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 alleging that non-fungible tokens (NFTs) called Moments are considered securities, a federal judge held in Friel v. Dapper Labs that a lawsuit against the creator of the NBA Top Shot platform can proceed. By surviving the motion to dismiss, the Plaintiffs plausibly alleged 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 could 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 Dapper Lab’s 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 qualify as a security under the Howey test. In its decision to deny the motion to dismiss, the court focused on prongs two and three of the Howey test.

Under prong two of the 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 used to support and grow the Flow Blockchain. Furthermore, once Moments are purchased on the platform, they are able to be sold only in 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 the Flow Blockchain, the value of all Moments would drop to zero.

Turning to the third prong, expectation of profits, the court held that social media statements made by Dapper Labs showed promotion of sales and statistics of Moments on the marketplace. The court found that because the posts included emojis such as the “rocket ship,” the “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 promotion, are crucial to Moments retaining and increasing in value.

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