NBA Top Shot Lawsuit Could Be Bad For Dappers – Could It Be Good For NFTs?

The multi-billion dollar NFT market has for years been anxiously awaiting the answer to a single question: Will the US government classify non-fungible tokens as securities?

A federal judge in Manhattan on Wednesday offered the first glimpse of an answer, decision against one of the best companies in the NFT space: CryptoKitties and NBA Top Shot maker Dapper Labs.

Dapper sought to dismiss a lawsuit against the company over allegations that it violated securities laws in its offering of NBA Top Shot NFT Moments. Judge Victor Marrero denied Dapper’s motion to dismiss because he found arguments for labeling Top Shot NFTs as securities “plausible” — a first for this new technology. Several NFT collectors took to Twitter following the news to praise the industry, but such reactions may be premature, legal experts say Decrypt.

“For most people who create NFTs using public blockchains, and who allow their NFTs to be traded on marketplaces, I think this is actually a pretty good decision,” said Jeremy Goldman, a lawyer who specializes in blockchain technology. Decrypt. “They can breathe a sigh of relief.”

Goldman reasons that the court’s decision actually bodes well for the broader NFT market because of the emphasis Judge Marrero placed on Dapper Labs’ Flow blockchain as a “private” network. Top Shot NFTs can be securities not only because Dapper Labs created them, the judge said, but also because the company built the Flow blockchain on which the NFTs were launched.

“If, hypothetically, Dapper Labs went out of business and shut down the Flow blockchain, the value of all Moments would drop to zero,” Marrero wrote. “That’s the critical causation that other collectibles cases lack.”

Holders of Top Shot NFTs are therefore inevitably invested in the success, or at least the survival, of Dapper Labs, according to the judge. Such a relationship between a passive product and the active work of a separate entity is at the heart of the definition of a security under US federal law.

“That Dapper Labs created and maintains a private blockchain is fundamental to the court’s conclusion,” Marrero said.

This dynamic, where a company builds both an NFT pool and the blockchain it lives on, is atypical in the industry – the vast majority of NFT pools exist on public, permissionless blockchains like Ethereum and Solana.

But not everyone agrees that this distinction is particularly important when deciding whether an NFT should be considered a security.

“It would be a mistake to conclude from this, ‘Well, I’m on a public blockchain, so this is irrelevant to me,'” said Lewis Cohen, a lawyer focused on blockchain and tokenization. Decrypt.

“Judges cut through the BS. “They’re really trying to understand what’s going on, and they’re doing a pretty good job of that,” he said. “And if [an NFT project] looks and feels like something where people give money and trust a promised roadmap, it could be in the same position.”

If the impact of Wednesday’s ruling on the broader NFT market is still up for debate, one point that isn’t is that things aren’t looking good for Dapper Labs. The company’s founder and CEO Roham Gharegozlou referenced Wednesday’s ruling in a letter to employees announcing a further 20% reduction in Dapper’s staffafter cutting 22% of its workforce in November.

“There is a lot of misinformation circulating about the nature of this ruling,” Gharegozlou wrote Wednesday, mocking reports that inaccurately framed Wednesday’s decision as a final verdict in the case. Marrero’s ruling only allows the private lawsuit to move forward.

Still, the judge’s unusually thorough rejection of Dapper’s motion to dismiss seems to indicate that the company faces a very steep road ahead.

“I wouldn’t be surprised at all if Dapper just goes and settles down now,” Cohen said. “The wind is not blowing in a good direction for them, and the last thing they need is a direct verdict and a real precedent.”

It has been very windy in crypto lately. A shower of enforcement action and legal decisions against various crypto companies has piled up in the wake of the stunning and very public collapse of crypto exchange FTX in November; the US government has clearly signalled it can no longer afford to look passively on the issue of crypto regulatory enforcement.

While Wednesday’s ruling may have produced the first legal document on the specific issue of NFTs’ status as securities, and while some see that decision as net encouragement, the current regulatory atmosphere in the US may already have had a chilling effect on the US’s role in it global NFT market.

Miroslav Đurić, a Frankfurt-based lawyer specializing in cross-border financial regulation, regularly advises clients on how best to launch NFT projects worldwide. In recent months, he has observed a reluctance to relate to one country in particular.

“We’re seeing clients that operate in multiple jurisdictions right now that are accelerating in Europe, or in the UK in the short term, but paying a lot more attention to their new products and services in the US,” Đurić told Decrypt. “Customers have been quite reluctant to take the risk of opening up the option for US investors to buy their tokens, to avoid dealing with the SEC at all.”

In that sense, despite the fact that the US government has not yet decided whether it considers most NFTs to be securities or not, recent postings may have already effectively answered the question.