Understanding Dufoe v. DraftKings: Massachusetts federal case concerning the Evolving Landscape of Digital Assets (NFTs)
Dufoe v. DraftKings Inc: Boston
The rapid expansion of digital assets, particularly non-fungible tokens (NFTs), has wide-spread implications for securities regulations in Massachusetts’ federal and state courts. This blog post takes a look at a recent case in Massachusetts federal court called Dufoe v. DraftKings Inc., where the court (Judge Casper) examined whether NFTs offered by DraftKings constituted unregistered securities under federal law. This case serves as a critical reference for Massachusetts residents and businesses navigating the intricate regulatory environment surrounding digital assets.
Dufoe Case Overview
In Dufoe v. DraftKings Inc., plaintiff Justin Dufoe filed a class-action lawsuit against DraftKings Inc. and its executives, alleging violations of federal securities laws due to the sale of unregistered securities. DraftKings moved to dismiss the case (a standard move), and Judge Casper, a widely respected jurist, issued a decision. The central issue in the court’s decision was whether DraftKings' NFTs, digital collectibles featuring professional athletes, qualified as investment contracts under the Howey test—a standard used to determine what constitutes a security.
What is a Non-Fungible Token?
In order to understand why an NFT can be deemed a security it is first important to understand what exactly an NFT is.
Non-fungible tokens (NFTs) are assets like a piece of art, digital content, or video that have been tokenized on a blockchain. Imagine you have a special digital certificate that proves you own something unique, like a one-of-a-kind piece of art or even a newspaper article. This certificate can't be copied, its yours and yours alone. Moreover, it's stored on a digital system called a blockchain. A blockchain is like a secure digital database that keeps track of ownership. The connection between the token and the asset is what makes them unique.
NFTs can be traded and exchanged for money, cryptocurrencies, or other NFTs—it all depends on the value the market and owners have placed on them. For instance, you could draw a smiley face on a banana, take a picture of it (which has metadata attached to it), and tokenize it on a blockchain. Whoever has the private keys to that token owns whatever rights you have assigned to it.
Cryptocurrencies are tokens as well; however, the key difference is that two cryptocurrencies from the same blockchain are interchangeable—they are fungible. A bitcoin can be exchanged for another bitcoin, and no one would know the difference. Two NFTs from the same blockchain can look identical, but they are not interchangeable.
Key Legal Issues in Dufoe v. Draftkings
Application of the Howey Test to NFTs
The Howey test is something Dynamis attorneys have discussed in multiple other blog posts. The Howey test is the premiere “test” for determining whether something is a security. It stems from a 75-year old Supreme Court decision. An investment contract, as set forth in Howey, is one form of a security. And Howey defines an investment contract as a transaction involving:
An investment of money
In a common enterprise
With an expectation of profits derived from the efforts of others
The Dufoe court evaluated whether DraftKings' NFTs met these criteria:
Investment of Money: Purchasers bought NFTs using monetary transactions, satisfying the first prong.
Common Enterprise: The NFTs were minted on the Polygon blockchain and traded exclusively on DraftKings' Marketplace, indicating a common enterprise controlled by DraftKings.
Expectation of Profits from Others' Efforts: DraftKings' promotional activities and the structure of the NFT offerings suggested that purchasers had a reasonable expectation of profits based on DraftKings' efforts.
2. Control Over the Marketplace
A significant factor considered by Judge Casper was DraftKings' control over the marketplace where the NFTs were traded. This control test is important for crypto companies in Massachusetts and beyond, and it deals with decentralized aspects of crypto. This control implied that the value and liquidity of the NFTs were closely tied to DraftKings' actions, reinforcing the argument that the NFTs functioned as securities because the more the NFTs relied on DraftKings, the more consumers could expect profit from DraftKings’ actions.
Court's Decision in Dufoe
The court denied DraftKings' motion to dismiss, finding that Dufoe had plausibly alleged that the NFTs met the criteria of an investment contract under the Howey test.
Specifically, the district court held that Dufoe had plausibly alleged that the NFTs met the criteria of an investment contract. Specifically, the court noted that the NFTs were minted on the Polygon blockchain and traded exclusively on DraftKings' Marketplace, indicating a common enterprise controlled by DraftKings. Additionally, the plaintiff alleged that purchasers had a reasonable expectation of profits based on DraftKings' promotional activities and the structure of the NFT offerings.
This decision allowed the case to proceed to discovery, which will be long and expensive for DraftKings.
Implications for Massachusetts Crypto-Asset Law
The Dufoe case offers several critical takeaways for consumers and businesses in Massachusetts:
Regulatory Scrutiny: Digital assets, including NFTs, are subject to federal securities laws. Businesses must evaluate whether their digital offerings could be classified as securities, when deciding whether to create and distribute NFTs.
Marketplace Control: Operating a proprietary marketplace for digital assets can influence the classification of those assets as securities, especially if the business exerts significant control over the trading environment.
Promotional Activities: Marketing strategies that emphasize potential profits from digital assets may contribute to their classification as investment contracts.
Navigating the Legal Landscape
Given the finding that the NFTs in Dufoe were deemed securities, there are multiple takeaways for Massachusetts consumers and businesses engaging with digital assets:
Dufoe is one of the first digital asset cases in the District of Massachusetts: This case could have a significant impact on how the law is shaped going forward in Massachusetts.
Massachusetts could become a plaintiff-friendly court: Of course Dufoe is not binding on other judges in Massachusetts (yet). However, Massachusetts judges tend to follow each other in rendering decisions. It is rare to have a “split” within the district court judges. Judge Casper is widely respected and other judges will credit her considered opinions.
Seek Expert Legal Counsel: Because of the changing environment, it is critical to consult with attorneys experienced in securities law and digital assets to navigate the evolving regulatory environment effectively.
NFT Post Conclusion
The Dufoe v. DraftKings Inc. case is one of the first Massachusetts federal cases involving digital assets. While not yet precedent, given the relatively small size of the federal bench in Massachusetts, certainly other district judges will look to this decision in rendering their own decisions on similar cases. Massachusetts could become a fairly plaintiff-friendly jurisdiction for bringing unregistered securities offerings cases against crypto-asset companies.
For personalized legal guidance on digital asset compliance in Massachusetts and beyond, contact our firm, lawyer Eric Rosen, today: erosen@dynamisllp.com
