At Art Basel Miami, security token debate rages on

‘There is no AML/KYC in art’

One can expect lavish parties at Art Basel Miami, the sprawling, star-studded, fashion-infused, week-long rave in early December that this year featured the works, insights and sounds of Christo, Bansky, Venus Williams, Sofi Tukker, Calvin Harris, Pharrell Williams, Kanye West, Lil Wayne, Paris Hilton and other personalities. But increasingly leading tech brands like Google and LG are in the mix offering lavish CES/Coachella-like experiences, all in an effort to grab the attention of the luxury goods crowd. From opening night on December 5 at The Bass Museum of Art to closing night on December 8 at the Versace Mansion, you never would have known that FAANG and crypto prices were crashing. Optimism for the Art + Tech + Finance Revolution was everywhere.

The dream

The promise of blockchain technology unlocking value through tokenization was the main theme of Art Decentralized: The World of Distributed Masterpieces, one of the many crypto conferences at the show.

Panelists shared visions of a world where patrons could stroll through museum galleries and buy fractionals of modern masterpieces on display with just a tap of their phone, a world where up-and-coming artists could pre-sell their portfolios and keep a percent of ownership in their own works. In this utopia, museums would get rich, the public could delight in owning a piece of previously inaccessible art, and artists could secure funding to support their craft while benefiting from the long term appreciation in the value of their creations.

Chris Eberle, COO of security token marketplace Swarm, presented a video to the audience of family offices, institutional investors and collectors explaining the investment opportunity in art tokens:

“There is a new technological institution that will fundamentally change the way we exchange value and it’s called the blockchain. The next generation of the Internet: Transparent. Democratic. Decentralized. Secure. Comparing the benefits of blockchain with the greatest store of wealth to let you profit from the most stable asset class, art. Art returns beat the total returns of the S&P 500, with an average annual return of 10 percent over the past four decades.”

The video referenced a 2016 Deloitte Art & Finance Report which states, “Post-war & contemporary works of art delivered compound annual returns of 10.85 percent–above the performance compared with US equities in the last 40 years” citing this Mei Moses chart:

Deloitte Art + Finance Report
(via Deloitte Art + Finance Report, 2016, pp. 106-107)

Looks like a duck

Excitement over the potential for these new financial instruments was tempered with debate over whether art tokens are securities subject to regulatory compliance.

“These are absolutely securities!” said Eberle. In an interview with me that followed his presentation, he explained, “They are created as investment vehicles from the get go for people to own and trade with the primary use to appreciate in value. We view STOs [securities token offerings] as a subset of ICOs designed to operate within the law.”

“Just because it looks like a security doesn’t exactly make it one.” said Jeremy Gardner, co-founder of Augur and Ausum Ventures on his Art Decentralized panel. “There is no case tested that art [tokens are] a security. Historically, buying art does not go through KYC/AML [“know your customer”/anti-money laundering checks].”

Referencing the Howey Test, Gardner continued, “It has to be investing in a [common] enterprise. A piece of art is not a [common] enterprise and there is no case tested otherwise.”

For reference, under the Howey Test, a transaction is an investment contract if:

  1. It is an investment of money
  2. There is an expectation of profits from the investment
  3. The investment of money is in a common enterprise
  4. Any profit comes from the efforts of a promoter or third party.

Responding to comments on how to proceed during this period of regulatory uncertainty, Gardner explained, “The U.S. is five years ahead of almost any other jurisdiction [in terms of technology]. I think [U.S. regulators] have been slow and methodical, initially only going after fraud, now setting case precedent and getting some push back. I created the first ICO for a utility token and first ICO for a tokenized security and it was scary, but then we had a dialogue with regulators, we reached out. It was constructive and I never got a subpoena and none of our portfolio companies ever got subpoenas. So many startups have been reckless in this space, [U.S. regulators] have done a very good job of just enforcing the laws.”

Secrets and Lies on The Blockchain

The next day, I spoke at the SCOPE Art Fair on “When Deals Turn Digital: New Technologies, Banking, and the Future of the Art Market” with Kiki del Valle of Mastercard, Katya Fisher  of Fisher Cataliotti, Elena Zavalev of New Art Academy, and Vanessa Grellet of ConsenSys.

Before we began, I asked Fisher, who is an attorney representing art collectors, whether art tokens could be considered securities. “It’s a facts and circumstances type of situation, depends on what type of work we’re looking at and how the work is being marketed and sold,” she responded “If you have an artwork and the ownership is fractionalized and no one is actually taking the artwork home and putting it on a wall, and they’re purchasing it for purposes of speculative investment, that appears to me to look very much like to what I would refer to as a security instrument.”

“There’s no AML/KYC in art,” I said to Fisher during the panel referencing the regulations set forth in the U.S. Bank Secrecy Act of 1970.

