Friel v. Dapper Labs: 5 Crypto Decisions From 2023 Every Lawyer Should Know

5 Under the Radar Crypto Decisions from 2023: What You Need to Know

2023 was a big year for crypto litigation. SEC cases against Ripple and Coinbase dominated the headlines. But, a number of other decisions (some known, some not known) have the potential to shape this growing area of law. See below our list of five important decisions, together with a brief analysis.

Van Loon v. Department of Treasury (“Tornado Cash”) - August 17, 2023 (Western District of Texas)

The Van Loon decision rejected Coinbase’s attempts to get a court to hold that OFAC had no ability to regulate/designate Tornado Cash, a crypto mixer that had been added to the Treasury Department’s Specially Designated Nationals and Blocked Persons List. For those of you who are unaware, a crypto mixer is exactly what it sounds like: send crypto to the mixer, the crypto gets mixed together with crypto from other users, and then it is withdrawn by the depositor to an address that he or she designates, often in different quantities than what was originally deposited. Mixers obscure the source and ownership of crypto, making it difficult to determine who controls a particular Wallet. For people with a lot of crypto (whales) these can be very helpful for entirely legitimate reasons.

Without getting into the many complexities of the case, the precise legal issues involved whether Tornado Cash (effectively a system of smart contracts) fell under the “person” or “national” definition of OFAC laws, and also whether Tornado Cash (the entity) had a property interest in the smart contracts governing the mixer system. The Court rejected all of the challengers’ arguments, ruling that Tornado Cash had been properly designated under OFAC rules. This has dealt a blow to DeFi protocols - the judge (like the judge in Sarcuni, discussed below) did not buy the argument that simply hiding behind a DAO takes a protocol outside of government regulation. DeFi users/protocols should watch to see how this body of law develops.

James Friel v. Dapper Labs, Inc. (NFTs) - February 22, 2023 (Southern District of New York)

The issue in Dapper Labs was whether certain NFTs (“Moments”, a type of digital basketball card) qualified as securities under the now familiar Howey test. The Court acknowledged this was a “close call” and limited the holding to the particular NFTs at issue. However, the Court found that NFTs could be securities under the Howey test, and therefore declined to dismiss the complaint. The interesting part of this case is how the Court analyzed the issue. The Court rejected Dapper’s arguments that the accompanying tokens (FLOW) could be separated from the NFTs at issue. The Court found that without the FLOW tokens, no transactions on the blockchain could be validated, and therefore the NFTs would have no value without the tokens.

Underwood v. Coinbase (Securities Laws Class Action) - February 1, 2023 (Southern District of New York)

In Underwood, a case brought against Coinbase for allegedly offering securities for sale on its platforms, the Court dismissed claims brought under Section 12a1 (Securities Act), Section 29b (Exchange Act), and state law blue-sky laws. The Court determined that the plaintiffs failed to prove Coinbase was a statutory seller under the Securities Act. The plaintiffs did not establish a direct relationship with Coinbase in the sale of securities, which is a critical part of setting forth a claim under Section 12(a)(1). Additionally, under the Exchange Act, the court found no evidence of Coinbase entering into prohibited securities transactions. Interestingly, the Court relied heavily on admissions in an earlier complaint, even though the plaintiffs had filed a superseding complaint that should have rendered the earlier complaint moot. Further, the Court cited Coinbase’s user agreement, which made clear that Coinbase was not acting as an intermediary in an asset transaction. This ruling, together with the Uniswap ruling set forth below, make clear how difficult it is holding exchanges liable for unauthorized sales. Notably, the Court in Underwood highlighted the difference between crypto and other asset trading, a distinction that is being credited less and less as courts feel more comfortable applying old laws (i.e. Howey) to new technology.

Risley v. Universal Navigation (Uniswap) - August 29, 2023 (Southern District of New York)

Everyone knows UniSwap - the preeminent decentralized exchange. Well, the plaintiffs sought their money back after investing in a scam token trade-able on UniSwap, but where they could not identify the issuer of the scam token. This lengthy decision should certainly be read. However, the Court rejected the plaintiff’s arguments that the decentralized exchange, which operated through self-executing smart contracts, could somehow be considered a securities exchange. This well-reasoned opinion highlights the difficulty in holding exchanges (particularly decentralized exchanges) liable for tokens traded on their protocols.

Sarcuni v. bZx Dao (DeFi protocols) - March 27, 2023 (Southern District of California)

In my opinion, this opinion will have far-reaching effects as it goes to the very issue at the heart of DeFi - is it truly decentralized? Here, the plaintiffs sued because of a hack of a DeFi protocol that was ostensibly built and controlled by the bZx DAO (“decentralized autonomous organization”). The protocol itself offered crypto margin trading and lending products. A host of charges are pled, and the Court largely rejected the defendants’ motion to dismiss. As an example, in upholding the negligence claim, the Court held that the DAO owed a duty to secure their protocol and that it breached that duty. The Court also ruled that anyone holding the BZRX governance token was a member of a general partnership under California law. While confined to the facts of this case - the Court cited public calls from some of the DAO’s leadership - obviously, the Court did not accept the central premise of the case proffered by the defendants, which was that a DAO truly is decentralized such that it cannot either have duties or true members. DeFi protocols beware!

For another example of a DAO ruling where the Court didn’t buy the decentralized argument, see the ruling regarding Compound (Houghton v. Leshner - September 20, 2023) from the Northern District of California. This case also has Section 12 (statutory seller) implications that will be tackled in a related blog post.