A recent court case involving Dapper Labs, the company behind NBA Top Shot moments, has raised questions about the security status of NFTs. A class action lawsuit has been filed against Dapper Labs for allegedly violating federal securities laws by offering NFT collections without first registering with the US Securities and Exchange Commission (SEC).
A ruling on a motion to dismiss the case states that Dapper Labs’ flow tokens are necessary to the totality of the scheme at issue, and without the flow tokens, no transactions on the blockchain can be validated. The judge’s decision was based on the “Howey test,” which has three prongs: an investment of money, a common enterprise, and a promise of profit.
The ruling has sparked debate about the status of NFTs, with some arguing that if NFTs are considered securities, then why not consider everything on the blockchain as such? However, the judge ruled that NBA Top Shot moments are different from other collectibles like baseball or Pokemon cards, as they involve pooling investor funds with the expectation of profit.
The first prong of the Howey test, an investment of money, is not contested by either party, as buyers pay for individual NFTs. The second prong, a common enterprise, refers to an enterprise in which the fortunes of the investor are interwoven with those of the person offering the investments, a third party, or one or more investors.
The court found that there was a common enterprise, as the fortunes of investors were tied to the overall success of Dapper Labs. This was due to Dapper Labs’ control of the flow blockchain as well as the online marketplace where the moments were sold and traded.
The third prong of the Howey test, a promise of profit, was found to be met by the court, as the defendant’s public statements and marketing materials led purchasers to expect profits. The ruling cited Top Shot tweets as examples.
The ruling has led to concerns that more cases may be brought against NFT creators in the future. While the Howey test is loose, it comes down to the details that can be proven in court. The case highlights the need for clearer regulations on NFTs and the blockchain, and how they are traded and used.