By: Mauro Wolfe and Vincent J. Nolan III
Following the January 23, 2025 White House Executive Order on crypto (see our post on that executive order here), and its aggressive timeline for developing a crypto-friendly regulatory environment, it appears that all levers of government have been switched “on” when it comes to the world of digital assets. From the Executive Office working group that includes the top agencies and government departments, to the halls of Congress, discussion of all things crypto – and especially the development of legislation (i.e., revamping FIT21), is at the forefront in Washington. In this article, we take a look at one aspect of the discussion: NFTs as digital assets and current proposed legislation to regulate.
NFTs are unique digital assets that represent the ownership of a digital item or real-world asset that are recorded on a blockchain. “Non-fungible” means that, unlike, say Bitcoin, where one Bitcoin is exactly the same as another Bitcoin in the same way one dollar bill is identical to another one-dollar bill, an NFT is a unique, one-of-a-kind digital asset showing ownership of a specific and unique asset, like a piece of art.
So, what is so special about NFTs and why are we interested? The future of NFTs could be big. There are numerous and interesting use cases for NFTs beyond digital images of apes (digital collectibles). The use cases include: digital identification, real estate, art and music, healthcare and medical research, metaverse transactions, car ownership, insurance, consumer rewards, banking and credit. The options are limitless. By some estimates, the global NFT market could reach $14 billion USD by 2027, or $265 billion by 2032, at a growth rate of 30% or more. So, getting legislation and regulation on NFTs wrong could be a deal breaker. NFTs use of blockchain makes proof of ownership fast, efficient, tamperproof, and verifiable.
What is the current state of legislative proposals on NFTs? For today’s article, we want to focus on the resurrection of the New Frontiers in Technology Act (the NFT Act), originally released in September 2024 in the 118th Congress by Congressman Scott Timmons (R-SC) and co-sponsored by Congressman Ritchie Torres (D-NY). That bill has resurfaced and is aimed to be added in the crypto legislation passed by the House last year, known as FIT21, which is now in the process of being revised in preparation for another attempt at passage.
How does the NFT Act propose to deal with NFTs? The answer is: it is limited and “it’s complicated.” The NFT Act expressly removes “Covered Non-Fungible Tokens” from the definition of a security or an investment contract under US securities law and the now well-known Howey test. What kind of digital assets fall within this category? The NFT Act includes NFTs which are, “developed primarily for personal, family, or household consumption,” and includes things like: art, music, literary works, intellectual property, collectibles, merchandise, virtual land, or video game asset, among other categories.
However, within that definition, there are specific exclusions that relate to how the NFT is marketed or used. Specifically, if the NFT is a work of art, but the NFT is “marketed by an issuer or promoter… primarily as an investment opportunity,” or promises activity designed to increase the value of the NFT, then the NFT is no longer a Covered Non-Fungible Token and may be a security. Further, other exclusions apply. For instance, NFTs that represent digital ownership of securities or commodities will not be included in the definition of a Covered Non-Fungible Token. In effect, it appears that there are two categories for NFTs. They are either a security or a commodity. Finally, the NFT Act requires the Comptroller General of the U.S. to study NFTs and report to Congress within one year, addressing questions about the NFT market.
The NFT Act still needs some work. As drafted, it appears that the NFT Act does not directly address the role of NFT marketplace exchanges. Additionally, the NFT Act is very narrow and provides limited protection for market participants. For example, if a fine artist paints a picture, and creates an NFT through an art dealer who specializes in NFT art for collectors and an LLC subsequently acquires the NFT, is that a security or a commodity, or both? The answer is unclear and “it’s complicated.” Hopefully, we receive more clarity from Congress and the relevant regulators as to how NFTs will be treated and how this will all work.
Duane Morris continues to monitor developments in digital assets and the blockchain sector so we can adequately advise our clients. We look forward to seeing the next proposed piece of legislation that impact NFTs.