NBA Top Shot Users Sue Dapper Labs and its CEO in NFT’s First Lawsuit

A recent lawsuit underway in the U.S. reminds us once again that despite being born out of the chain world, NFT is inevitably subject to the legal scrutiny and restrictions of the traditional world.

NBA Top Shot Users Sue Dapper Labs and its CEO in NFT's First Lawsuit

NFT (Non-fungible Token) has become the hottest blockchain offshoot in 2021, rapidly moving from a certificate of ownership and a token of intellectual property to the investment world, with a variety of record high selling prices that have raised concerns: where is the legal boundary of NFT investment, and will it be considered a token financing transaction? A recent lawsuit underway in the U.S. reminds us once again that although NFT is stripped from the chain world, it is inevitably subject to the legal scrutiny and restrictions of the traditional world.

I. Jeeun Friel v. Dapper Labs: An Ongoing Lawsuit
(i) Facts of the lawsuit

NBA TOP Shot is a blockchain-based project launched by Dapper Labs in cooperation with NBA, which is to chain and make NFTs of various players’ highlight moments. this project was quite hot at the beginning of this year, and according to statistics, by the end of February this year, the turnover has exceeded $260 million, an increase of 390%, and the number of buyers exceeded 110,000.

On May 12, an NBA Top Shot user sued Dapper Labs and its CEO, alleging that the NFT it sold was essentially an unregistered security. The plaintiff alleges that Dapper Labs should have registered with the U.S. Securities and Exchange Commission (SEC), but the latter failed to do so. In addition, the plaintiffs allege that the company used NBA Top Shot to deliberately prevent collectors from withdrawing their funds for “months” in order to artificially bolster the market value of the platform. At this time, the allegations are private, and all allegations are based on the plaintiff’s “personal knowledge. Defendant Dapper Labs has 30 days to respond to the subpoena, but has not yet done so.

(ii) Howey Testing

In terms of the direction of the lawsuit, the court should again use the Howey Test to determine whether the transaction between the plaintiff and the defendant has the quality of an investment contract, and thus whether the NFT deck is a security.

The so-called Howey Test consists of four conditions: 1. whether the investment is for money; 2. whether the investment is in expectation of benefits; 3. whether the investment is for a specific cause (common enterprise); and 4. whether the benefits arise from the efforts of the issuer or a third party.

Compared to other countries’ definitions of securities, this standard covers a wide range of securities, so much so that Crypto Mom SEC Commissioner Hester Peirce has criticized the use of this standard to measure whether crypto assets are securities as “ineffective for the industry as a whole.

What may work against the plaintiffs in this lawsuit is that NBA TOP Shot’s user agreement requires players to agree that they will “use the NFT primarily as a gaming object and not for investment or speculation. However, Plaintiffs do allege that the platform gives investors an “expectation of profit” from its marketing materials, i.e., that the platform’s marketing materials tout the success of the platform and the inherent scarcity of NFTs.

(iii) What if some NFTs are securities?

According to Article 2(1) of the Securities Law, the scope of securities is only “stocks, corporate bonds, depositary receipts and other securities as determined by the State Council in accordance with the law”. Therefore, even if the NFT cards similar to NBA Top Shot are recognized as securities in the United States, it is difficult to make the same recognition in China. However, according to paragraph 4 of Article 2 of the Securities Law, if the securities issuance and trading activities outside the People’s Republic of China disrupt the market order in the People’s Republic of China and harm the legitimate rights and interests of domestic investors, they shall be dealt with and held legally responsible in accordance with the relevant provisions of this Law. Therefore, if NFTs are recognized as securities abroad, their issuance and trading activities may also fall within the protection jurisdiction of China.

Second, NFT, how far is it from ICO?
If some NFTs can be recognized as securities, or at least considered to be of a securities nature, the question that arises is whether their production and issuance may constitute ICOs that are officially prohibited in China.

To say that NFTs may be in the nature of securities and that their issuance constitutes an ICO is a slippery proposition at first glance. After all, we all know that the essential feature of NFT is that the smallest unit of its assets is 1 and cannot be further divided, which is fundamentally different from other homogenized tokens or stock securities with percentage modifiers, for example. However, there are still two issues that deserve further consideration.

First, the “non-homogeneous” feature of NFT is inherently ambiguous. On the Ethernet blockchain, NFTs are created based on standards such as ERC-1155. Tokens created using the ERC-1155 standard ensure uniqueness, so we say that NFTs are “non-homogeneous”. However, it is not technically difficult to create an NFT. If we mint a large number of essentially identical NFTs and distribute them to the market, will a “homogeneous token” be formed naturally? Just like the RMB, each RMB is not exactly the same as the other, but has a different number, but the different numbers do not affect the identification of its type.

Second, there are already “segmented” NFT items. Just as one of the original purposes of the NFT concept was to solve the circulation problem in the art collecting world, it is already very attractive to NFT owners to break up NFTs into fractionalized proceeds for investors and further speed up circulation. For example, a decentralized project called “F-NFT” enables NFT owners to tokenize fractional ownership of their own works, thereby facilitating the buying and selling of NFTs on a percentage basis. Another project called “DAO-Fi” breaks down the irreplaceable ERC-721 tokens into replaceable ERC-20 tokens, allowing buyers to take partial ownership of NFTs. In this way, NFT is equivalent to a specific asset that is originally indivisible and creates other tokens that can be substituted for each other. If financing is done in this way, the behavior pattern is very similar to ICO, which is explicitly prohibited in China.

In the end
As SEC Commissioner Hester Pierce urged at the Draper Goren Holm Summit on March 25, NFT issuers should be careful about selling fractional interests in NFTs (sell fractional interests). “You better be careful that you’re not creating something that’s an investment product – And in China, similar financing practices are likely to be identified as ICOs and cracked down on by regulators.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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