The universe of NFTs, or Non-Fungible Tokens, is the current digital asset wild west craze. It’s an industry where fortunes can be made or lost in the blink of an eye! At Token ATH!, we’re monitoring these advancements, cutting through the noise and BS. One of the most recent cases making waves in the crypto community is the lawsuit filed by Nike over its RTFKT NFTs. Was this really another authentic claim of a “rust $5 million rug pull”? Or does it just show the true nature of the dangerous investing risks in this boom/bust market? Let's dive in.

Recently Jadeep Cheema, an enterprising young designer and artist, filed a lawsuit against Nike. He alleges the company violated consumer protection laws in New York, California, Florida, and Oregon. It further alleges violations of state unfair trade and competition statutes. The crux of the argument comes down to the claim that Nike’s NFTs are actually unregistered securities. Cheema puts a fine point on the Howey Test. This legal precedent serves as a key test to help decide if a given transaction is an investment contract and therefore a security.

The Howey Test describes an investment contract to exist where a person invests money in a joint venture. They hope to make money primarily by being on the receiving end of the fruits of other people’s labor. Cheema argues that Nike, through its continued support of the RTFKT project, created a reasonable expectation of profits for NFT holders. This expectation, he argues, renders the NFTs registered securities, which Nike purportedly sold without registration or disclosure requirements.

Cheema isn’t only after money damages. He wants Nike to disgorge all profits from the RTFKT project. He seeks an injunction to stop Nike from selling any further supposedly unregistered securities. This case has the potential to make waves in the NFT world. Second, it may have broader implications for how we think about classifying and regulating NFTs.

NFTs as Securities: A Gray Area

Whether or not NFTs are securities is very much up for debate. The Securities and Exchange Commission (SEC) has been wading into these waters, as demonstrated by their action against Impact Theory, LLC. The SEC found that Impact Theory's NFTs were indeed securities because investors purchased them with the expectation of profit derived from the company's efforts to build a "next Disney." Its own investors’ fortunes were deeply connected to the shop of indie video game maker Impact Theory.

Advocates say that this wide-ranging interpretation is not universally accepted. SEC Commissioners Hester Peirce and Mark Uyeda have been vocal opponents of the SEC’s ongoing strategy. They ask whether NFTs should presumptively be deemed securities simply because they are marketed with representations of future value. Specifically, they noted that SEC does not typically exercise jurisdiction over sales of collectibles, like a watch or painting. This is especially the case even when those items are sold with the express purpose of increasing their resale value.

The Commissioners additionally called for the SEC to take a more definite stance on how securities laws are applicable to NFTs. This would aid both creators and investors in understanding the legal landscape and avoiding any potential traps. Furthermore, the NFT market overall is devoid of clear rules, leaving the entire industry in a murky limbo. This uncertainty creates challenges in determining which NFTs are subject to securities regulations.

Our climate lawsuit against Nike raises an important and related question. The court can rule on whether the RTFKT NFTs meet the Howey Test requirements. If the court finds that Nike, in substance, created a reasonable expectation of profit, the NFTs would likely meet the test as securities. Such a classification might expose Nike to massive liability. This case illustrates a continued lack of clarity and regulatory guidance in the NFT realm.

Rug Pulls and Investor Protection

The lawsuit touches on the notion of the “rug pull.” As you might have guessed, this term has become all too familiar in the crypto world. A rug pull is a type of scam. Under this plan, project developers disappear with the money of investors, leaving them holding useless tokens or NFTs. These scams usually consist of blowing up a project with baseless claims and fake hype to lure unsuspecting buyers.

Rug pulls come in various forms. Some are more egregious, where developers disappear overnight with the funds. The second type is more insidious, revealing themselves over time and under the guise of standard market fluctuations. “Soft rug pulls” are difficult to identify. They can mean chopping away at funding for a mile at a time or silently swapping project dollars to a different location.

The real world case upon case of rug pulls within the NFT realm. The Evolved Apes NFT project is a classic example of this crime. The anonymous developer behind it—under the pseudonym “Evil Ape”—disappeared with $2.7 million in investor money. In a separate but similar example, the creators of the Frosties NFT project were hit with felony charges. They were charged with wire fraud and money laundering for supposedly absconding with investors’ cash.

  • Evolved Apes: The anonymous developer disappeared with $2.7 million of investor funds.
  • Frosties NFT: The developers were charged with wire fraud and money laundering.

As a result, the Nike lawsuit doesn’t come out and charge Nike with doing a rug pull per se. Nike’s decisions, omissions, and inactions have greatly affected RTFKT NFT holders. Consequently, they experienced a tremendous devaluation. The court will need to decide whether this case is a true rug pull or merely a speculative investment that soured. This question is fundamental to the case.

Navigating the Metaverse: Risks and Rewards

The emergence of the metaverse further complicates the NFT ecosystem. The metaverse, a virtual world where users can interact with each other and digital assets, presents both opportunities and challenges for investors and consumers. Liability for defective products, content, or services within the metaverse poses a legal and regulatory minefield. Who is responsible when something goes wrong? Whose responsibility is it—the business selling the product, the creator of the metaverse enabler, or a third-party developer?

Intellectual property law and severe counterfeiting are two other prominent issues amidst the metaverse. The MetaBirkin case features an artist who designed NFTs resembling Hermès’ Birkin bags. Such uncertainty creates an environment that encourages trademark infringement and highlights the necessity for clearer regulatory guidance. Marketing communications and sponsored experiences within the metaverse raise issues from a consumer protection perspective. UK consumer law, for instance, mandates that marketing communications be easily recognizable as such. Sponsored experiences in the metaverse would be a clear breach of this rule without clear labeling.

To tackle these growing challenges, many jurisdictions are passing consumer law reforms. These reforms enable the Competition and Markets Authority (CMA) to take direct enforcement against breaches of consumer law. This has provided the impetus for introducing strong enforcement measures, including imposing serious financial penalties on violators. UK religious law, under times of Sale, automatically imposes certain terms into all contracts of sale for the consumer. Others include satisfactory quality and fitness for purpose. These same terms need to be honored in our new metaverse transactions, too.

  • Establishing liability: Determine who is responsible for faulty products or services.
  • Intellectual property: Address counterfeiting and trademark infringement.
  • Marketing: Ensure transparency in sponsored experiences.

Whether you invest in NFTs inside or outside the metaverse, there are risks involved. Here are a few tips to help investors protect themselves:

  1. Do your research: Before investing in any NFT project, thoroughly research the team behind it, its roadmap, and its community.
  2. Understand the risks: Be aware of the potential for rug pulls, scams, and market volatility.
  3. Diversify your portfolio: Don't put all your eggs in one basket. Spread your investments across multiple projects.
  4. Be cautious of hype: Don't let social media buzz and celebrity endorsements sway your judgment.
  5. Only invest what you can afford to lose: The NFT market is highly speculative, and there's no guarantee of profit.

The NFT-related lawsuit against Nike has been a jarring reminder of the inherent risks in owning digital assets. The rewards are huge! That said, it’s important to enter the market with eyes wide open and an understanding of the need for diligence. As the NFT space develops further, we can expect to see more litigation and regulatory attention. At Token ATH!, we recognize staying informed can be a big challenge for any trader. Consider us your guide through the exhilarating, but frequently deadly landscape of crypto.