Is Online Art a Security? The Debate Over NFTs

Beauty is reputed to be in the eye of the beholder. Where some see ugly apes, others see creative joy. Perhaps nowhere is this more prevalent right now than in the online world. Does a virtual piece of art carry the same value as a physical one? Is it considered art, or something else?
Over the past few years, the U.S. Securities and Exchange Commission (SEC) has begun to challenge some transactions involving non-fungible tokens (NFTs). This has brought a firestorm of criticism from creators, along with lawsuits as well. What's going on in cyberspace?
WTF Is an NFT?
While the term NFT is becoming more common, the details are still a mystery to many. To understand what a non-fungible token is, it might help to identify a fungible token. To start, fungible tokens are uniform, interchangeable, and divisible. Think of currency, either hard or crypto. Every U.S. dollar bill carries the same value. If broken down into smaller values, they remain uniform.
Fungible tokens are commonly used in markets as a means for conducting transactions. Since the value is uniform, it provides a stable type of currency. NFTs, on the other hand, are designed to be unique. Cutting a painting by Picasso into quarters wouldn't give you four pieces bearing equal value. The worth of any particular NFT can't be broken down into separate bits.
Because they're unique, each NFT has a distinct value. They're not swappable or interchangeable with another NFT unless both owners make a separate agreement that they are. Unlike currency, which has no provenance, NFTs have all transactions recorded on their particular blockchain. This acts as a ledger showing past and current ownership.
NFTs can be different things and serve a variety of roles. While some are designed to be observed as digital art, others act as proof of membership or an admission ticket. When NFTs began being issued with certain promises regarding value (specifically, the likelihood of that value increasing) the Securities and Exchange Commission (SEC) got involved.
This Is Howey Do It
Along with the Treasury Department, the SEC has been wary of how NFTs are being bought and sold. Because every sale involving an NFT is recorded on its blockchain, original creators can track each subsequent transaction to earn further revenue if the original sale contains such a provision.
While that's legal, the SEC has acted against what it perceives to be violations of SEC v. Howey. It uses the Howey Test to determine if the NFTs are being offered as securities instead of unique tokens. If pitching the NFTs as a source of potential profit, the creators may be guilty of selling an unregistered security and face legal action from the SEC. Resale royalty payments are also under scrutiny.
Issuers and would-be issuers of NFTs have expressed dismay and concern at the SEC's response. They accuse the SEC of selectively enforcing an area without regulatory guidelines or rules. Some have launched pre-emptive strikes in the form of civil complaints.
But Is It Art?
In a July 2024 filing, a musician and an artist alleged that the SEC is overstepping its authority by asserting jurisdiction over the sales of digital art. The case is pending.
The plaintiffs' concern is not without cause. Celebrity Mila Kunis faced just such scrutiny for her sale of the cartoon Stoner Cats in 2023, which we previously wrote about. That case was ultimately settled and all NFTs were destroyed as part of the agreement.
So, are NFTs art or a new type of security? As the U.S. government tries to determine its authority over NFTs, many issues like the ones listed above will either end up in court or trigger legislative action from Congress.
In the meantime, agencies like the SEC will continue to try to apply the rules and laws they've used as guidelines all along. Whether these can adapt remains to be seen.
Related Resources
- Can You Legally Pass on Cryptocurrency or NFTS in a Will? (FindLaw's Estate Planning Basics)
- Mila Kunis' Show Stoner Cats Says 'TTFN' to NFTs (FindLaw's Legally Weird)
- The Securities and Exchange Commission: Overview (FindLaw's Security Law)