Loyola University Chicago School of Law, JD 2024
Cryptocurrency’s lack of regulation has been a major focus in the news recently. Furthermore, there is a lack of regulation over non-fungible tokens (NFTs) as well, which is a further concern for consumer safety. Although the first known NFT was established in May of 2014, NFTs didn’t really take-off until 2017. Due to the unique nature of NFTs (being either jpegs, real estate, etc.) the Securities and Exchange Commission (SEC), along with other regulatory authorities, still haven’t clearly laid out if NFTs are securities or what rules/regulations will apply. Unless securities are clearly at issue it is unclear if NFTs will fall under securities laws at this point in time. However, there is a potential way consumers can invest in NFTs related to real estate and still find protection through the SEC.
What is an NFT and what are the risks?
NFT’s are digital assets such as real estate, music, video games, drawings, and just about anything else you can imagine. Like cryptocurrency, NFTs exist on a blockchain, however, NFTs are not interchangeable like cryptocurrency. Each NFT has its own identification code, distinguishing them from other digital assets, even if there are duplicates (i.e., there could be two Mona Lisa paintings on the blockchain, but each will have its own unique identification code). Something that makes buying NFTs unique is that the price for a particular asset can vary immensely across the board, even if both digital assets are the same in nature like the example above. There is no marketplace setting the value of particular assets, so the price can be arbitrary between buyer and seller basing the price off what they believe the value is.
Although NFTs are traded through blockchain, they still pose serious risk to investors. Without proper caution and due diligence, investments can be gone in the blink of an eye. With any type of trading, it is always important to be aware of trading within reliable marketplaces, to watch out for phishing attacks, and other scams. However, the biggest risk taken in investing in NFTs is the fact that there really isn’t any regulation, hence, there is no real way for investors to recover lost/stolen assets. This makes clicking on the wrong button or sending confidential information to the wrong person much more worrisome. However, there could be a safe way for investors to still invest into NFTs, especially real estate NFTs, and have some level of comfort.
Limiting the risk posed by NFTs through real estate investment trusts
NFTs can sometimes be digital assets such as real estate some of which are actually tied to physical properties in the real world. In 2017, Michael Arrington bought the first real estate NFT. So, what does that mean for consumer protection? In the 1960’s Congress established real estate investment trusts (REITs), which allows investors to buy shares in a company that owns/operates income-producing real estate or real estate-related assets. Thus, this allows investors to invest in real estate, especially investors who cannot afford to go out and buy property.
REITS can be either publicly traded or non-traded REITs, the former is registered with the SEC and is publicly traded, while the latter is registered with the SEC, but not publicly traded. Some of the differences between the two are seen in transaction costs involved, liquidity, management, minimum investment amount, and etc. What is important for investors is the fact that both publicly traded and non-traded REITS registered with the SEC are required to make regular SEC disclosures, including quarterly financial reports and yearly audited financial reports. This gives investors peace of mind in knowing that companies have to do their due diligence in order to follow SEC regulations.
Another added bonus of investing in REITs, is that for publicly traded REITs, NYSE and NASDAQ rules call for fully independent audit, nominating, and compensation committees. The North American Securities Administrators Association (NASAA) requires non-traded REITS to have a majority of each board committee consists of independent directors. However, in order to even qualify as a REIT, companies must first have the bulk of their assets and income connected to real estate investments and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends. There are also other requirements REITs must meet in addition to the aforementioned, such as being managed by a board of directors or trustees.
Essentially, by investing in REITs that invest in real estate based NFTs, cautious investors can take an investment risk with some added protection they would not normally have if investing in the digital asset directly. Although there are always risks in the stock market as well, investors in real estate based NFTs now have the opportunity to go through the SEC for complaints of fraud, misinformation, dividend payments, and other claims against organizations or dealers. Even with the added protection by investing in NFTs through REITs, investors should still do their own due diligence just as they would for any other investments and seek financial advice. Until the SEC makes it clear what a digital asset is, this could be one potential step in finding consumer protection.