In its first enforcement action of the year involving ICOs, the U.S. Securities and Exchange Commission (SEC) charged two companies and their founder for violations of antifraud and registration provisions of the federal securities laws in connection with an initial coin offering (ICO).  On January 6, 2022, the SEC announced charges against Australian citizen Craig Sproule and two companies he founded, Crowd Machine, Inc. and Metavine, Inc. (collectively, the Defendants), for making materially false and misleading statements in connection with an unregistered offer and sale of digital asset securities in an ICO.  (SEC v. Crowd Machine, Inc., No. 22-00076 (N.D. Cal. filed Jan. 6, 2022)).

These charges add to the SEC’s growing list of enforcement actions that target unregistered offerings of digital assets.  ICO activity peaked in 2017, when hundreds of issuances raised an estimated $5 billion from investors.  Since that time, scrutiny from the SEC has cooled this practice. However, the SEC remains vigilant in taking action against unregistered ICOs, based on its view that digital tokens are likely to be securities. In remarks last year, SEC Chairman Gary Gensler voiced agreement with former SEC Chairman Jay Clayton’s position on ICOs: “To the extent that digital assets like [initial coin offerings, or ICOs] are securities — and I believe every ICO I have seen is a security — we have jurisdiction, and our federal securities laws apply.”

On November 10, 2021, the SEC announced that it had instituted proceedings against a Wyoming-based decentralized autonomous organization (DAO) to halt its registration of two digital tokens, alleging that disclosure in the organization’s registration statement was deficient and contained materially misleading statements. (In the Matter of American CryptoFed DAO LLC, No. 3-20650 (SEC Order Nov. 10, 2021)).  Without the SEC’s latest action, the issuer’s Form 10 filing was scheduled to become effective on November 15, 2021 (sixty days from the initial filing date).  The action against American CryptoFed DAO LLC (“CryptoFed”) serves as a clear reminder that cryptocurrency remains in the SEC’s crosshairs, and token issuers must carefully consider regulatory risk when launching new products.

On August 6, 2021, the Securities and Exchange Commission (SEC) announced that it had charged two men, Gregory Keough and Derek Acree, and their company, Blockchain Credit Partners, doing business as DeFi Money Market (collectively, the “Respondents”), for unregistered sales of more than $30 million of securities using smart contracts and so-called “decentralized finance” (DeFi) technology and for making false and misleading statements about their business to investors in violation of the federal securities laws. (In re Blockchain Credit Partners, No. 3-20453 (SEC Order Aug. 6, 2021)).

In recent days, many eyeballs were closely watching the drama behind the cryptocurrency taxation and transparency measures contained in the Senate’s infrastructure bill  and are still digesting SEC Chair Gary Gensler’s recent remarks before the Aspen Security Forum that offered some clues on where the agency will go with respect to cryptocurrency regulation and enforcement. Meanwhile, the SEC continued its enforcement efforts to shut down what it deems fraudulent and unregistered securities offerings involving digital assets. After ceasing operations in February 2021, Respondents consented to a cease-and-desist order that includes disgorgement totaling almost $13 million and civil penalties of $125,000 each of the individual Respondents.  The SEC’s order provides another example of how the now-familiar investment contract analysis applies to tokens, with some additional insights on the impact of voting rights under the Howey test and a further analysis of tokens as notes.

Gary Gensler, Chair of the Securities and Exchange Commission (SEC), attracted a lot of attention following his remarks at the Aspen Security Forum earlier this month, asking Congress for more authority “to write rules for and attach guardrails to crypto trading and lending” and opining that for the “volatile” industry to truly prosper it needs more investor and consumer protections.  But make no mistake: Gensler is not waiting around for Congress to act.  In his remarks, Gensler highlighted various areas where the SEC currently has jurisdiction and emphasized that “we have taken and will continue to take our authorities as far as they go.”

On July 14, 2021, the Securities and Exchange Commission (“SEC”) settled an action against the operator of a platform that promoted current and upcoming digital token offerings for violations of the anti-touting provision of the Securities Act of 1933.  In the Matter of Blotics Ltd. f/d/b/a Coinschedule Ltd. (July 14, 2021).  The SEC claimed that the primary source of revenue for the platform operator, Coinschedule Ltd., was compensation received from issuers that paid to list, market, and rate their token offerings on the platform. The SEC charged that Coinschedule’s failure to disclose the consideration it received from token issuers for promoting their token offerings was a violation of the anti-touting provisions (Section 17(b)) of the Securities Act.  The respondent, Blotics Ltd. (successor to Coinschedule Ltd.), was ordered to pay disgorgement of $43,000, plus interest, and a civil penalty of $154,434.

