Layup or Airball? Court Holder NBA Top Shot NFTs May Be a Collateral in Friel v. Dapper Labs | Venable LLP

The start of 2023 hasn’t gone much better for the blockchain and cryptocurrency industry than the end of 2022 did. In declining to dismiss a case that argued that non-fungible tokens (NFTs) called Moments are considered securities, a federal judge in Friel v. Dapper Labs that a lawsuit against the creator of the NBA Top Shot platform may proceed. In surviving the motion to dismiss, plaintiffs plausibly argued that these NBA Top Shot NFTs, and only these NFTs, could be a security. While the first of its kind to hold that an NFT can be considered a security, this seemingly narrow ruling could have far-reaching implications for other NFT projects and marketplaces.

NBA Top Shot is an NFT platform, owned and operated by Dapper Labs, that allows consumers to buy, sell and trade Moments (digital video clips of player highlights) on the Dapper Labs Flow Blockchain. On February 22, 2023, the United States District Court for the Southern District of New York denied Dapper Labs’ motion to dismiss, holding that although “it [is] a close call and the court’s decision is narrow,” Moments qualifies as a security under Howey test. In its decision to deny the motion to dismiss, the court focused on prongs two and three of the Howey test.

Under the tip two off Howey test, the court reasoned that the value of Moments is “causally related to the profitability of [Dapper Labs] as a whole” because their value depends on the success of the Flow Blockchain. Dapper Labs’ sale of “packs” of Moments and the transaction fees on the marketplace generate revenue that is used to support and expand the Flow Blockchain. Furthermore, once Moments are purchased on the platform, they can only be sold on the marketplace, which runs on the Flow Blockchain and is controlled by Dapper Labs. The court reasoned that if, hypothetically, Dapper Labs were to go out of business and shut down Flow Blockchain, the value of all Moments would drop to zero.

Regarding the third prong, expectation of profit, the court held that Dapper Labs’ social media statements showed promotion of sales and statistics from Moments in the marketplace. The court found that because the posts included emojis such as “rocket ship,” “stock chart,” and “money bags,” they objectively meant one thing: a financial return on investment. The court also found that Dapper Labs’ continued management and efforts to develop the Flow Blockchain ecosystem, both technologically and as a matter of marketing, are essential to Moments’ retention and increase in value.

This narrow ruling was the first of its kind to establish that an NFT could be considered a security. Indeed, the court concludes its ruling by stating that “[n]ot all NFTs offered or sold by a company will constitute collateral, and each arrangement must be evaluated on a case-by-case basis.” While the order attempts to underplay the significance of this ruling, the court’s analysis and reasoning of Howey test prongs in relation to NFTs can have far-reaching effects for customers native to the NFT area and traditional brands expanding into the space.