If you are attending law school, are your teachers telling you that, once you become a lawyer, you need to watch people’s X feed because they may contain insights into how somebody could argue their case?
We certainly believe this should be part of your intel gathering. Previously, we argued that Paul Grewal’s (Coinbase CLO) X feed is a window that opens into Coinbase’s strategy. That one was about Bitcoin. Here is another one, which involves collectibles:
Grewal touched on this issue before. Here are a couple of other posts:
and
What is Coinbase’s argument here? Let’s take a step back.
The Concern
During oral argument, Judge Failla was concerned about sweeping collectibles into the securities territory. She said:
THE COURT: But again, looking at either the limits of or the logical extension of your arguments, I am presented with the specter of collectibles being regulated by the securities industry. And I'm not minimizing. I've not thought about Beanie Babies in decades, and yet it's been presented to me in multiple briefs, and that's fine. But lest I be confronted with a class action about Beanie Babies, you were, I think, suggesting to me a moment ago what the limits are. So I want to understand how your standard that you've just articulated to me does not sweep in collectible markets or commodities, which is my bigger issue. So I think you were suggesting that it was sort of the collective undertaking, but let me understand that. Because it is a real fear that I have that your argument is just sweeping too broadly.
The Dismissal
When rendering her opinion and denying Coinbase’s motion to dismiss, Judge Failla must have felt, like any good judge would, that she had to address her own concern, which led to this blurb in the opinion:
In this way, the offer and sale of cryptocurrencies can be distinguished from commodities or collectibles. Unlike in the transaction of commodities or collectibles (including the Beanie Babies discussed during the oral argument, see Jan. 17 Tr. 55:8-58:9), which may be independently consumed or used, a crypto-asset is necessarily intermingled with its digital network — a network without which no token can exist. See Balestra, 380 F. Supp. 3d at 357 (stating that “without the promised ATB Blockchain, there was essentially no ‘market’ for ATB Coins, which clearly distinguishe[d] the coins from the precious metals to which Defendants attempt to analogize them”); cf. Friel v. Dapper Labs, Inc., 657 F. Supp. 3d 422, 439 (S.D.N.Y. 2023) (rejecting comparison of non-fungible token transactions to collectibles).
The Case Update
On April 12, 2024, Coinbase motioned to certify for interlocutory appeal. As you would expect, Beanies are mentioned:
When alerted during briefing that its conception of “investment contract” would capture trades of Bitcoin, Beanie Babies, and other commodities, the SEC argued just that digital assets are different because they are “[in]tangible” and lack “inherent value.” SEC MJOP Opp. at 14-15. Then at oral argument it pressed an undefined concept of “ecosystem” as a potential limiting principle to distinguish securities from commodities. See, e.g., Hr’g Tr. at 55:8-58:4.
The SEC filed its opposition on May 10, 2024. It did not mention Beanie Babies but made a broad reference to it:
[T]he Order also rejected the notion that the SEC’s argument would sweep in “all investment activity.” Id. It noted that the comparison between crypto assets and consumer goods “ignore[d] … the need for a common enterprise,” and cited other authority refusing similar comparisons. Id. at 59-60 (citing Balestra and Friel v. Dapper Labs, Inc., 657 F. Supp. 3d 422, 439 (S.D.N.Y. 2023)).
It was Coinbase’s turn again. It filed its reply on May 24, 2024. Beanies were not mentioned, but this comment is pertinent:
The SEC sought to distinguish these cases by claiming that digital assets, unlike real estate, have “no inherent value.” ECF No. 69 at 14-15 & n.8. But that purported fact is not even pleaded, and Coinbase respectfully submits that no part of the Howey analysis turns on the “inherent value” of the asset at issue. ECF No. 69 at 14-15. Joiner and the SEC’s own briefing in Howey make that plain. See Mot. 18.5.
Coinbase is wrong. Whether or not an asset has “inherent value” (intrinsic value is probably the more proper phrase here) fundamentally changes how Howey is applied. This is because in cases concerning digital assets, or, more broadly, any assets that do not generate cash flows, the fourth Howey prong is deactivated (yes, Howey has four prongs). The fact that we are dealing with assets that do not generate cash flows also means that Coinbase’s observation that “no appellate court” has “ever found an investment contract absent a post-sale obligation” (Coinbase’s opening brief, p. 15) means nothing; Coinbase itself admitted during oral argument that “[n]early every single one of the cases that followed [Howey] was a primary issuer privity case.” Further, Coinbase’s attempt to describe the relationship between securities and commodities as a mutually exclusive one (“An instrument that carries no ongoing relationship with and claim upon a business may be a commodity but is not a security.”) will likely go down in history as one of the most disingenuous arguments; that’s a myth that was explicitly refuted by three current or former CFTC commissioners.
The Outlook
Whether the interlocutory appeal is granted or not, this collectibles issue is destined to come up eventually. The question of whether secondary crypto transactions constitute investment contracts appears to be Supreme Court-bound.
So, let’s dive deeper. What are some factual differences between crypto and collectibles, and how do those differences impact the Howey analysis? Those are the questions that we’ll explore in the next couple of posts.