Lawyers fielding client calls on the potential litigation risks for non-fungible tokens, or NFTs, might be able to take some cues from another blockchain inhabitant: cryptocurrency.
“No one really knows what box to fit a lot of blockchain technologies into,” said Steven Ragland, a litigation partner at Keker, Van Nest & Peters. “That includes federal and state government regulators, it includes plaintiffs lawyers, it includes the securities class action bar.”
As regulators and litigators hem in their legal theories against cryptocurrency marketplaces and exchanges, attorneys can get a better picture of the potential risk for clients dealing in NFTs.
Ragland, who represents cryptocurrency clients including Coinbase Global Inc., said he expects to continue to see “garden-variety fraud” securities cases against cryptocurrency companies that could potentially translate to NFTs.
“A lot of what we’ve seen from the SEC is taking real traditional ideas of ‘Does it pass the Howey Test? Is it a securities offering, and if so, is it registered? Does it defraud investors? Are you actually buying a token, or is it some vaporware-type thing?’” the San Francisco-based attorney said. “It’s really not terribly unexpected—in a sense, they’re looking at fraudulent business practices writ large.”
Ragland said he’s also seen a number of securities class actions apply old-school legal theories to the Web3 space, which have largely not panned out. The theories have included, “I bought an NFT yesterday, and it’s now not worth anything, and it was supposed to be worth something else … or I tried to buy a crypto token, and I ended up buying it for much more than I thought I’d buy it for, and then the market fell out because it now isn’t worth much. And therefore, I’m somehow defrauded,” he said.
As people “struggle to figure out” how to target the suits, Ragland said he recommends companies ensure they’re developing good business practices and oversight, including registering offerings that ought to be registered.
Cryptocurrency exchanges and platforms have also faced lawsuits from users claiming the company’s negligent cybersecurity practices led to stolen assets or that their crypto wallet was subject to unauthorized transfers.
Ragland said one lesson to emerge from that litigation is that companies with robust cybersecurity and protection efforts have great defenses. “You can’t fault a marketplace because someone fell victim to a phishing scam and gave up their password more than you can for Bank of America, because someone broke in under the cover of night and took stuff from the safe,” he said. “If the security is good, and people crack it, that’s not the provider’s fault.”
In addition to strong cybersecurity protocols and hiring a lot of experts to ensure a secure ecosystem, Ragland said the big players in the blockchain space are educating consumers of the rules of the road in the user agreement. As the technologies mature, he said, consumers might become more sophisticated and opt for using an authenticator app or a private key.
“The interesting issue is what is the standard of care here, both for what’s expected of the consumer and what’s expected of the provider,” he said. “And I think the key of that is education, and doing what you can—you can’t cover everything—but maybe you can prevent a lot.”
Mayer Brown’s Christopher Leach, a Washington, D.C.-based partner and former lawyer in the Federal Trade Commission’s Division of Financial Practices, said many major blockchain marketplaces have user arbitration clauses, so consumer cases regarding cybersecurity breaches and unauthorized transfers are likely to be routed to arbitration, making it difficult to assess macro trends in the cases.
Another potential liability for NFT marketplaces and exchanges could be fraudulent activity. Regulators and prosecutors have targeted alleged cryptocurrency scammers, including the founder of Bitconnect, who was indicted for an alleged $2 billion crypto Ponzi scheme. When it comes to fraudulent activity on NFT platforms, Leach said the FTC could potentially focus on the NFT marketplaces’ representations about the authenticity of assets it sells.
Yet, if marketplaces and exchanges aren’t making those representations, they could have protections under Section 230 of the Communications Decency Act. “To the extent that the exchange itself is not making representations, for example, that every piece of art on its site is authentic or that it makes its own sort of independent assessment of the art—if it’s just providing a marketplace, then the exchanges and marketplaces will have very good arguments that misrepresentations and other scams on the site are not necessarily something that they that they should be responsible for,” Leach said.
Earlier this month, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioned virtual currency mixer Blender.io for allegedly aiding in North Korea’s money-laundering of stolen virtual currency. Frost Brown Todd’s Courtney Rogers Perrin in Nashville said accidentally selling to someone on a sanctions list will be the biggest risk for NFT sellers.
“Say you have a $1 million NFT and you sell it to a North Korean leader, that’s jail time,” she said. “Some people might say money issues are bigger, but, to me, anything that could potentially land me in an orange jumpsuit is a bigger risk.”
Perrin said the OFAC regulations, which designate individuals and geographic locations you are not allowed to sell to, are important but a lot of people forfeit them.
“One of the things that is a deeply held belief [in this ecosystem] is anonymity,” she said. “And I understand some of the reasons that people love that, but I maintain that all American citizens and residents have an obligation to comply with OFAC. And it can have very, very serious financial or jailed penalties for violation.”