An emerging asset class- nonfungible tokens (NFTs)- has taken the crypto world by storm. NFTs are used by blockchain games, crypto artists, and countless others because of their digital scarcity and uniqueness, capturing the attention of investors and consumers alike. This is no longer a tiny niche. As of 2021, the NFT market was valued at $40 billion, and that’s not accounting for the most recent boom. As the market evolves, so do the legal and regulatory issues, presenting various policy concerns from intellectual property rights to cybersecurity concerns.
Here’s a terrifying thought: the US government doesn’t know how to regulate the $2.5 trillion crypto market, and NFTS- a small segment of that market- have made that abundantly clear. It’s not that laws don’t exist, or that Congress is uninterested in digital assets. In fact, the President’s Working Group for Financial Markets Stablecoin report, the Fed’s pending central bank digital currency report, and that Securities and Exchange Commission Chairman Gary Gensler’s adamance that crypto belongs under SEC’s watch are all indicative that even if lawmakers have no clue what they are, NFTs move to influence Congress.
There’s a lack of consensus on how to apply existing regulations to an industry that seems to mutate every few weeks, even when crypto has no partisan bent.
Background & Popularity
In a technical sense, an NFT is just a unique token on the Blockchain. Most NFTs are a part of the Ethereum blockchain- a cryptocurrency like bitcoin. NFTs can be anything digital; videos, drawings, music- but the current boom is around using tech to sell digital art. The “nonfungible” component is designed to give you something that can’t be copied, and complete ownership of a work. To put in terms of physical art collecting: anyone can buy a Mona Lisa print, but only one can own the original.
While crypto is abstract, complex, and snarled in a web of tech, coding, and economic theory- NFTs are a bridge to worlds that are fun. They’re the gateway to massive new audiences, with minimal barriers of entry. Tech entrepreneur Anil Dash and artist Kevin Mccoy introduced “monetized graphics” in 2014, with the idea to give artists a chance to make money and retain control over their work via vis non- interchangeable digital assets. Three years later, NFTs took off when prices of CryptoKitties tokens began to climb. The space is now populated with just about everything; artworks, videos, gifs, memes, and some of the most influential names in sports, fashion, and culture.
It’s almost impossible to keep track of NFT developments, and policymaking is lagging substantially. While the legislative landscape around crypto has matured tremendously since 2019, NFTs reveal the biggest cracks in crypto policy.
Classification & Federal Law
How lawmakers go about regulating NFTs is predicated on how they’re classified- and that seems to be a point of confusion.
By their nature, NFTs can be linked to a variety of different assets, representing various rights and obligations. They’re considered tradable assets that serve as units of cryptocurrencies, but also represent other things of value. NFTs could qualify as commodities- under the Commodity Exchange Act– as they are bought, sold, and held using Blockchain technology. Alternatively, NFTs could qualify as securities, in which case they’re subject to common securities laws, and agency oversight under the SEC. There’s also a question of whether The Financial Crimes Enforcement Network (FinCEN) defines NFTs as “value that substitutes for currency”. If it does, NFTs are subject to FinCEN regulations- particularly anti-money laundering laws and sanctions. And if NFTs aren’t considered substitutes for currency, they simply aren’t under FinCEN’s oversight. But for now, there’s no definitive answer to what NFTs even are, technically.
To muddle things further, crypto lingo isn’t without its loopholes. Just last year, as a part of a trillion-dollar bipartisan infrastructure bill, cryptocurrency “brokers” were put on the hot seat for tax reporting. But the definition of what a broker is, in the crypto world, was up for debate. Specifics were missing. This is a recurring theme: as Congress continues to grapple with the digital space, and uncharted territories, pitfalls in language and definition redirect the path forward completely.
Cybersecurity & Data Protection
NFTs thrive from decentralized digital platforms that allow people to buy and sell freely, and with this comes a myriad of vulnerabilities.
It goes without saying that NFTs can be exploited by hackers. The fact that NFTs are fully digital assets alone means they’ll likely be targeted with greater frequency by cybercriminals. But the Blockchain also presents unique risks, such as built-in smart contracts- which can be broken, manipulated, or exploited. ‘Crypto Punks’, one of the most popular NFT projects in history, was affected by a bug that prevented cryptocurrency from going into the seller’s wallet in 2017. And even though the Blockchain exists on the internet, it’s a markedly unique corner. Common internet regulations don’t hold up. Take, for instance, the fact US users have the right to alter and delete private information online under common data protection laws, such as the California Consumer Privacy Act. How this translates to the Blockchain isn’t so straightforward. The Blockchain can actually prevent users from this right because of the obstacles it imposes; it’s not necessary that users disclose their identities. NFTs can violate rudimentary data protection principles.
There’s no dispute that Blockchain technology is risky. Until further security measures are taken, NFTs will remain the wild west of crypto. And even with more comprehensive security measures, such as the EU’s proposed Markets in Crypto Assets Regulation, there’s a pronounced need to enforce a more nuanced body of laws.
The virtues and founding principles of cryptocurrency- that it’s decentralized and unregulated- are also its vices. NFTs showcase all the pitfalls. The stakes are high for the crypto industry: until it becomes a part of the regulated economy, it will be associated with a notion of criminality. It’s not a stretch to say that the future of crypto is uncertain. What is for certain is that lawmakers consistently misunderstand and underestimate this new digital space. The parameters are always changing. The policy considerations are plenty and tangled. Washington is paying attention to crypto, but perhaps not enough.