Dapper Labs’ NBA Top Shots Moments were said by the court to represent investment contracts offered to the public with an expectation of profit. That, together with the finding that the NFTs’ financial success is tied to the success of Dapper's bespoke platforms, satisfies two prongs of the Howey Test – the four-prong test, resulting from a U.S. Supreme Court case, used to determine whether certain assets fall under the Securities and Exchange Commission’s purview.
Marrero begins his legal analysis by referencing the definition of an “investment contract” as “a contract, transaction or scheme whereby a person invests [their] money in a common enterprise” where “profits solely from the efforts of the promoter party.” The court defines NFTs as “digital assets whose authenticity and ownership can be recorded on a blockchain.” On Page 9 he writes, “Moments are a digital video clip of highlights from NBA games, such as a spectacular dunk or game-winning shot.”
See also: Dapper Labs Ruling Could Spell Trouble for Other Centralized $NFT Projects, Experts Say
Distilled to its essence, on Page 23, Marrero’s finds it was Dapper Labs’s control over its private blockchain that showcases how the scheme operates to promote Moments: “[T]he economic realities and technological interplay between FLOW [token], the Flow Blockchain, and Moments, as alleged by Plaintiffs, are what supports the Court’s conclusions.”
On Page 56, the court writes that “a company’s efforts to develop and maintain an ecosystem for trading sufficiently establishes the third Howey prong.” On the next page, he recognizes “Dapper Labs’ implicit promise to maintain the Flow Blockchain and facilitate trades on the Marketplace drive Moments’ value.” Further, on Page 62, “The allegations that Dapper Labs created and maintains a private blockchain is fundamental to the Court’s conclusion.” (emphasis added).
In particular, Marrero is concerned that Dapper Labs restricts the trading of Moments to the Flow blockchain, a network built by Dapper as a faster and cheaper alternative to Ethereum. While this raises questions about profits and transaction fees, the judge also argues that, on a technical level, “by privatizing the blockchain” Moments “purchasers must rely on Dapper Labs’s expertise and managerial efforts as well as its continued success and existence.” Writing in agreement with the plaintiffs, Marrero found this situation altogether different from “public blockchains, such as that underlying Bitcoin.”
Compelling authority
While Marrero made the correct ruling as to Dapper Labs, there is always the possibility a future court might misconstrue what was done to the disadvantage of those selling NFTs using, for example, a layer 2 platform built on a public blockchain or a platform not reliant on a native token ecosystem. Such a potential future ruling would be an obvious bridge too far.
For example, unique items such as artwork more typically sold on an individual basis would not easily square with this ruling. It also raises potential concerns about $NFT creators who partner with firms like Dapper to market and host their work. Judge Marrero actually addresses this issue when responding to Dapper’s motion to dismiss on Page 35, saying the case law the company cites, Dahl v. English, was not equivalent because the “unique pieces of artwork” being sold in that case did not have a “causal connection” to “the promoter making the offering.”
Fine art NFTs also retain another point of distinction from Moments, given that fine art NFTs will always have an intrinsic value. In its motion to dismiss, Dapper had argued Moments should not be seen as an investment contract because the works have intrinsic value. The judge did not buy that argument and noted Dapper’s terms of use states multiple times that Moments have “no inherent or intrinsic value.”
As a point of comparison, the company originally behind the messaging platform Kik – which raised a multimillion-dollar initial coin offering that was later found to be a securities offering, similarly promoted something with no intrinsic value. “Unlike real estate, [the kin token has] no inherent value and will generate no profit absent an ecosystem that drives demand,” the court there found.
See also: NBA-Branded 'Top Shot Moments' NFTs May Be Securities
There are certainly valid reasons why platforms built on private blockchains should be treated differently from those built on public blockchains, and likely why Voice recently made the move to a public blockchain. Platforms using native tokens such as Rarible with its RARI token may also have to strategize a bit after this decision. Finally, private blockchains focused on NFTs such as WAX may have to reevaluate how its promoters are compensated.
Going forward, however, the safest approach for $NFT creators is to partner with a company that has built a platform from the ground up using a public blockchain and without the use of a platform native token or any other direct means of controlling the value of the digital assets. And further, those NFTs sold using such a platform that are least likely to be considered investment contracts are the fine art ones underlying the nascent Digital Art Movement now well underway.
coindesk.com
