Is Non-Fungible Token a Security or Asset?

A non-fungible token (“NFT”) is a non-exchangeable unit of data that is stored on a blockchain and is transferrable to another party. In short, blockchain is a type of a digital ledger. NFTs can be related to photos, videos, or audio files. NFTs are not the same as cryptocurrencies because they are uniquely identifiable. In addition, the legal rights granted by NFTs are speculative as they cannot restrict the sharing and copying of digital files and do not convey their copyrights.

The question of whether NFTs are securities or assets revolves on several issues. One issue is whether the item has been “fractionalized” to permit the sharing of its ownership with other parties. It’s important to realize that fractionalization does not make the asset into a security since it depends on its purpose. For example, if an individual decides to fractionalize a personal property to allow shared ownership, the personal property does not automatically convert to a security. As such, the NFT may not constitute a “security” just because it has increased in value. But, if the fractionalization’s purpose is to assign shares to trade in a secondary market, and to provide liquidity, then it would fall under securities laws. Therefore, the test is whether a purchaser has a reasonable expectation of profits that is derived from someone else’s efforts. See Securities and Exchange Commission v. W. J. Howey Co., 328 U.S. 293 (1946) wherein the United States Supreme Court confirmed that an “investment contract” means a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.

The Securities Act of 1933 (which is codified under 15 U.S.C. §§ 77a, et seq.) defines “security” as any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

NFTs are unique properties that can be created on a blockchain and can be exchanged on a market based on the same blockchain technology. ERC-721 was the first standard for representing NFTs on the Ethereum blockchain. ERC-1155 is another standard that can offer semi-fungibility for NFTs. Therefore, the NFT market has been created on the Ethereum blockchain using these two standards.

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