- The SEC could determine that NFTs are securities subject to regulation, which would make selling them a decidedly unattractive option.
Everyone’s heard of cryptocurrency. It’s the twenty-first-century gold rush, with feverish investors throwing money at every new opportunity, the more ridiculous, the better. A touch of kismet and a joke like Dogecoin becomes a blue-chip investment. These days, you can even buy Bitcoin at a gas station ATM, although it’s unclear what you can do with it.
Anyway, the latest entry in the crypto craze is non-fungible tokens or “NFTs.” Essentially, an NFT is an encrypted unit of data stored on a digital ledger, just like any other crypto asset. However, in theory, NFTs are different because each one is unique. Specifically, an NFT is a “token” because it at least nominally represents some other asset and is “non-fungible” because it isn’t interchangeable with any other NFT.
NFTs were invented in 2014 by Kevin McCoy and Anil Dash when they created a blockchain marker linked to a video clip by Jennifer McCoy. But they didn’t catch on until 2017 when Larva Labs released CryptoPunks and CryptoKitties, which enabled users to create and trade unique digital cartoon characters. Gradually, people began investing millions of dollars in NFTs of various kinds, from virtual sneakers to sports highlights.
And then, in 2021, the NFT market exploded. All of a sudden, everyone was selling NFTs of everything imaginable, and demand was seemingly insatiable. Grimes sold about $6 million of assorted NFTs, Chris Torres sold an NFT of a Nyan Cat GIF for $600,000, Mike “Beeple” Winkelmann sold an NFT of his digital artwork Everydays: the First 5000 Days at Christies for $69.3 million, Jack Dorsey sold an NFT of his first tweet for $2.5 million, and Kevin Roose sold an NFT of his New York Times article about NFTs for $558,000.
What happened? Who knows. A lot of people suddenly wanted to spend a lot of money to buy nothing. Because that’s what an NFT is, nothing.
There are two problems with NFTs. They don’t work, and they’re probably illegal. I know, it sounds bad. But bear with me, it might still be ok.
In theory, owning an NFT is supposed to mean owning the asset it represents. But it doesn’t and can’t. While NFTs are nominally linked to other assets, the connection is purely notional. There’s no intrinsic relationship between an NFT and the asset it purports to represent. You can sell an NFT of an asset without selling any ownership interest in the asset itself. In fact, you can sell an NFT of an asset you don’t even own. Why? Because when you sell an NFT, all you are selling is the NFT, nothing more. For example, I sold an NFT of the Brooklyn Bridge, which I certainly don’t own. Many NFT markets try to prevent people from selling NFTs of works they don’t own; however, there’s no particular reason for the limitation, other than the tendency of authors to get mad when people sell NFTs of their work without permission.
Of course, the owner of an asset can sell an NFT of the asset and the asset itself at the same time to the same person. But then the buyer just owns the asset and an NFT. Nothing binds them together. The new owner can sell the asset and the NFT together or separately, at their discretion.
Let’s make it more concrete. The killer app of NFTs is supposedly to make selling art easier and more transparent. Does it work? Most artists create tangible objects. They own both the object and the copyright in the intangible work of authorship it represents and can sell them separately. Of course, artists can also sell NFTs of their work. But if the buyer of an NFT doesn’t own the object or the copyright, what’s left? Nothing but a naked NFT, with no actual connection to the artwork.
They’re in a pickle because the tangible object and intangible work of authorship merge and become indistinguishable. In theory, digital artists can sell NFTs of their work in lieu of tangible objects. But what’s the difference? The right to use digital works belongs to the copyright owner, who is usually the artist. So the owner of the NFT gets nothing other than the right to claim ownership of the NFT, which still has no actual connection to the artwork it nominally represents.
It’s not as bad as it sounds. The art world has long recognized and respected ownership of reproducible or uncopyrightable works via certificates of ownership. Artists simply declare that the work exists in a limited edition and sell editions as if they were unique objects, even though the limit is purely artificial. In any case, the owner of an edition typically has the right to exhibit the work or permit others to exhibit the work.
NFTs could do the same thing. After all, an NFT is literally a limited edition unit of data. The author of a work could create an NFT of the work and stipulate that the owner of the NFT also has the right to exhibit the work. But why? The NFT is doing the same thing as a certificate but in a riskier and more burdensome way. What if the owner of the NFT loses the password and can’t access it anymore? And what about the fees associated with NFT transactions, which can be substantial? When it comes to art, it seems like NFTs are a solution in search of a problem.
Even worse, the one thing NFTs could do well is anathema to the art market. NFT evangelists tout their ability to increase transparency. But transparency is the last thing the art market wants. On the contrary, it thrives on secrecy and opacity. Art market success depends on access to information and product. For better or worse, transparency would be a disaster.
So, NFTs might be pointless or even undesirable. But the bigger problem is that they might also be illegal. The Securities and Exchange Commission (SEC) regulates the issuance and sale of securities. Under US law, “securities” are broadly defined to include any investment in a common enterprise that generates profit from the efforts of others. Of course, shares in a company are securities. But lots of other things are as well. Until recently, the SEC mostly hasn’t regulated crypto assets, with the notable exception of initial coin offerings. But it could very well determine that NFTs are securities subject to regulation, which would make selling them a decidedly unattractive option. Time will tell, but artists, be wary. When the main chance looks too good to be true, it often is.
Despite their shortcomings, NFTs may still be tonic for art. It’s a truism that money is bad for art. It creates terrible incentives for artists and distracts audiences from the art it comes to represent. Art is reduced to its price tag, and artists complain all the way to the bank. But maybe NFTs can solve the problem by destroying the art market? If it turns out that all collectors really care about is money, NFTs are much more convenient than artwork, which must be stored and maintained. If NFTs manage to suck the money out of the art market, artists and their patrons will have fished their wish. It remains to be seen whether they will enjoy their reward.