By: Charlotte Golnik
The non-fungible token (“NFT”) market is expanding and expected to reach $231.98 billion by 2030. NFTs traded on platforms like OpenSea are unique digital assets with monetary value that represent real-world objects. Unlike fungible cryptocurrencies, NFTs are non-fungible and cannot be replicated, thanks to digital signatures and smart contracts that secure ownership records on blockchains. When treated purely as collectibles, NFTs are likely not subject to securities laws. However, if a trading platform treats NFTs as investments to raise funds, the SEC may intervene, and NFT investors are taking notice.
In the absence of regulatory clarity regarding NFTs and their securities status, federal securities laws seemingly did not regulate NFT trading because the definition of “security” in the Securities Act of 1933 does not include digital asset trading mechanisms, nor would they likely qualify for a registration exemption. However, the definition does include investment contracts. In SEC v. W.J. Howey Co., the Supreme Court held that investment contracts exist when individuals invest money in a common enterprise with a reasonable expectation of profits from another’s efforts. Interpreting investment contracts in this way aligned with the Securities Act’s purpose of fully protecting investors. In response to the Howey test and digital asset development, the SEC released its “Framework for ‘Investment Contract’ Analysis of Digital Assets” in 2019 (the “Framework”). The Framework outlines the Howey test and provides examples of when instruments might qualify as investment contracts. It guides digital asset platforms in determining whether their instruments are investment contracts—and thus securities—requiring registration with the SEC.
When assessing the first part of the Howey test, investments need not be cash. For the common-enterprise prong, federal courts (but not the SEC) require proof of horizontal or vertical commonality, which examine the relationships between individuals’ investments or the investors collectively and active participants (“AP”). The final two prongs of the Howey test (which are often combined) are satisfied when an AP contributes critical management efforts that influence the success of the venture, and investors reasonably expect to earn profits from those efforts. Securities regulators look at the economic reality of the transaction, considering whether investors reasonably expect to depend on the AP’s efforts and whether those efforts are critical to the venture’s success or failure.
Using the Howey analysis, the SEC charged and ultimately settled with two NFT offerors in 2023 for unregistered security offerings: Impact Theory (“IT”) and Stoner Cats 2 LLC (“SC2”). IT’s investors reasonably expected profits based on IT’s assurances that investors would benefit from IT’s success through NFT purchases. Similarly, SC2’s marketing campaign emphasized NFT ownership advantages, including resale potential, leveraging its crypto and Hollywood expertise to suggest profit opportunities from rising resale values. SC2 also designed its NFTs to generate a 2.5% royalty on secondary transactions, inducing investors to expend over $20 million across 10,000 trades. These settlements may have far-reaching implications for ongoing federal cases.
Boasting itself as “the first and largest marketplace for NFTs” since 2017, OpenSea represents one of those cases. In maintaining this status, OpenSea expended considerable efforts by partnering with popular entities for NFT launches and increasing NFT visibility. It also charges a 2.5-10% fee for primary drops and a 2.5% fee for secondary sales. In a bid to invest in its success, OpenSea placed most of its cash reserves into a single cryptocurrency to “put its money where its mouth was,” but the currency’s value plummeted nearly 80% by June 2022.
In the same year, the SEC issued third-party subpoenas to OpenSea regarding other entities. OpenSea and its legal team initiated a vocabulary guide for its employees to avoid terms associated with securities and emphasized the new terms’ “impacts [on OpenSea’s] tax and legal obligations.” Some instructions included using “purchase on the blockchain,” instead of “buy, sell, or pay on OpenSea,” and to avoid using terms like, “exchange,” “broker,” “marketplace,” “profit,” “shares,” and basically any form of “trade.” These efforts proved futile, as OpenSea received an SEC Wells Notice and lawsuit in August 2024. OpenSea founder Devin Finzer responded to the Wells Notice, asserting that the platform does not facilitate securities trading, as NFTs are “collectibles, digital art, game items, and event tickets, among other uses” and classifying NFTs as securities would threaten innovation and artists’ livelihoods. While the Wells Notice simply informed OpenSea of the SEC’s intention to initiate enforcement actions, the Shnayderman Complaint alleges that OpenSea offers and sells NFTs as investment contracts, thus classifying them as unregistered security interests.
As platforms like OpenSea advocate for NFTs to remain collectibles rather than securities, they claim to prioritize individual consumers and creators; however, this does not exempt them from security registration requirements, particularly when they meet the components of the Howey test. OpenSea’s offerings easily meet the first two prongs of Howey, as investors pay for the NFTs and with the expectation of profits tied to OpenSea’s efforts and development. Regarding the final two Howey prongs, OpenSea attempted to improve its chances of compliance with its vocabulary guide, yet it fundamentally overlooked the economic reality of its NFT transactions. As investors witnessed OpenSea’s rising success, they reasonably expected the platform to continue making sound decisions after purchasing NFTs, thereby increasing their resale profits in OpenSea’s secondary marketplace. Instead, OpenSea’s decisions critically affected its reputation and undermined investors’ anticipated profits, which depended on OpenSea’s success.
Furthermore, OpenSea’s implementation of a vocabulary guide for customer interactions suggests that customers viewed their NFTs as securities; indeed, a semantic workaround would likely be unnecessary if the offerings were truly non-securities. This underscores why Howey interpreted investment contracts so broadly: powerful companies with nearly unlimited resources should not be able to exploit the investing public through dubious practices like OpenSea’s vocabulary guide.
Despite OpenSea’s best efforts, the Securities Act’s protective purpose will likely compel NFT security registration as investment contracts. The SEC and the Supreme Court dictate that if something functions as an investment contract, it qualifies as one. Recognizing who securities laws aim to protect will offer valuable guidance to digital asset trading platforms like OpenSea.
Student Bio: Charlotte Golnik is a second-year law student at Suffolk University Law School. She is a staff writer on the Journal of High Technology Law and is Events Co-Chair of the Women’s Law Association on the Events Committee. Charlotte received a Bachelor of Arts degree in Linguistics from The Ohio State University in 2018 and a Master of Arts in Forensic Linguistics from Hofstra University in 2022.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.
