Why the U.S. Securities and Exchange Commission's view on NFTs is wrong?
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Why the U.S. Securities and Exchange Commission's view on NFTs is wrong?
Regulatory ambiguity toward NFTs further exacerbates the problem of legal over-enforcement, thereby undermining the rule of law.
Navigating Web3 tides with focused insightsAuthor: Edward Lee
Translation: Scott Liu, BitpushNews
In the 2024 book *Over Ruled*, Supreme Court Justice Neil Gorsuch and Janie Nitze document the rapid expansion of federal law—not only through congressional legislation and court rulings but also via the growing body of rules, regulations, informal public guidance, and enforcement actions issued by federal agencies. What began as a single volume has now grown to 54 volumes exceeding 60,000 pages. In 1936, federal agency rules spanned just 16 pages; today, they exceed 200 volumes and 188,000 pages. Within these rules, there may be over 300,000 provisions carrying criminal penalties. More troubling still, federal agencies sometimes not only create and enforce binding rules but also act as prosecutors and judges.
While this expansion may reflect modern society's complexity, as the book argues, it has also led to over-enforcement of federal law at the individual level—often beyond the original intent of the statutes. When laws are enforced aggressively based on weak or even erroneous interpretations, the rule of law itself is undermined.
Unfortunately, the SEC’s ambiguous treatment of non-fungible tokens (NFTs) exemplifies this very problem. The regulator’s unclear stance on NFTs exacerbates over-enforcement and further erodes the rule of law.
In 2021, the digital art market flourished. NFTs offered artists an innovative way to sell their work and receive economic benefits through resale royalties. Yet despite $27 billion in NFT sales that year, the SEC issued no clear guidance on whether NFTs constituted securities—and top law firms had no definitive answers either.
By 2023, as the NFT market cooled, the SEC introduced another risk: potential lawsuits. The SEC announced settlements with two NFT projects, alleging their NFTs were investment contracts and unregistered securities. Although these settlements set no legal precedent and the parties admitted no wrongdoing, the SEC required both projects to destroy their NFTs. As a result, neither project survived. Other companies, such as GameStop, also terminated their NFT initiatives due to "regulatory uncertainty."
At the end of August, the SEC acted again. OpenSea revealed that it had received a Wells notice from the SEC, signaling potential enforcement action over its sale of NFTs as unregistered securities. While a Wells notice does not guarantee litigation, it typically precedes formal legal proceedings.
The news unsettled NFT artists and businesses. On social media, some even discussed the possibility of facing criminal charges. While such fears may lack legal basis, the market’s anxiety is real. By selectively targeting NFT projects and companies for enforcement—without issuing any formal rules or public guidance—the SEC has deepened uncertainty across the entire NFT ecosystem. This uncertainty deters artists from creating NFTs and stifles NFT-related business ventures.
But the SEC’s approach risks more than regulatory ambiguity—it may be unconstitutional. As I explain in an upcoming article in the *U.C. Davis Law Review*, requiring artists to register their NFT offerings with the SEC before selling them amounts to a prior restraint on artistic expression, violating the First Amendment. The Supreme Court has long held that prior restraints on speech—including pre-publication licensing or registration—are “the most serious and least tolerable infringement” on First Amendment rights. Such restraints enable censorship and suppress speech. Even delays in releasing artistic works raise serious constitutional concerns. Delayed speech, the Court has said, is tantamount to suppressed speech.
Artists should not have to hire securities lawyers before selling an NFT—or risk prosecution by the SEC. A system of prior restraint harms society. As the Supreme Court observed in election-related cases: “Many people would rather choose not to express protected speech than bear the heavy burden (and sometimes risk) of litigating their rights case by case.” This harms not only individuals but society as a whole, which loses the benefit of a free marketplace of ideas.
The solution to this constitutional problem is straightforward: the SEC and courts must return to the original meaning of the Securities Act of 1933—what the statutory text actually says. That is precisely what the Supreme Court recently did when interpreting the National Firearms Act of 1934. In 1933, the term “investment contract” referred to a specific type of investment: a contractual right to a share of profits from the efforts of others. When the Supreme Court interpreted “investment contract” in 1946 in *SEC v. W.J. Howey Co.*, it affirmed the ordinary meaning recognized by a state supreme court in 1920. Every Supreme Court case finding an investment contract—including Howey—involves this kind of profit-sharing right, or a “promise of profit.”
Of course, an investment need not be labeled an “investment contract” to fall under securities regulation. Because the Securities Act applies broadly to any offer, the existence of a formal contract is not dispositive. However, to qualify as an “investment contract,” the offer must involve a contractual right to profit shares from the issuer’s efforts. Without such a profit-sharing right, an offering may be an investment—but not an investment *contract*.
The SEC or courts cannot ignore the word “contract” in the Securities Act. That term exists precisely to distinguish investment contracts from other forms of investment, such as purchasing art or collectibles. Hermès allows buyers to purchase Birkin bags, and investors may reasonably expect to profit from Hermès’ efforts to maintain scarcity and value. But that expectation of profit does not turn a Birkin bag into an investment contract. The same holds true for NFTs. Buying a collectible—whether a Birkin bag or an art NFT—is fundamentally different from entering an investment contract: the former lacks the profit-based contractual rights that define the latter.
If the word “contract” in the Securities Act continues to be ignored, the Supreme Court will ultimately have to intervene. The rule of law demands nothing less.
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