Non-fungible digital asset. It’s a term few people even heard of five years ago. Now it’s the cause of an effort to figure out the best regulatory policy for these blockchain doodads. Like, which agency should actually take the lede here. To learn more, Federal Drive with Tom Temin spoke with Information Technology and Innovation Foundation VP Daniel Castro.
Tom Temin And you have written that this is kind of a morass trying to figure out how to regulate all of these types of instruments. Let’s begin at the beginning, though. What exactly is a non-fungible token and why does it have economic importance?
Daniel Castro Yeah, so NFTs can best be thought of as digital certificates ownership. They allow you to prove that you own something unique. That unique item could be something that is virtual or it can be something that is physical. Because NFTs use the blockchain like cryptocurrencies, they also allow you to have smart contracts. And those smart contracts enable really interesting types of applications that people have started using with NFTs.
Tom Temin So basically it’s like a title to a car, for example, but instead of a piece of parchment, it’s a digital item that is on a blockchain encrypted.
Daniel Castro Exactly. That encrypted piece of ownership can be traded. It can be bought and sold. You can combine it with other items. And that creates a lot of really interesting possibilities, particularly, you know, people that want to sell things quickly. You know, if you wanted to sell a car, you had to physically take a title to one person and give it to another. But now, if you wanted to use an NFT to trade something, you could have a thousand transactions in a minute and trade it very quickly without ever actually having to take the title somewhere, mail it. Because it’s all done on the blockchain securely, there’s less risk of fraud.
Tom Temin So in other words, instead of a burglar getting your title, a hacker can get it.
Daniel Castro Exactly. That’s the risk.
Tom Temin And so there is a policy that you’ve written about from the Biden administration to regulate these. Why do they need regulation? And what are some of the strengths and shortcomings of that policy? And maybe just give us a brief description of what it actually calls for.
Daniel Castro Right. Well, as you can imagine, when you can buy and sell things very quickly online, that opens up lots of possibility for fraud. Just like in the physical world, for example, with art, there’s a risk that people that want to launder money will use purchases of physical art to transfer large amounts of funds and hide where the sources of transactions are coming from. The same concern exists within NFTs, especially some of these NFTs that are selling for millions of dollars. And so the Biden administration has put out a policy on digital assets. That policy covers a wide range of issues, everything from cryptocurrencies and the potential for creating a US digital dollar to also NFTs, which are digital assets as well. And looking at everything from who should regulate them, how they’ll be regulated, how to address crime that happens in this space, how to protect consumers, how to encourage innovation and how to address issues like taxation. Because when you’re buying and selling these items, there can be tax implications and you need to make sure that people are actually paying taxes on them.
Tom Temin Sure. So the NFT then can apply to other digital things like Bitcoin or cryptocurrency or to a piece of art that somebody created digitally and you can ensure there’s only one copy of it, so to speak. They hope. As well as again to physical things. But instead of having the paper recordation, you’ve got the digital recordation, for lack of a better word.
Daniel Castro Right. Except the NFT will never apply to a cryptocurrency. Cryptocurrencies are kind of the opposite of NFT because they’re fungible. One Bitcoin is the same as another Bitcoin in contrast with an NFT. Every NFT is supposed to be unique. It represents a very specific item.
Tom Temin Okay, well, good distinction to make then. And under this policy, then which federal agency gets a task? And that’s part of the problem, right?
Daniel Castro That’s exactly right. The big problem right now is it’s not clear what exactly an NFT is in terms of existing law. So there are you know, the Securities Exchange Commission regulates securities. You have the Commodity Futures Trading Commission, which regulates commodities. NFTs don’t squarely necessarily fall into any of these categories. And there are, of course, many different uses of NFTs. So some might be a security and others might not be a security. And so it really depends on how it’s being used. There’s also a lot of various types of crime that goes on in this space, everything from money laundering to, you know, just kind of outright fraud where people are selling NFTs for items that don’t exist, people are selling NFTs for art that they don’t own. And so there’s a lot of consumer fraud and there’s questions about how do we protect consumers in this space so that they’re not taken advantage of.
Tom Temin We’re speaking with Daniel Castro. He’s a vice president at the Information Technology and Innovation Foundation. And maybe there will never be a lead agency. If you look at, say, Medicare fraud and sometimes the Justice Department puts out really lurid press releases on when they break up a Medicare or Medicaid fraud ring. And you’ve got elements from the IRS Investigative Service. You’ve got elements from the Justice Department. You’ve got investigative and policing authorities from Health and Human Services. Sometimes there’s even more agencies involved. So does there need to be a lead agency? And if there does? Who would that be, do you think, best? Because you said it’s not necessarily a commodity in the sense of the CTFC. It’s also a financial thing, so maybe Consumer Financial Protection Bureau?
