Unexpected twist: SEC became defendant in the NFT classification lawsuit

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.