an “investment product” or “managed investment scheme” found in regulations of many countries since the case of SEC vs Howey in the U.S. in 1946.
Economically, such a security would generally be understood as someone’s promise in exchange for cash to perform some economic venture that might result in profits. Thus, there are two sides to this deal: someone who promises something and the one who invests money. To complete this picture, there can be a secondary market where such securities are traded between those who hold them and those who want to acquire them.
When it comes to the economy around real estate, traditionally securitized property represents a small fraction of the overall property market. For instance, as of 2023, the market capitalization of US publicly traded real estate investment trusts (REITs) was approximately .4 trillion, which is 1.3% of the whole US real estate value, estimated at 3 trillion.
Source: NAREIT, Statista, courtesy of the author
This disparity highlights that securitized real estate forms only a minor segment of the broader property market. The limitation arises from the legal nature of such relations. Security is an economic interest in someone’s property (a promise secured with a legal instrument). The one who holds the security is not the property owner. The security holder does not enjoy the whole bundle of legal rights; hence, its economic application is also limited.
Security token vs. Title token: A real estate security token represents the holder’s economic interest in someone else’s property. A title token is the actual record of the property right.
Why #tothemoon won’t happen
Starting from the first wave of tokenization—also known as the initial coin offering boom—in 2016-2017, there has been unreasonable excitement around real estate tokenization, which aligns with the hype that is overall present in the crypto industry. Tokenization is associated with the potential for high profits, which are made on market bubbles.
Tokenization of real estate is advocated as a way to increase the liquidity of real property. It is usually explained that digital technology along with fractionalization will reduce the barriers and make this investment more attractive. It will, no doubt, but having real estate as the underlying asset projects the behavior of the underlying asset.
Prices on real estate are not the same as company stock markets, where business expansion and innovation can make company shares skyrocket. Usually, real estate doesn’t dramatically fluctuate; moreover, it is unlikely that one building will rapidly increase in price while the rest around it stay the same. Normally, the real property market moves all in one trend, with some minor discrepancies from region to region.
REITs and real property tokens
It is reasonable to interpolate publicly listed real estate investment trusts (REITs). Investment trusts democratize investments in real estate by reducing barriers, as these are shares of companies that own real property traded on exchanges.
It is evident that daily dollar volumes on REIT markets are much lower than on major stock exchanges. The average daily trading volume (ADTV) of the U.S. equity market exceeded 0 billion in 2023, while publicly-traded REITs often see volumes in the range of billion.
Source: NAREIT, Russell Instruments, courtesy of the author
Additionally, REIT markets exhibit lower volatility compared to the broader stock market. This stability stems from the nature of their underlying assets—real estate—which typically do not experience dramatic short-term price swings. Most importantly, public REITs go along with the general trend in the real estate market. The performance of REITs often reflects the broader trends in the real estate market because both are influenced by similar economic factors such as interest rates, economic growth, and property values.
So, the overall excitement about real estate tokenization looks more irrational. It is unreasonable to expect that tokenized property will make substantial gains, while, for example, the rest of the real estate market is stagnating. Nevertheless, with the digitalization of finance, it is reasonable to expect a reduction in transaction costs. Web3 and other digital technologies can make security markets more transparent and accountable, rendering some bureaucratic procedures redundant and obsolete. Thus, the advent of innovations can make the REIT market more efficient under the condition that the government reduces red tape to unleash the potential of digital technologies.
Now, facts and some concluding thoughts
Finally, let us explore some empirical evidence that supports this discussion. STM (Stomarket.com) is a popular resource in the world of tokenized real-world assets (RWAs). Similar to Coinmarketcap.com, it consolidates tokens, their capitalization, volumes, and other essential market data.
A closer examination shows how much smaller the tokenized RWA market is compared to the cryptocurrency market. STM’s capitalization of listed 465 ‘Real Property’ tokens is 6 million with only .7 million of trade volume per day. For comparison, Coinmarketcap’s list capitalization is .3 trillion, with .6 billion of trade volume per day of over 8,000 coins and tokens listed on the website (as of 14 May 2024). Deloitte analysis indicates more optimistic figures—.4 billion capitalization in 2022, according to their research, which is still 140 times smaller than Coinmarketcap’s list.
In summary, securitization is no revolution, and speculative excitement around the tokenization of real estate markets is far-fetched. Blockchain and other web3 technologies can make the securitization of real estate more efficient if introduced with more progressive regulations. However, securitized property constitutes just a small portion of the whole real estate market, so bringing efficiencies to this small segment does not make much of a difference.
All property rights, titles, and legal interests, in fact, are locked in government registries—old-fashioned land registries with paper-based transactions and bureaucratic registry and titling services. With web3 technologies, economic relations can become transboundary, online, instant, and peer-to-peer. Programmable relations reduce the need for intermediaries, i.e., agents, lawyers, notaries, conveyancers, and other registrars.
The old registry constitutes a bottleneck for the future of the digital economy as all this potential efficiency bumps up against the old-fashioned sluggish system. Government inertia to improve the system, i.e., automate and digitize, stifles the further evolution of the economy. In fact, the appearance of traditionally securitized and tokenized real property is a kind of response to that inefficiency. Though, as it was shown, it has a marginal effect that does not change the whole picture.
