Commercial – Crypto & NFTs
“Many retail investors, particularly those who chose to put their money into FTX, went looking for the greater fool only to find themselves looking in the mirror”
What are the biggest investment opportunities in digital – and how can clients decide on the best entry point for them?
It is always critical for attorneys to remind their clients, and specifically in-house counsel reporting to in-house clients (i.e., board of directors, c-suite personnel, etc.) that internal legal departments are not made up of investment advisors but rather risk mitigation officers. With that in mind, and given the ever-changing landscape of digital investment opportunities, in-house counsel’s role in advising on investment opportunities and entry points for digital and cryptocurrencies should be no different than any typical investment approach, albeit with an even higher level of scrutiny. Namely: (a) ignore the noise surrounding flavour-of-the-month cryptocurrencies that are seemingly sky-rocketing from nothing overnight; (b) perform due diligence with regard to crypto companies’ management team, financial records, and prospectuses; and (c) develop a long term approach based on risk tolerance.
While long term value is uncertain, and it depends on their industry, NFTs can provide an alternate avenue for companies and as well as investment in the digital landscape. Media and publishing companies should consider minting NFTs to protect their content and monetise it in the digital world. Using NFTs, companies can create a digital record equivalent for their intellectual property like patents, copyrights, trademarks and trade secrets. Even if your company has no interest in minting NFTs, in-house counsel and risk managers should monitor NFT platforms like OpenSea, to ensure their intellectual property, trademarks and copyrights have not found their way into the NFT marketplace without the company’s permission.
Crypto can be a volatile market: how do you advise your clients to mitigate risk when trading in digital currencies?
In the wake of the collapse of FTX, BlockFi and Celsius, mitigating risk when trading in digital currencies seems near impossible. In fact, that may be accurate, and it should be considered best practice to remind your clients of this reality. The rapid decline of FTX and its token FTT demonstrates the pitfalls of digital currencies backed by nothing more than the full faith and credit of an unknown entity and highlights the need for a solid due diligence analysis before committing company capital to these investments.
Undeniably, the digital currency market was predicated on the Greater Fool Theory of investing. The concept of the Greater Fool Theory is that, during a market bubble, one can make money by buying overvalued assets and selling them for a proﬁt later, because it will always be possible to ﬁnd someone who is willing to pay a higher price, i.e. the greater fool. Such strategy is subject to large sell-offs and rapid decline when the inflated price of the asset is exposed. Digital currencies and NFT trading operated under this pretext exclusively as tokens and new currencies sprung up overnight. Now, unfortunately, many retail investors, particularly those who chose to put their money into FTX, went looking for the greater fool only to find themselves looking in the mirror.
To lessen the potential exposure from digital currencies without outright avoiding them altogether, clients should look to exchanges based in the U.S., the UK or the European Union. Although regulation of digital currencies still lags behind the industry, these venues at least provide some level of potential recourse for investors get back their funds (at least some of them) in the event of a digital currency collapse which occurred with FTX.
How is your jurisdiction managing the legal challenges of NFTs: for instance, taxation on purchases, IP, ownership and theft?
The Commonwealth of Pennsylvania has several bills on deck that identify cryptocurrency or virtual currency as a form of money for use in any transactions. Nothing has passed to date and cryptocurrency remains officially undefined under Pennsylvania law. However, Pennsylvania has been considering action by way of House Bill 1724 which was introduced in July 2021. The Bill proposed establishing a digital currency taskforce to understand and study the use of digital currency, cryptocurrency and blockchain within Pennsylvania. The taskforce would set out to understand the who, what, where, why and how of digital currency use in Pennsylvania. Specifically, the taskforce would study: the number of currencies currently being traded and their approximate percentage of market share; the number of exchanges operating in this Commonwealth; the State and local tax issues; potential market manipulation; the regulatory measures taken by the Federal Government, other states, foreign countries and foreign political and economic unions to regulate the marketplace. Eventually, the taskforce would make legislative and regulatory recommendations to increase transparency and security, enhance consumer protections and to address the long-term impact on the use of cryptocurrency. The Bill has not made it to the House or Senate floor to date and may now be indefinitely stalled due to recent developments with FTX. On the other hand, perhaps the disappearance of almost $11 billion overnight from FTX customers provides the push necessary to get this Bill the floor of the Pennsylvania Legislature. Otherwise, it may be too little, too late for Pennsylvania investors.
One certainty clients can count on is that no state will pass up the opportunity for new tax revenue via NFTs and crypto transactions. This year the Pennsylvania Department of Revenue added NFTs to Pennsylvania’s taxability matrix, but provided no other guidance. By placing NFTs on the taxability matrix, Pennsylvania without much, if any, comment characterised NFTs as property subject to state sales tax. Thus, in short order every NFT sale will be treated like any other property sale and the taxing body will get its share.