Why NFTs Are Not a Safe Haven from Securities Laws

Splitting a high-value NFT into fungible tokens creates a textbook security. The SEC's case against Fractional.art (now Tessera) established the precedent. The Howey Test is triggered by:

• Pooled investment in a common enterprise.
• Expectation of profit from the managerial efforts of the platform.
• Secondary market trading on DEXs like Uniswap.

Projects like EulerBeats and Yuga Labs' Bored Ape Kennel Club used bonding curves to mint NFTs, creating a direct price appreciation mechanism. This is a fatal flaw:

• Automated price increases via the curve signal an investment contract.
• Royalty-sharing models frame the NFT as a revenue-generating asset.
• The SEC views this as a debt or equity offering, not a collectible.

Promising future utility (e.g., Staking rewards, Token airdrops, Game revenue share) attaches a profit expectation to the NFT itself. The SEC's action against Impact Theory's 'Founder's Keys' set the standard. Key risks:

• Explicit roadmaps promising financial returns are a prosecutor's dream.
• Secondary value becomes tied to the promised utility, not the art.
• This model blurs the line into a membership security.

The SEC's first NFT enforcement action established that promises of future value are the key trigger. The company's "founder's keys" were sold with explicit promises of building the brand and increasing value for holders.

• Key Precedent: Marketing language is scrutinized, not just asset structure.
• Outcome: $6.1M settlement and a forced refund offer to purchasers.
• Takeaway: Community-building as a value proposition is a red flag.

The animated series' NFT sale funded production, creating a direct link between purchaser funds and project success. The SEC argued this formed a common enterprise where profits were expected from the efforts of the creators.

• Key Precedent: Using proceeds for a specific project creates an investment contract.
• Outcome: $1M penalty and a cease-and-desist order.
• Takeaway: Utility tied to funding development is a dangerous legal model.

Platforms like Nifty Gateway and OpenSea face scrutiny over their role. By curating drops, promoting artists, and creating secondary markets, they risk being seen as facilitating securities transactions, not just art sales.

• Key Risk: Secondary market liquidity amplifies the investment character of NFTs.
• Precedent: The SEC's case against Coinbase for trading unregistered securities sets a parallel track.
• Takeaway: Curation + trading = exchange liability under the Howey Test.

The SEC's Howey Test hinges on an investment of money in a common enterprise with an expectation of profits from the efforts of others. PFP collections with roadmaps, promised utility, and celebrity endorsements fit this framework perfectly. The legal risk isn't about the JPEG; it's about the marketing and promises surrounding it.

Architect NFTs as consumptive assets with inherent, non-financial utility. This means:

• In-game items with real utility (e.g., wearables, land with gameplay mechanics).
• Membership passes granting access, not just status.
• Tickets or licenses for real-world events or software.
• Explicitly avoid treasury distributions, staking rewards, or promises of future development that drives value.

This 2023 case is the blueprint for enforcement. The SEC sanctioned an NFT project for selling NFTs as investment contracts. Key fatal flaws included:

• Promising to use proceeds to "enhance value" of the NFTs.
• Marketing "tremendous value" for holders.
• Creating a common enterprise where holder profits were tied to the company's efforts.
• This set a clear precedent that fractionalized or not, promotional language creates liability.

Mitigate risk through protocol-level design and clear communication.

• Fully on-chain provenance & metadata: Remove central points of failure and control.
• No centralized treasury or "team allocation": Distribute mint proceeds transparently or to a DAO.
• Clear, legally-vetted disclaimers: State the asset is for use/consumption, not investment.
• Post-mint utility activation: Launch core functionality after the mint concludes to decouple purchase from promoter effort.

For projects where profit-sharing or equity-like mechanics are core, build a compliant security token. This path involves:

• Working with licensed broker-dealers and transfer agents.
• Issuing on regulated platforms like tZERO, INX, or using ERC-3643 standard.
• Accepting KYC/AML requirements and trading restrictions.
• This is the path for real-world asset (RWA) tokenization, not speculative PFPs.

A common misconception is that a secondary market on OpenSea or Blur creates securities status. It does not. The Howey Test is applied at the point of sale from the issuer. If the initial sale was an investment contract, the token remains a security, regardless of where it's traded. The SEC's action against Impact Theory was about the primary sale. Protocol architects must focus on the initial distribution mechanics above all else.