Daniel Castro There’s definitely many agencies that will need to be involved. I think it will help to have one lead regulatory agency in some cases because there still needs to be some rules of the road. For example, various platforms are used to sell, buy and sell these NFTs. When there are restrictions on, for example, you know, export restrictions after the Russian invasion of Ukraine, we sanctioned a lot of people. We want to make sure that Americans aren’t buying and selling NFTs with sanctioned individuals. You have to have a regulatory agency that can supervise these types of actions. I think that will apply in a lot of spaces, particularly because as NFTs become more mature. And we are seeing cases that extend beyond these NFT art where people are just selling art, we’re seeing this used for ticketing to events, we’re seeing it used for gaming, we’re seeing it used for digital collectibles, like with the NBA. When it becomes more mainstream, you want companies that are investing in this technology to be able to do it and know that they’re following the law and have a regulator who they can go to and get their questions answered. They don’t want to be doing something illegal. And if you don’t have a lead regulatory agency, it’s very confusing because you can ask one agency, am I doing things right? And then, you know, six months down the road, another agency is knocking at your door saying, Hey, why didn’t you talk to us?
Tom Temin Sure. And of course, this policy is coming from the Biden administration as a regulatory and policy proposal. Where is Congress in all of this?
Daniel Castro Congress has been on the sidelines. They’ve had a few hearings on these issues. They’ve mostly been focused on cryptocurrencies and stablecoin, and they haven’t really looked at NFTs as much, which is unfortunate because, again, consumers are buying and selling these in large quantities. The volume continues to rise overall. It’s fallen a bit with, you know, some of the cryptocurrency collapsed in the last few months. But you know, many of these platforms are still going strong. And so, again, the question is always how can you make sure the consumers are not hurt? And that we’re also setting rules of the road so that businesses that want to innovate in this space can do it successfully and they don’t have to go abroad to do it.
Tom Temin It’s sort of like there’s the possibility of a Wild West land grab fraud type of activity going on here, nationally.
Daniel Castro It’s very easy to commit fraud in this space. All you have to do is create a website, say you’re creating some really interesting game. You never actually have to produce any product. People will invest lots of money, and that money is untraceable after it’s given to you and then people run off with it. And there’s been some investigations in this space, but there’s probably a lot more fraud that’s going undetected right now.
Tom Temin And for that matter, you really can’t be assured of the provenance of the digital asset that is being protected by the nonfungible token. You mentioned earlier souvenirs from the National Basketball Association. I mean, if I go to a stadium and there’s a representative there and there’s a signed jersey that I want to buy, I take that home and you know where I might even have it signed by the player. But you have no idea whether it’s really an NBA issued asset or any other organization you trust asset, in the digital world.
Daniel Castro It’s definitely buyer beware right now. Buyers can, because it’s on the blockchain, check the provenance, you know, to see who actually issued it. But it’s very much you’re looking at trust signals, you know, do you trust who you’re buying this from and could you trace its origins? Does it come back to a company that you can find the NBA has put on its website? Yes, they have a licensing deal with. But again, as you said, there’s a lot of cheating that goes on. And unless buyers are being careful, they can buy something that maybe looks real. But when they start scratching the surface of it, they realize maybe they wasted their money on something that nobody else is going to be interested in.
Tom Temin Or maybe the real issue is can I sell it again and get the heck away from it and let the next guy worry about it? All right. Definitely a role for the government to step up here, though, it sounds like.
Daniel Castro There is. And again, there’s so much innovation in this space. I mean, you have to look at why people are also buying these. Creators, for example, one of the things they like is right now, if an artist sells a piece of art, they only get revenue when [indistinct] for sale. But NFTs, because of the smart contracts, they can actually get revenue a percentage of the sale every time the item is sold after that. So there’s some really interesting applications like that where, you know, people are finding out that they can create new business models. In gaming, that’s something similar. Game companies are creating these games where you earn NFTs as you play, and so it creates a reward system where early adopters of the game who encourage others to play it too, the time that they invest in that they actually get in share in some of the rewards as the game grows. So there’s these really interesting business models that again, are likely going to take off. Some of them are legitimate, but some of them start to look more like Ponzi schemes or other types of scams.