Could Ordinals Erode Bitcoin’s Regulatory Moat?

Bitcoin is a commodity, but the regulatory backdrop for NFT-like assets is still developing.

By: André Beganski

December 13, 2023

Bitcoin is the only digital asset that can boast it’s a commodity, but Wall Street Goliaths like BlackRock have warned prospective investors that certain changes to the network are worth paying close attention to.

The potential risks include a change in Bitcoin’s regulatory status and the impact of NFT-like assets on the network. And as Bitcoin Ordinals continues to generate buzz, the protocol's skeptics have wagered recently that inscriptions could risk turning Bitcoin into a web of unregistered securities.

Launched earlier this year by developer Casey Rodarmor, Ordinals have led to a surge in NFT-like assets on Bitcoin. By enabling data to be “inscribed” on an individual satoshi — equal to 1/100,000,000th of a Bitcoin — the protocol has reignited experimentation with crypto’s oldest coin. Its popularity has also resulted in a fervent debate over how Bitcoin should be used.

Among Ordinals' outspoken critics on X, Bitcoin advocate Max Keiser claimed it’s illegal to trade the assets in El Salvador last Wednesday. While Luke Dashjr, another noted Ordinals skeptic and Bitcoin developer, agreed with the purported outcome, he was less resolute that Ordinals inscriptions could indeed be securities.

“While the rationale (‘unregistered securities’) might be flawed, I think the outcome is correct,” Dashjr said on X. “Maybe this is just the easiest way to do it in their legal system.”

(Coinage could not independently verify that Ordinals inscriptions are considered unregistered securities in El Salvador, nor NFTs.)

Given the uncertainty in the U.S. around how the so-called Howey Test applies to digital assets, “it’s a little premature” to say that a Bitcoin transaction, even if it taps Ordinals, could constitute the offering of an unregistered security, Alexander C. Kim, an associate at law firm Katten Muchin Rosenman told Coinage.

“I don't view that as a material risk at this point,” he said. “We have legal clarity with respect to the characterization of Bitcoin as a commodity, and in order for there to be a change in that characterization under the law, something significant must have occurred.”

If Bitcoin's status as a commodity is challenged in court one day, a judge could make decisions on a transaction-by-transaction basis, Kim added, pointing to Ripple Labs' partial courtroom victory over the Securities and Exchange Commission (SEC) earlier this year. In her landmark ruling, U.S. District Judge Analisa Torres found programmatic sales of XRP by Ripple did not violate federal securities laws, while certain ones made directly to sophisticated investors did.

When BlackRock, one of the world’s largest asset managers, submitted an S-1 filing with the SEC for its proposed spot Bitcoin ETF in June, the firm highlighted Bitcoin’s regulatory status in a section that outlined potential risk factors for its prospective iShares Bitcoin Trust.

“A determination that Bitcoin or any other digital asset is a ‘security’ may adversely affect the value of Bitcoin and the value of the shares, and result in potentially extraordinary, nonrecurring expenses to, or termination of, the Trust,” the filing stated.

Farther down, the filing referenced the “adoption of Ordinals” as a factor that could reduce demand for Bitcoin because of its potential impact on “the volume and speed of [Bitcoin] transactions.” The protocol caused Bitcoin transaction fees to spike significantly this spring, the filing pointed out, adding that “increased fees and decreased settlement speeds could preclude certain uses for Bitcoin.”

Taproot Wizards co-founder Udi Wertheimer has been one noted proponent of Ordinals. Our Episode above focuses on Udi's mission to bring digital assets to Bitcoin.
Taproot Wizards co-founder Udi Wertheimer has been one noted proponent of Ordinals. Our Episode above focuses on Udi's mission to bring digital assets to Bitcoin.

In May, MicroStrategy Co-Founder and Executive Chairman Michael Saylor said that offerings comprised of Ordinals inscriptions could be considered unregistered securities depending on how they’re used or perceived, per Decrypt. He highlighted BRC-20 tokens, an experimental class of tokens built on top of Bitcoin using Ordinals that parallels the structure underpinning meme tokens on Ethereum.

“If BRC-20 tokens are viewed as fungible tokens to issue unregistered securities, there's a lot of objection to that, because it's unethical. It's illegal,” he said. “And you can't blame [Bitcoiners] for objecting to that.”

In February, SEC Chair Gary Gensler said that “everything other than Bitcoin” could be considered a security in an interview with New York Magazine. At the same time, Commodity Futures Trading Commission (CFTC) Chair Rostin Behnam said that “under existing law, many of the tokens constitute commodities” on CNBC on Tuesday.

While advocates of the digital assets industry bemoan a lack of regulatory clarity in the U.S., regulators have stepped up scrutiny toward firms issuing NFTs this year.

The SEC set its regulatory scope on NFTs for the first time in August when it unveiled an enforcement action against Impact Theory, a Los Angeles-based media and entertainment firm. The regulator alleged that Impact Theory raised $30 million through an “unregistered offering of crypto asset securities” that comprised NFTs.

Promotional statements attached to Impact Theory’s so-called Founder’s Keys — represented as NFTs — indicated that the assets were sold as investment contracts, according to the SEC. Impact Theory ultimately agreed to pay $6.1 million as part of a settlement with the regulator. SEC commissioners Hester Peirce and Mark Uyeda disagreed with the crackdown.

“We do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items,” they wrote.

Several existing NFT projects that launched on Ethereum have migrated over to Bitcoin using Ordinals in 2023, including OnChainMonkey. However, whichever chain an NFT calls home, regulatory scrutiny will likely remain.

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