The settlement order does not shed any light on when a digital token is a security.  The anti-touting provisions of Section 17(b) apply only if the instrument being touted is a security, and the order states that some portion of the digital tokens offered and sold on the Coinschedule platform were securities in the form of investment contracts.  However the settlement order does not address how many or which of the 2,500 individual token offerings profiled on the Coinschedule platform involved securities, providing no analysis and only a conclusory statement that “[t]he digital tokens publicized by Coinschedule included those that were offered and sold as investment contracts, which are securities pursuant to Section 2(a)(1) of the Securities Act.”

Except for the extensive coverage surrounding Coinbase’s IPO last week and the volatility in the price of cryptocurrencies, much of the air in the crypto space in the last few months has been taken up by the meteoric rise of non-fungible tokens (NFTs). At this point, we will assume that readers have at least a basic familiarity with NFTs. If not, we suggest a review of this SNL skit, as it is actually a pretty good summary.

It seems like new articles appear on a daily basis addressing some aspect of the legal issues associated with the NFT phenomenon. Interestingly, however, there have been few articles and little attention paid to what ultimately might be the most interesting development in this space, that is, the rise of fractional NFTs (F-NFTs).

F-NFTs Stir Up New Issues

Given that many NFTs are selling for significant amounts of money (in both fiat and digital currencies), the idea of fractionalization is taking shape to allow smaller investors to pool resources to purchase fractional interests of a NFT.  Additionally, there is great interest in the opportunity to buy fractional interests of large NFT collections. For example, it was recently reported that a collection of fifty CryptoPunks, which are early, now valuable NFT pixel art collectibles, were fractionalized into millions of tokens. The interest in fractionalization is not surprising given the high sale price of some NFTs and the widespread adoption of crowdfunding in many areas in e-commerce and investing.

Beyond mere entry into the market, purchasers can hold onto an F-NFT in the hope of seeing investment gains or realizing dividends, or else sell the F-NFT (from a technical perspective, referred to as a “shard”) to another investor. Several entities have emerged to facilitate the sale of F-NFTs to unlock liquidity in the market and create and trade fractions of NFTs.  For example, the NFT trading platform Niftex states that it allows owners to break NFTs into shards for purchase at a fixed price, with the fractions able to be subsequently traded in the market. The site also states that it allows shard owners some local governance rights on the platform with respect to a particular fraction set and provides an investor with a certain percentage of shards who wishes to own the entire digital asset with a method to bid on the remaining shards.

As most anything can be reduced to an NFT, it’s interesting to think of the possibilities of fractionalization. Now that the buying and trading of cryptocurrency has become mainstream, with major fintech platforms having begun to allow users to buy, sell or hold crypto and more and more decentralized finance (or DeFi) and decentralized applications (DApps) being developed to offer new digital solutions for various financial transactions, the continued fractionalization of NFTs is almost inevitable.

But is it legal?

On April 11, Blockstack Token LLC (“Blockstack”) filed a preliminary offering circular with the SEC for a $50 million token offering under Regulation A of the Securities Act. The offering circular is now under review with the SEC and must be qualified (i.e., cleared) by the SEC before sales of Blockstack’s tokens (“Stacks Tokens”) can be effectuated under the program.

Blockstack’s offering circular is notable because it treats the Stacks Tokens as securities today but discloses that the issuer expects the Stacks Tokens will, at some point in the future, no longer be required to be treated as securities under the federal securities laws. This approach is consistent with recent SEC staff guidance, which stated that the analysis of whether a digital asset represents an investment contract (and thus, a security) may change over time, depending on how the asset is used, offered and sold. Blockstack states that it will refer to the Framework for “Investment Contract” Analysis of Digital Assets, recently published by the SEC’s Strategic Hub for Innovation and Financial Technology, for regulatory guidance in connection with making this determination.

If the SEC qualifies Blockstack’s offering under Regulation A, it will be the first time the SEC has done so for the offer and sale of a blockchain-native digital asset.

The Securities and Exchange Commission (“SEC”) recently issued highly anticipated guidance to assist market participants in determining whether a digital asset is offered and sold as a security.

On April 3, 2019, the SEC’s Strategic Hub for Innovation and Financial Technology published an analytical framework for evaluating whether the offer