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Please think of NFTs more like street art you might buy in New York City or, perhaps, a Beanie Baby, and less like any financial asset.
Matt Robinson, writing for Bloomberg last week, reported that the SEC is taking a hard look at creators of NFTs (and crypto exchanges where they trade) to determine if securities laws are being broken.
A focus of the probe, according to Robinson, is on whether certain NFTs, digital assets that can be used to denote ownership of unique items, are being utilized to raise money like traditional securities. According to unnamed sources, Robinson said that the SEC is “seeking information on so-called fractional NFTs, which involve breaking down the assets into units that can be easily bought and sold.”
We appreciate John Reed Stark’s take on the matter. He spent 18 years at the SEC, the 11 of which was as its founder and chief of the Office of Internet Enforcement. Stark, in part, wrote:
SEC interest in NFTs should come as no surprise. Spending one’s life savings on a cheap looking JPEG is bonkers and soon or later the SEC was going to have to step in and stop the madness.
The NFT maniacal beany-baby-like frenzy is just another scam, orchestrated by a growing legion of con artists and crooks using the same playbook from the notorious penny stock and microcap frauds of the 80s and 90s. It’s all in plain view, even Jordan Belfort, the Wolf of Wall Street, is shilling NFT’s. You just can't make this stuff up.
I get it -- Never before has investing become so unrestricted and egalitarian. [emphasis added]. Anyone with an Internet connection can happily join the fray.
But while exciting, nostalgic (?) and certainly amusing, the gamification of digital asset investing also poses a serious threat in particular for main street investors.
Sinking hard earned cash into nascent, wildly fluctuating and wholly unregulated NFT markets, is rife with risk. The multi-billion dollar Wild West NFT marketplace creates extraordinary opportunities for theft, fraud, trickery and market manipulation.
The bottom line: In the NFT marketplace, market manipulation appears not only rampant and tolerated, but also encouraged. And NFT market fraud appears not only accepted and rewarded, but also taught.
Meanwhile, the cadre of starving artists who helped pump the cryptocurrency and who shelled out real U.S. dollars to pay for the minting of the NFTs “may get a few crumbs” from the undertaking, but in the end, the promoters, trading platform owners and other NFT profiteers are the ones who will typically commandeer the real profits.
To me, NFTs exist so that the crypto-fanatics can pitch the latest miraculous “get rich quick” elixir to earn real dollars from techno-neophyte investors whose idea of due diligence is a 5-minute Google search. Once the digital grifters collect the cash, there no longer exists any reason for the NFT to carry on -- except perhaps to evaporate into the ether (pun intended) that created it.
Speaking about the egalitarianism of investing, Robinhood is NOT your friend.
If you do not like reading as much as you like video, watch this clip from the March 3rd episode of The Problem With Jon Stewart. If you don’t have 16 minutes, here’s our summary: the trading platform, Robinhood, let’s its customers trade stock without paying any commission. How does Robinhood make its money, then? It gets paid by Citadel to direct the buy and sell orders it receives from its customers to Citadel. Citadel is then able to match buyers and sellers using its own inventory of stock that it already owns, instead of executing the orders on the stock exchange. Citadel makes money on a spread between the price the seller gets and the price the buyer pays.
This system by which Citadel pays Robinhood is not by any means unique to those companies. The practice has been around for decades and the term that describes it, coined in 1984, is “Payment-For-Order-Flow.” And, as Stewart hilariously explains like no one else can explain, none other than Bernard Madoff Investment Securities was one of the first players (if not the first) to engage in Payment-For-Order-Flow. And, ironically, one of the earliest critics of Payment-For-Order-Flow: Citadel!
None of this is new. The only difference is that lately it's been in the news.
So, what should an investor do differently?
In a word, nothing. That is, do not change a thing about how you invest because Payment-For-Order-Flow exists. Again, it is not new. And, in our humble opinion, having studied the issue, it is not bad. If you don’t believe us, then read this unusually short and readily understandable academic article from 2007 on the subject: Does Payment for Order Flow to Your Broker Help or Hurt You? By Professor Robert H. Battalio and Professor Tim Loughran
Is there anything you should do differently?
Yes! Using John Reed Stark’s language, do not be a techno-neophyte investor whose idea of due diligence is a 5-minute Google search. Do not get your “investment” ideas from Reddit. If that is how you “invest,” then you do not invest. That behavior is gambling.
And do not abdicate the function of managing your investments to any advisor blindly. Investing is neither rocket science nor brain surgery. It just takes a little education using reliable information. How, pray tell, can you do this? If nothing else, take five minute sand read the latest installment in Jonathan Friedland’s popular series, Investing Basics for Beginners, Investing is Risky But Not Investing is Riskier.
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