“There’s no lots of things in art,” Fisher laughed. “When you sell or buy art, the wonderful thing about the art market is that it’s unregulated. In order to be an art dealer, you don’t need a license. You don’t have to be a licensed gallery. It’s not the same thing as a real estate agent or broker dealer advisor. This is one of the things people love about the art market.”

“Blockchain creates transparency which is great for technologists, but people in the art market they don’t want transparency,” she continued “If you know how a piece moves from one place to another, no one knows who the buyer is, who the seller is, and then there are dozens of consultants in between giving each other LOIs [letters of intent] and proof of funds, hiding everything from each other, and putting on all sort of commissions and fee-splitting on the back end.This is how people make money. If you go ahead and start seeing security offerings with people purchasing fractional shares that they want to appreciate in value, not because it’s a beautiful work of art they truly appreciate and want on their wall, and if you start to have transparency in the art market to see how much it costs and who owns it and where it came from, you’re going to spoil the fun for a lot of people!”

Looking ahead, Fisher added, “In any industry where you can save costs expenses and make a lot of money, the market is going to get disrupted. My father is a leading expert on Holocaust Art Restitution and he can tell you that before 1945, there’s a lot that people don’t want on the blockchain. For contemporary art, blockchain offers transparency, authenticity and provenance and because of that I do believe tech is the future. You’re going to have a lot of push back so it’s going to take longer, it’s going to be harder, but it’s going to happen.”

Ode to CryptoKitties

Following the SCOPE panel, I was approached by Fanny Lakoubay, CMO of Snark.Art, the Brooklyn-based gallery issuing art tokens for Eve Sussman’s 89 Seconds Atomized, which I had previously written about on Modern Consensus.

I asked her if their art tokens were securities. “We worked with security lawyers on that and it is not a security token,” she replied. “Each token of the artwork is ERC721 and are collectible like a CryptoKitty or Cryptopunk. They add up to being something, but each one is its own piece of art. It plays in your crypto wallet or on the Snark.Art website. You can visualize the whole video within each 20 by 20 pixel square. It’s being offered face down at the primary market, and for trade on the secondary market like other collectibles.”

“Eve is putting in the hands of the collectors the responsibility to make this artwork live,” Lakoubay continued. “When you sell [a work] to a museum, it goes to an archive and no one sees it. The MoMA archive owns [Sussman’s] original; it’s not on view or display anywhere. This is the only way to see it. There’s a function in the smart contract that you can lend your piece to the community to do viewings of the artwork. Anyone with an atom can request a showing from the community and can charge admission fees. We all know one hundred percent of active users is never happening, so even if fifty percent agree, it can still be on display, there will just be holes.”

“We’re very lucky that CryptoKitties paved the way. They essentially invented the ERC-721 nonfungible token on the public blockchain and went through all of that for the rest of us.”

What’s next

Industry is still working out the kinks of the good, bad and ugly.

The ugly being that lies can live on forever on the immutable ledger, like the Verisart registry verifying developer Terence Eden instead of legendary artist Leonardo da Vinci as the creator of the Mona Lisa. The good being that DNA tagging with magic spray, hi-res photography, and smart tags are now providing a way to tie physical goods to digital provenance.

The bad being that cross border payments are still a nightmare for gallery owners who don’t have an American bank account and cannot accept international credit cards. I had a chance to talk with Elisabeth Ramfjord of the Norwegian gallery Galleri Ramfjord at the SCOPE Art Fair and she told me she’d rather let the client take the work home from the show and invoice them later with wire instructions trusting that they’ll pay rather than having to deal with the timing and fees of PayPal or the complexity of Bitcoin.

To address this, fintech solutions like Artpaie discussed by Fisher will be coming on to the blockchain to facilitate instantaneous, secure payments for high value transactions with no fees.

“The world of payments we envision at Mastercard is to operate in a tokenized-only world. It’s the way we’re moving forward whether or not you’re aware of it as a consumer when you use Apple Pay or Samsung Pay. All of these solutions are using a proxy for your account number to drive security. The ability for a consumer to associate their credentials with a specific device could be very well applied to the world of art,” said Mastercard’s Kiki de Valle.

“The industry will change in ways we have not anticipated,” added ConsenSys’ Vanessa Grellet. “Technology will increase competition between experts and galleries who will have to compete in this transparent environment and create added value, and it will increase because determining who are the leading artists will no longer be in the hands of the very few galleries. You will see influencers who will lead the trends and in five years we’ll be having a very different conversation about how the art market is shaped and how the artists are able to make money, especially with the digital art space that will be growing exponentially.”

 You May Also Like

Martine Paris is a Silicon Valley tech reporter who follows the money across AI, robotics, gaming, crypto, and blockchain. She writes for Fast Company, The FinTech Times, Hacker Noon, Pocket Gamer, Blockchain Gamer and other Sea of Reeds publications. Disclosure: She owns an insignificant amount of crypto. Follow her on Twitter.