If Fractionalized NFTs Were Regulated as Securities, How Would It Affect Investors?

NFT (Non-Fungible Token) Futuristic Background.
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NFTs are continuing their explosive growth, and now, the Securities and Exchange Commission (SEC) is reportedly probing into their trade, calling for more information specifically on so-called fractionalized NFTs.

This comes against the backdrop of President Joe Biden’s executive order on digital assets signed this week — an order which signaled intentions of regulating the crypto space, and which was largely lauded by the industry.

Now, Bloomberg reports that a key legal question is whether digital assets — including NFTs — are securities, and therefore subject to the same rules as stocks. The outlet added that in recent months, the SEC’s enforcement unit has sent subpoenas demanding information about the token offerings, with a large focus on fractionalized NFTs.

While the crypto market at large is struggling, the NFT space — nascent in comparison — is faring very well. In 2021, the global market value for NFTs hit $23 billion, per blockchain analytics firm DappRadar. Further, a sub-sector — fractional NFTs — experienced a rapid growth as well, as they had an overall market capitalization of around $212.6 million by Dec. 12, 2021, according to Bitcoin.com.

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But what are fractionalized NFTs?

As the name suggests, a fractionalized NFT is a single NFT divided into pieces — a scenario which grants multiple people part-ownership of the collectible, Rebekah Keida, an NFT expert and head of marketing at cryptofinance firm XBTO, told GOBankingRates. From a technical perspective, these NFTs feature smart contracts that break up the asset’s token for any number of owners, she added.

“Fractionalization is most typically implemented in high-value collectibles, expanding access to these items beyond the mega-wealthy. They are really meant to grow accessibility, democratization and participation in the NFT space,” Keida said. “In terms of the larger ecosystem, fractionalized NFTs also boost liquidity, given more people can participate in the market.”

While Biden’s executive order on cryptos did not expressly address NFTs, many assume — as the government seeks more information related to crypto — they will look into NFTs as well.

“Within the NFT ecosystem, I can confidently say that almost everyone is desperately waiting for fair regulation,” Keida said. “Fractionalization is expected to be a high-focus area, but most platforms that offer this service have always been aware that they would eventually have to adjust their operations to be compliant.”

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Anthony Georgiades, co-founder of NFT infrastructure provider Pastel Network, echoed this sentiment. He told GOBankingRates that, as Biden’s executive order requests that government agencies assess the risks and benefits of digital assets (under the auspices of consumer protection), it’s reasonable to presume that NFTs — including any methods of fractionalization — will be scrutinized. It’s quite possible that a regulatory framework could be developed from the order’s research findings, he suggested.

“However, I should note that the Biden administration appears open to implementing clear and constructive regulation that would help to foster the growth of a wide variety of digital assets, including fractionalized NFTs,” Georgiades explained.  “Current regulation is stuck in the 1930s, and it’s pretty clear to both investors and even regulators that an upgrade is needed to properly cater to this emerging market so as to foster healthy and safe growth.”

Keida added that the NFT industry is calling for regulation, as it will be critical for the implementation of new products and the development of roadmaps. A successful regulatory framework could provide clear instructions on how to expand projects without risk, she continued.

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She said that to paint the picture of how fractionalized NFTs may be considered securities, you can think of an NFT as a stock — instead of buying the whole stock, which may be extremely expensive, you can own a small share of it for a more affordable price. “Take the Amazon stock split, for example,” she said.

In addition, she explained that some organizations may look to NFTs as a means to raise funds — these assets are technically legitimate for crowdfunding, much like securities.

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“If that is the case, regulation can protect purchasers from investing their money in collectibles tied to illegitimate organizations or scammers,” she concluded.

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About the Author

Yaël Bizouati-Kennedy is a full-time financial journalist and has written for several publications, including Dow Jones, The Financial Times Group, Bloomberg and Business Insider. She also worked as a vice president/senior content writer for major NYC-based financial companies, including New York Life and MSCI. Yaël is now freelancing and most recently, she co-authored  the book “Blockchain for Medical Research: Accelerating Trust in Healthcare,” with Dr. Sean Manion. (CRC Press, April 2020) She holds two master’s degrees, including one in Journalism from New York University and one in Russian Studies from Université Toulouse-Jean Jaurès, France.
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