Why NFT Profile Pictures Matter to Investors — and Regulators

It seems that no one – not even the US government – ​​can agree on exactly how to classify digital assets known as non-fungible tokens (NFTs). Yet digital artworks have grown in popularity and attracted the support of creators, collectors, a growing sector of digital asset advocates, and everyday social media users.

One dominant trend is NFT profile pictures, or PFPs. Throughout 2021, collectors began changing their social media avatars to display their most prized pieces from their NFT collections. Last month, Twitter attempted to make PFPs more legitimate by releasing a tool to verify the authenticity of PFPs. Platforms like Reddit and OnlyFans would be next.

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Collectors like to display their NFT profile pictures because avatars convey confidence in blockchain as an emerging technology. They are also a signal of belonging and status. Additionally, NFTs often come with a “utility,” meaning an ownership registration can unlock access to online and in-person membership communities. With all the hype, the demand for these exclusive assets has caused prices to skyrocket.

NFT as membership tokens

The tokens produced by NFT artists are something of a cultural timestamp. Collaboratively designed by artists and developers, PFPs represent a mix of randomly generated characters. The artwork uses a template base, then an algorithm assigns a unique mix of attributes for each NFT hit. Some features end up being rarer – like the pale blue alien CryptoPunk that just sold for $23 million – which makes some NFTs more valuable than others.

The Top Collections chart on OpenSea, a popular NFT marketplace, shows a seven-day trading volume of 6,185 ETH for the CryptoPunks collection, one of the first (and inadvertently) PFP collections to drop before the trend took off. . Below on the OpenSea board are new collections containing up to 10,000 randomly generated avatars with mixed traits.

Floor prices for popular PFP projects on OpenSea vary widely. The Coolman’s Universe Collection of 10,000 “Speshies” cartoons, for example, is #45 on OpenSea’s Top Collections list and has a floor price of around 1.4 ETH with seven-day trading volume of around 887 ETH at the time of writing. Meanwhile, the World of Women collection, with its seven-day trading volume of 937 ETH, ranks 43rd and has a floor of around 8.74 ETH.

Owning one of these or other PFPs entitles the collector to certain privileges. On its website, for example, World of Women lists the benefits of NFT ownership. These include raffles and discounts reserved for holders, an invitation to an annual gala and organized presales, among other advantages. And on the social justice of things, the sold-out women go up The project presents a roadmap to support gender equality and girls’ education, including donating 2.5% of profits to the Malala Fund. PFPs therefore signal inclusion in the type of future collectors that are well-organized and aligned with the values ​​they want to be a part of, as well as the promise of a community.

But when profit also enters the equation, regulators and lawyers have questions.

The uncertain regulation of PFPs

According to Howey’s test, a monetary investment in a common enterprise with the expectation of profit from the effort of others is the definition of a security. Buying into an NFT collection to support a good cause or join an artistic community is one thing, but it’s also no secret that the rarest and most coveted PFPs are now worth millions.

But while the U.S. Securities and Exchange Commission (SEC) has issued general guidelines on digital assets, the agency has not focused specifically on NFTs, which differ from stocks or even cryptocurrencies like the bitcoin.

“[SEC guidance] was really not designed for NFTs,” James G. Gatto, a licensing and regulatory attorney and partner at the law firm Sheppard Mullin, explained during an online NFT conference in February.

In most cases, an NFT won’t be a security, Gatto said, but his firm came across a few examples where NFTs had the characteristics of a security, which means securities law would have to come into play. The main example so far has been the case of splitting, or taking a high-value piece of art and creating multiple NFTs that split the revenue.

This model is similar to that used by alternative investment platform Masterworks, which states in its disclaimer that it is “testing the waters under Regulation A under the Securities Act of 1933”. Masterworks files its artwork with the SEC as security, even though the platform itself is not registered or licensed as a brokerage. While PFPs don’t automatically fall into the Fractional category, this particular nuance could have implications for certain NFT marketplaces like Fractional that offer shared ownership of expensive digital artworks.

Examine the intent behind your purchase

As with any purchase, investors should have a clear investment thesis supporting their reasoning for buying NFTs. The recent Pudgy Penguins scandal makes this point clear. The founders of the Pudgy Penguin project never delivered on their promises, and the laudable failure made headlines when Pudgy Penguin NFT holders coded a smart contract to keep their tokens liquid while denying owners of source access to other commercial benefits. The situation was described as a “patently fraudulent illegal securities offering and embezzlement” in a LinkedIn post written by Carlos Mercado, a data scientist and founder of crypto firm CharlieDAO.

However, for every failed NFT project, there is a similarly thriving community with transparent leadership and a committed collector base – and sometimes it’s hard to tell which is which. “Blatant” often only becomes clear in hindsight.

NFT enthusiasts would then tell investors to consider the “why” behind their purchases and not to view PFPs as an enrichment scheme. This not only protects investors from impulse purchases of NFTs, but could also provide a buffer in determining exactly what is a security and what is not. NFT collectors won’t necessarily ever have to defend their NFT purchases with the SEC, but everyone should always have a solid case to back up their purchases.

“There are collectibles, utility tokens, and clear titles in the NFT space. It’s important to understand the differences when buying them,” Mercado wrote in a follow-up LinkedIn post after I told him about his Pudgy Penguins comment. Mercado isn’t a lawyer — just a data scientist and Web 3 enthusiast — but he has experience buying a variety of digital assets. He also speaks regularly with digital asset lawyers while creating his DAO, or Decentralized Autonomous Organization, of token holders.

“I buy a lot of NFTs just because I want to support these artists,” he told CoinDesk. “Then I buy other entities that are like, ‘We’re going to build this game. It’s going to look so cool. Here are some previews of our new 3D renders.’ There is a clear promise of development [in these examples], and the expertise of the people who want your money. This is where you enter safe territory – if they promise you something.

Investors should always be able to clearly articulate what they hope to get out of their NFT purchases, even if it’s just supporting an artist. With PFPs in particular, it will be harder to argue that the purchase was just for the love of the art, as the artwork is randomly generated and the images facilitate online social engagement. and unlock some utility.

But if profit is the secondary motivation for your purchase—behind community membership and well-organized perks—that argument is easier to convey when you’re used to aligning your dollars with your values, your hobbies. time and your social life.

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