Are NFTs securities?
In this episode, Ryan Adams and David Hoffman are joined by Brian Frye to discuss NFTs, securities, SEC, value capture, public goods, copyright law and more.
Read our notes below to learn more.
About Brian
He went to Art school and Law school.
Law Professor at the University of Kentucky.
Former securities lawyer at Sullivan and Cromwell Wall Street law firm in 2007 to 2010.
Worked for Goldman Sachs in the side of securities law related to litigation work and some IPOs.
Are all NFTs Securities?
The SEC isn’t in the business of deciding whether or not things are in our security.
The Howey test (test used to determine if something is a security) is so broad that any investment can be a security.
The primary mandate of the SEC is to create and maintain healthy capital markets which are supposed to be making the market better.
Conceptual art in particular sure looks a lot like a security.
Brian wrote an article titled “SEC No Action Letter Request” which consisted of sending the SEC a no letter action request proposing to sell a work of conceptual art.
The SEC is a very unique federal agency and was formed back in 1934 when federal agencies were not that common and most of them were relatively small.
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Brian’s project was trolling the SEC.
No Action NFT was composed of 200 editions.
After Brian did the NFT project, he sent a second letter of no action request to the SEC asking why the NFT project was also the sale of an unregistered security.
Securities were invented because they were a really good tool for maximizing the value of capital or maximizing people’s ability to use capital to productive ends.
Securities were a financial innovation that people invented in order to facilitate the investment and distribution of capital.
Securities predated Blue Sky laws.
The SEC was created for a purpose which was to make the financial markets work in a more regular, more predictable and less vulnerable to fraud fashion.
The SEC was not designed to regulate the art market.
New Securities
Coffee, wheat, gold and $BTC are very commodity like assets and there is zero material non-public information about these things as in zero privileged parties or zero coordinated centralized entities.
Businesses like Apple, Amazon and Tesla are registered compliant securities and are a centralized coordinated team that does have material non-public information that the public does not know.
Security assets are assets that are produced by humans.
Commodities assets are assets that are produced by nature.
Part of the struggle that the SEC is really wrestling with is understanding what its real purpose and mission is in a world where most of the security disclosures that they require are irrelevant to an overwhelming majority of investors.
Most or all retail investors don't really pay attention to security disclosures and mostly rely on market prices.
An overwhelming majority of retail investment is driven by perception of brand equity rather than anything that has anything to do with the fundamentals of particular companies.
The art market is largely controlled by insiders.
The SEC as a regulator should be thinking harder about what they can do well and how they can use their regulatory powers in a way that’s going to benefit the market.
The regulators need to understand the markets they’re regulating.
Creative Assets
NFT has the potential of giving creators access to capital markets to enable people to invest in their project in the hope of making a profit.
People think of the art market as a market for objects but it's not.
The only thing that’s valuable in the art market as an investment market in art is the attribution.
The cool thing about the NFT market is it got rid of the physical token and all of the sudden we could see how the market actually worked.
NFTs reduced the transaction costs of producing authorship goods.
Copyright Law and Clout Sales
Copyright was invented to enable publishers to invest in the production and distribution of works of authorship copies with some degree of financial certainty.
Copyright was a decent way of reducing transaction costs when publication and distribution were expensive.
Copyright law was a policy tool designed to solve certain kinds of market failures.
It was a way of minimizing competition in the production and distribution of works of authorship in a way that made it more economically feasible for publishers to do that.
Copyright was initially an industry self-regulation and wasn’t enshrined into law until hundreds of years after the stationers company in London.
When the technology changed, it stopped being a valuable policy tool because the publication, distribution costs and marginal costs of reproducing are now zero.
The NFT technology reduced the transaction costs just enough that all of a sudden that latent demand exploded.
The premise of copyright is artificial scarcity.
There’s no need for artificial scarcity in a world of perfect abundance.
Copyright has always been a terrible way of encouraging the production of works and never really benefited artists.
Public Goods
Information wants to be free.
People want to be able to speculate on what’s going to be valuable in the future.
Introducing speculation to the creative economy from the perspective of the consumer is actually an incredible monumental shift.