NFTs, The Crypto World’s Most Useless Invention, Just Got Even Worse

Non-fungible tokens, better known as NFTs, have been a controversial subject ever since they entered the mainstream in the last crypto bull market.

To their supporters, NFTs are an innovative way of using blockchain technology to mint, exchange and authenticate digital artwork. And, to be fair, there’s no denying that the immutability of blockchain ledgers has the potential – in theory – to revolutionize how digital assets are issued and certified.

(If that last sentence gave you a headache: imagine the data on a blockchain being permanently set in stone and impossible to fake. If an artist distributes his latest masterpiece on that data tree, he can sleep easy knowing there will only ever be one legitimate copy and one legitimate owner of that artwork.)

To their detractors, however, NFTs are frankly rather silly – in their current form, anyway. Unlike the Art Security Tokens (ASTs) pioneered by Sygnum Bank and Artemundi – fractional ownership tokens that actually bestow legal control of artwork to an owner – there’s nothing whatsoever protecting anyone who buys an NFT. Artists who issue NFTs can (and frequently do) release 100 identical “prints” at the click of a button. In doing so, they dilute the value of your supposedly unique artwork by 99%. If the piece is popular, they might just issue another 500 copies tomorrow. You have no say in the matter.

It gets worse. During the peak of the NFT mania in the 2020/21 bull market, these digital magic beans were being sold for tens of millions of dollars. Sound too good to be true? That’s because it was. We now know that artists, exchanges and auction houses were engaged in rampant wash trading: allowing these worthless gifs to change hands for eye-watering sums on paper, when, in reality, the buyer and seller were often the same person. All the hype that followed created the most glorious and painful pump-and-dump scheme (depending on which side of the trade you were sitting).

Depressing, huh? Yeah, it still gets worse. Now the Securities and Exchange Commission (SEC), one of America’s financial regulators, is driving another nail into the coffin of this cleverly conceived but woefully executed asset class.

Yesterday, for the first time ever, the SEC unveiled successful enforcement action against an NFT creator who conducted an “unregistered offering of crypto asset securities in the form of purported non-fungible tokens”. Never before has the regulator successfully concluded a case that treats NFTs as securities under US law (the defendant, Los Angeles-based Impact Theory, chose not to contest the findings). That matters, because once a financial asset has been classified as a security, the floodgates open to legal obligations on the part of the issuer and legal protections on the part of the holder.

That’s not a burden that most NFT creators – whose collections of stoned monkey gifs and other luminous contributions to the world of art are plummeting in value – particularly want to bear.

It’s important to note, of course, that the legislative Iron Maiden slamming shut on Impact Theory may not be so deadly in other enforcement action. The regulator’s success with this case hinged on its ability to demonstrate that Impact Theory had marketed its NFTs “as an investment into the business”, with buyers encouraged to believe that they “would profit from their purchases if Impact Theory was successful”. That’s what earned this specific collection of gifs the unwelcome status of a financial security; other NFT collections might fall short of that bar, particularly given the general principle that art and collectibles are considered “non-securities” or “real assets” under law.

But that, in turn, begs the question, ‘What is art’?

If a canny programmer builds a website that churns out AI-generated images with the sole intention of creating hype and selling those images for a profit, does he really deserve to be called an artist? Isn’t he just executing the same scam as most low-cap altcoin developers – another corner of the cryptosphere being actively targeted by the SEC?

I’ll leave it to the legal community to ponder that question. Suffice to say, if you invest in one of the ASTs alluded to earlier, you can sleep easy knowing that the Swiss courts will uphold your ownership rights. If you invest in an NFT, meanwhile – an asset class that purports to be an art security token, while simultaneously dodging that legal obligation – well, best of luck.