Non-fungible tokens (“NFTs”) have revolutionized how
artists sell their art; now, artists are hoping that NFTs
can revolutionize how they fund their art. Recently, the
sale of collectible NFTs has funded the production of two
television projects: Stoner Cats and The
Gimmicks. Stoner Cats raised around $8 million in NFT
sales on the premise that only those that purchase Stoner
CatNFTs will be able to watch the show. The Gimmicks,
on the other hand, has promised that NFT holders will be
able to determine how the show’s story progresses from episode
to episode. While this new way of funding is exciting for artists
and fans alike, it is important to consider the securities law
implications that may arise.
What is an NFT?
First, we’ll start with the basics. An NFT is an intangible
digital token that represents an item. That token is composed of
unique data stored on a ledger using blockchain technology. Being
“non-fungible” means that each token is one-of-a-kind.
For instance, cryptocurrencies like Bitcoin are considered
“fungible” tokens because they function like money; a
loonie is the same as every other loonie and can be substituted for
similar tokens of equal value, such as 20 nickels1. NFTs are unique in that they are not
replicable or interchangeable in such a way. Simply put, NFTs are
digital collectibles.
NFTs and ownership
When someone buys an NFT of a work of art, they purchase a token
that represents ownership of the art – not necessarily a portion of
or an interest in the art itself. The common misconception
surrounding ownership is that buyers own the real-life version of
the asset. The reality is that owning an NFT is like buying a
limited-edition print of a painting: the buyer does not typically
own the copyright to it, nor does the buyer have the right to
reproduce the painting for resale or other commercial purposes.
They do, however, own that unique individual copy and that
certificate of authenticity to match. Similarly, in the case of the
television funding mentioned above, the NFT buyers do not own a
portion of the show or its potential profits; rather, they own a
collectible NFT that comes with certain tertiary benefits. (For
more on NFTs and the entertainment industry, tune in to the
upcoming American Bar Association (ABA) discussion – Lost in Tokenization: Legal Implications of
Non-Fungible Tokens on Finance, Art, Property, and
Culture).
Securities law considerations
Alongside issues surrounding IP rights, NFT ownership raises
important considerations for Canadian securities laws. The offer of
ownership of or income streams from a venture in association with
NFTs connected to entertainment products might trigger requirements
for dealer registration or rights to license. It is therefore
important for artists, agents, or anyone in the business of
creating or selling NFTs to first answer the question of whether or
not the NFT that they are selling might be a security.
While many cryptocurrency offerings do involve the sales of
securities, the Canadian Securities Administrators
(“CSA”) has advised that a unique token valued for its
entertainment or collectible purposes is not
typically a security.
To help understand some Canadian securities law implications for
selling tokens, the CSA offers helpful guidance in Staff Notice 46-308. The guidance is based on
the investment contract test (referred to more commonly in Canada
as the Pacific Coin test or in the United States as the
Howey test), a token will be classified as a security
where it involves (i) an investment of money (ii) in a common
enterprise (iii) with the expectation of profit (iv) to come
significantly from the efforts of others. 2
For many entertainment-related NFTs, the purchaser determines
the value of the token based on their own personal preferences in
relation to the unique characteristics of that token as a
collectible item. Accordingly, market forces, rather than the
continued development of a business by the issuer or the promise of
future profits from that enterprise, determines the token’s
future market value. If a token’s unique characteristics, and
not the effort of others, determine its value, then it is likely
that there is no common enterprise and therefore, it would not
satisfy the test mentioned above.
In the case of television shows or other artistic endeavours
raising funds through the sale of NFTs with ancillary benefits or
value, here are some common “red flags” that indicate
that the sales might be considered investments contracts or
otherwise securities rather than mere tokens. First, watch out for
where the NFT owners appear to receive benefits beyond merely
owning a collectible, such as exclusive access to watch the show or
having some creative control. Second, where the tokens are being
sold to raise capital, this will be a strong indicator of a
security and could mean that the purchasers are not merely
purchasing the tokens in appreciation of their actual unique
characteristics. And finally, where it may be said that the value
of the NFT is closely tied to the success or failure of the show or
project itself, this could potentially indicate a common
enterprise. For example, if a television show funded through NFTs
grants exclusive access to NFT holders, then the price of those
NFTs will increase alongside the public’s desire to watch the
exclusive show, especially if that show receives favourable ratings
or award nominations.
If the NFTs were found to be securities, their distribution
could be subject to prospectus requirements, resale restrictions
and dealer registration requirements. Jurisdictional considerations
would also need to be kept in mind for NFTs that are offered
internationally. The CSA notes that a Canadian securities
regulatory authority may have jurisdiction over trades to investors
residing outside of Canada where there is a real and substantial
connection between the transaction and Canada. Given these Canadian
securities law concerns, it is important for artists and producers
to consult their legal counsel before moving forward with minting
and selling NFTs, especially as a means to fund their projects.
Footnotes
1. Susan Abramovitch et al.,
NFTs: Why a picture is worth a thousand Bitcoins. Webinar
(May 31, 2021).
2. Securities Law
Implications for Offerings of Tokens, CSA Staff Notice 46-308
(June 11, 2018), https://www.osc.ca/sites/default/files/pdfs/irps/csa_20180611_46-308_implications-for-offerings-of-tokens.pdf.
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