Hong Kong Regulator Warns of Securitization Risks for NFTs

The Securities and Futures Commission (SFC) of Hong Kong recently issued a statement on the financial and legal risks surrounding non-fungible tokens (NFTs). It claims that such tokens are not only prone to the typical security vulnerabilities of crypto, but could also constitute financial assets bound by SFC regulation.

From Collectibles to Financial Assets

According to the regulator’s statement on Monday, NFTs “generally” do not fall under the SFC’s regulatory purview. These include NFTs created as “genuine” digital representations of collectibles, such as digital images, artwork, music, and videos.

However, the commission claims that there are other NFTs that “cross the boundary” between collectibles and financial assets. Some, for example, are “fractionalized” or “fungible”, causing them to resemble securities and/or collective investment schemes (CIS).

“Where an NFT constitutes an interest in a CIS, marketing or distributing it may constitute a ‘regulated activity,” stated the regulator. “Parties carrying on a regulated activity, whether in Hong Kong or targeting Hong Kong investors, require a license from the SFC unless an exemption applies.”

Authorization requirements may also be triggered if an arrangement related to an NFT involves public offers to participate in a CIS.

NFTs saw their first true surge in popularity in 2021, mainly recognized as simple collectibles or speculative items. Some of the most valuable collections included the Bored Ape Yacht Club, and simple images of rocks.

However, newer NFTs are beginning to incorporate various forms of utility, such as staking and metaverse interoperability. Gary Vaynerchuck – CEO of VaynerMedia – believes NFTs will be a part of “every contract,” including buying homes, cars, and financial assets.

For now, the SFC urges caution to anyone thinking of becoming an NFT investor. “As with other virtual assets, NFTs are exposed to heightened risks including illiquid secondary markets, volatility, opaque pricing, hacking and fraud,” reads their statement.

America’s Approach to NFTs

So far, the US approach to regulating NFTs is unclear, along with the rest of crypto. Senator Cynthia Lummis, who is set to reveal her digital asset regulation bill this week, said that NFTs will not be addressed in the legislation due to the difficulty of defining them.

That doesn’t mean they aren’t being taken seriously, however. New York lawyers filed charges last week against a former OpenSea employee who was caught insider trading with NFTs in September.

“Today’s charges demonstrate the commitment of this office to stamping out insider trading – whether it occurs on the stock market or the blockchain,” said attorney Damian Williams at the time.