Each year, the Business Law Section sponsors the Mendes Hershman Student Writing Contest to encourage and reward law student writings on business law subjects of general and current interest. Essays submitted for consideration must be the work of the submitting student without substantial editorial input from others. The papers are judged on research and analysis, choice of topic, writing style, originality, and contribution to the literature available on the topic. Depending on the topic, whether the paper has been previously published, and other factors, the winning essay is considered for publication in The Business Lawyer. The winning essay for the 2021–2022 contest was submitted by Wai-Lin Danieley.
In the early 2010s, internet users began producing digital images known as “memes,” which they often shared casually as telecommunication humor. In concert, an internet user originated the digital pedigree for “Doge,” a meme and digital image of a comic-sans-overlaid Shiba Inu. Though a classic joke, Doge became a multifaceted asset when its novelty was monetized within the digital economy. In late 2013, “Dogecoins” allowed meme-users to trade fungible crypto-tokens represented by an image of their favorite joke. Later, and uncoupled with the independent Dogecoin cryptocurrency, Doge’s artist converted the digital image into a Non-Fungible Token (“NFT”). For the purposes of blockchain terminology, the Doge artist “minted” the artwork on the Ethereum blockchain.
As an NFT, Doge was incorporated into the Ethereum blockchain, which assigned the image to a unique set of identifying metadata—similar to a titling of a vehicle or assigning a serial number to a product. Otherwise said, unlike fungible digital assets, NFTs are unique and individualized assets. In 2021, the Doge’s artist sold the original metadata of Doge to digital collective agency PleasrDAO for $4 million. The original artist entirely transferred ownership of the Doge NFT to PleasrDAO. Then, by layering the technical attributes of NFT technology, PleasrDAO subdivided the Doge NFT into a fractionalized NFT (“f-NFT”). Like the fully undivided Doge NFT, each fraction of Doge was represented by uniquely identifying metadata.
As incorporated assets within the Ethereum blockchain, Doge NFT and f-NFT values are monetized by fungible Ethereum-based cryptocurrencies known as Ether. As a characteristic of blockchain technology, anyone could search the Ethereum public ledger and locate the true owner of Doge and all fractions. To guarantee credibility, each Ethereum transaction is “authenticated,” or verified as “true,” and incorporated on the Ethereum public digital ledger. As an attribute of blockchain technology, the Ethereum ledger reflects PleasrDAO’s original transaction and Doge’s original mint as an NFT. Additionally, purchasers can ideally trace each Doge f-NFT to the original Doge NFT. The Ethereum ledger confirms the existence of the original Doge NFT, each Doge f-NFT, and their respective values. Accordingly, PleasrDAO marketed to consumers that they could own an original portion of their favorite classical meme by purchasing a fraction of the original “Doge” NFT.
In 2018, the Securities and Exchange Commission (“SEC”) published a guided framework for digital asset creators and technology developers. Although the SEC denounced the most prominent digital blockchains, Ethereum and Bitcoin, as securities, they cautioned other future digital asset developments. Particularly, the SEC enunciated the precedence of SEC v. W.J. Howey Co. and warned digital asset creators against developing assets that reflect the characteristics of securities. My note juxtaposes the technical attributes of NFTs and the NFT economy to the legal rationale explicated in Howey. Interestingly, I drafted my article while the United States District Court for the Southern District of New York began hearing the first arguments concerning digital assets and their possible classification as securities under Howey. In SEC v. Ripple Labs, Inc., No. 20-CV-10832, 2021 U.S. Dist. LEXIS 69563 (S.D.N.Y. Apr. 9, 2021), the federal judiciary must decide whether the initial coin offering (“ICO”) of the crypto token XRP mirrors the qualities of an initial public offering and meets the threshold as a security under Howey. Not to confuse the issues in Ripple Labs with the legal classifications of NFTs, any current digital asset litigation will significantly affect the SEC’s treatment of future digital asset developments.
Overall, it seems that the NFTs’ general features, including sales and development, do not surpass the Howey Test threshold that categorizes them as securities. Generally, NFTs do not reflect the second, third, or fourth factors in Howey, which require a common enterprise, supported by the effort of others, and a reasonable expectation of profits. Correspondingly, while the current f-NFT market mirrors the first three Howey factors, it does not meet the fourth, “reasonable expectation of profits” factor. Among those assertions, my note proposes solutions to optimize regulating NFT exchanges as the digital asset market expands.
Since July 2022, two states, including Tennessee and Arizona, passed legislation that defines “non-fungible token.” See 2022 Tenn. ALS 861; Tenn. Code Ann. § 9-3-602; 2022 Ariz. ALS 369. However, mainstream use and sale of NFTs began as early as 2021, alongside crypto-economic growth and blockchain technology expansion. Financial experts estimate that the entire crypto-economy has a market capitalization of $3 trillion. While, singularly, the NFT market surpassed a market cap of $40 billion in 2021. Prominent celebrities like Serena Williams, Shaquille O’Neal, Mark Cuban, Madonna, Timbaland, Future, Lil Baby, and many more have invested several thousands of dollars in the prominent NFT collection, Bored Ape. Whereas celebrities like Post Malone, Eminem, and Snoop Dogg have launched personal NFT collections. Beyond any reputable endorsement, entertainment entities and entrepreneurs have found NFTs as valuable assets for consumer and fanbase engagement. There are instances where entertainers like Post Malone have packaged personalized experiences for their NFT purchasing fanbase. Nevertheless, the SEC’s treatment of NFTs could entirely halt this entrepreneurial opportunity for entertainers and their consumer fanbase. Classifying NFTs as securities would require hundreds to thousands in registration fees at the expense of artists, musicians, and digital creatives, who are merely attempting to expand the avenues through which they reach their fanbase.
Wai-Lin Danieley, Meme Regulation: Analyzing the SEC’s Concerns Regarding Digital Assets and Non-Fungible Tokens, 21 Va. Sports & Ent. L.J. 236 (2022).
