Business NFT tokenization and its legal implications in Canada
Can you breach securities law by trading or issuing non-fungible tokens (NFTs)? An individual was recently arrested in the US for insider trading in NFTs. This article focusses on the securities law implications of NFTs and their tokenization.
NFTs are a growing digital asset class that raises novel legal issues. NFTs can be tokenized to allow for part ownership of the particular NFT to be transferred to others. Recently, tokenization has been heralded as the “future of Canada’s digital economy” with “the potential to unlock immense value and liquidity for many investors”.
NFTs and tokenization
NFTs are a type of digital asset. They identify an asset such that the asset, or a fraction of the asset, can be held and transferred on a blockchain. An NFT can be used to certify ownership over an asset that exists in the “real” world or it can be a digital asset. In either case, the asset is uniquely represented as a NFT on a blockchain; it cannot be duplicated. Whereas cryptocurrencies and tokens are fungible like cash, NFTs are not.
NFTs can be tokenized (or fractionalized / f-NFTs) to allow for part ownership of the particular NFT to be transferred to others. Tokenization can provide investors with a means to purchase, hold and trade assets that are perceived to have underlying value. It can also provide owners of such assets improved liquidity to realize some value from the asset without completely relinquishing ownership.
The emerging NFTs space is susceptible to the same forms of misconduct observed in cryptocurrency markets. According to a blockchain research firm, there are signs that wash trading (a form of market manipulation involving frequent trading between non arm’s length blockchain addresses) is being used to artificially boost the perceived value of certain NFTs. The research firm also found signs of money laundering.
Canadian securities law that may apply to NFTs
Canadian securities regulators have yet to definitively take a position on whether and in what circumstances NFTs could constitute securities. Limited guidance from the Canadian Securities Administrators (CSA) in 2018 endorses the expansive four-pronged test from OSC vs. Pacific Coast Coin Exchange (modeled closely on the U.S. Supreme Court’s “Howey Test”) to determine whether an NFT may be an “investment contract” and therefore included in the statutory definition of…