SEC warns fractionalized non-fungible tokens could be illegal amid NFT mania

Investors are increasingly investing millions of dollars in startups in the non-fungible token (NFT) industry, which has gained massive popularity this year as prices of popular cryptocurrencies like Bitcoin and Ether have climbed significantly.

Fractionalized NFTs could be against the law

The US Securities & Exchange Commission (SEC) commissioner Hester Pierce warned that issuing fractionalized NFTs could be considered investment contracts under the country’s securities law. 

Although the concept of NFT is to be non-fungible, which points to the fact it would be less likely to be deemed a security, Pierce highlighted that “people are being very creative in the type of NFTs they are putting out there.”

Fractional NFTs allow for retail investors to gain exposure to many highly-priced NFTs, which gives partial ownership rights to the buyers. 

Pierce further warned issuers to proceed with caution when selling fractional interests on NFTs and urged sellers to make sure that it is not an investment product that is being created. 

Investors pour $90 million into the NFT space

While the NFT mania continues to take on mainstream media, investors have poured $90 million into digital collectible companies and NFTs in 2021, according to CNBC data. Blockchain-based football game company Sorare raised roughly $50 million in February, led by venture capital funds including Benchmark and Accel.

Andrei Brasoveanu, the general partner at Accel, said NFTs are among the most exciting developments in the cryptocurrency industry the firm has seen for years. He added:

It’s one of those developments that has mass market appeal and could potentially impact a world outside the crypto niche.

NFTs have recently gained recognition in the wider market, with prominent celebrities including Snoop Dogg, Mark Cuban, Grimes, Lindsay Lohan, and Jack Dorsey launching their own unique tokens.

Twitter CEO Jack Dorsey sold his first-ever tweet for $2.9 million at the time of the sale, while Elon Musk also announced that he was selling his tweet, but later decided against it, saying “it doesn’t feel quite right selling this.”

Non-fungible tokens are no stranger to the sports industry as well. Dapper Labs launched an NFT platform aimed at basketball fans, which allows users to purchase and sell video highlight clips of iconic NBA basketball plays as NFTs.

From non-existent to a multi-million dollar marketplace

According to CoinMetrics, ERC-721 smart contracts that run on Ethereum to power most NFT tokens and have reached a new all-time high of roughly 19,000 amid the recent boom. 

In February 2021, NFT marketplaces traded a staggering $342 million, up from $12 million in December 2020. In the past few months, the NFT market has gone from “virtually non-existent to a flourishing multi-million dollar decentralized marketplace,” said Mati Greenspan, founder of Quantum Economics. 

Although NFTs have gained explosive popularity in recent months, ERC-721 contracts remain a relatively small portion of overall smart contracts deployed on the Ethereum network. 

With the massive growth in the industry, speculators have doubts about NFTs as an asset class. John Egan, CEO of L’Atelier BNP Paribas, said in an interview that NFT is one of the riskiest categories of assets out there.

Beeple calls NFT a bubble

In early March, digital artist Mike Winkelmann, known as Beeple, sold his famous digital artwork NFT for $69 million, making it the third most expensive artwork sold by a living artist. 

Despite his success with selling his NFTs, he admitted that NFT art is “absolutely” a bubble. He explained:

I absolutely think it’s a bubble, to be quite honest. I go back to the analogy of the beginning of the internet. There was a bubble. And the bubble burst.

The digital artist was “spooked” by Ethereum’s price volatility and immediately converted all the capital to US dollars. 

However, Winkelmann believes that the technology behind NFTs could be strong enough to outlive the bubble, much like the case with the internet.