Judge Paul Wallace of the Delaware Superior Court said Diamond Fortress Technologies, Inc. v. EverID, Inc.Clarify the handling of crypto assets when calculating damages. [1] Opinions also build a framework for analyzing the treatment of crypto assets in future actions and provide useful guidance in interpreting recent legislation.
Plaintiff DiamondFortress Technologies, Inc. and its CEO Charles Hatcher II have contracted with Defendants EverID, Inc. (EverID) to provide EverID Digital ID Verification Services. EverID created the cryptocurrency “ID Token” and developed a related blockchain-based financial platform. As part of this, EverID attempted to use Diamond Fortress’s ONYX software for identity verification. ONYX software allows you to verify your identity touchlessly by scanning your fingerprint with your phone’s camera. EverID also held Hatcher as a consultant, and the contract prohibited Diamond Fortress or Hatcher from working with other blockchain providers.
EverID has agreed to indemnify plaintiffs by distributing their ID tokens at the first coin offering (ICO) and subsequent regular token distribution events (TDE), rather than paying in traditional currency. EverID held an ICO of ID tokens on February 8, 2021, but did not distribute it to Diamond Fortress or Hatcher. Plaintiffs then informally and officially request the contractually agreed token distribution without a response from EverID and treat it as a breach of contract before sending the final communication on March 4, 2021. Declared intent. Immediately after making the final contact, the plaintiff filed a proceeding. EverID was unable to answer the complaint. Plaintiffs have moved for a default ruling.
EverID’s liability was not an issue, so the only issue in court was the proper measurement of damages. Since the plaintiff was to be paid in a cryptocurrency worth fluctuating according to the contract, the court had to decide how to compensate for the plaintiff’s loss. This required two steps. “First, the court needs to find a reliable cryptocurrency valuation source. Make sure you enter the values properly. Next, the court needs to find out the proper way to calculate the damages. ” [2] Courts used CoinMarketCap, a website that publishes daily cryptocurrency price data, as a source of evaluation, pointing out that other courts do so, and Congress has announced approval of the website by law. Did. [3]
More importantly, the court ruled that the ID tokens provided by EverID are securities because they are “investment contracts” subject to regulation under the Securities Act of 1933 and the Securities Exchange Act of 1934. Therefore, the damage should be calculated based on Delaware’s existing precedent. Failure to deliver securities based on a sale contract. The court first considered whether cryptocurrencies make up securities or commodities, and noted that both the CFTC and the SEC claim jurisdiction over the regulation of cryptocurrencies. The court noted the law (Digital Asset Market Structure and Investment Protection Act) introduced by Donald S. Beyer, Jr. (D-VA) in the House of Representatives in July 2021. [4] — Create a test to analyze whether a cryptocurrency constitutes an asset or security based on “Cryptocurrency” feature At some point ” [5]
To make this decision, the court Howie test [6] When the plaintiff suffered damages against the ID token, it was determined that the ID token constitutes security. First, the court found that plaintiffs’ commitment to provide software and consulting services in exchange for cryptocurrencies constitutes a monetary investment. Second, the court ruled that the token ID cryptocurrency is a common enterprise, as the value of the ID token is closely related to the performance of the EverID blockchain and the platform as a whole, both before and after the ICO. Did. Third, the court found that plaintiffs could not repay until the ICO was completed, so plaintiffs expect to benefit from the efforts of others. As the court pointed out, “[t]Plaintiffs’ overall investment in the platform was based on their expectation that they would be paid for in the final distribution of ID tokens after the ICO. This expectation is the same as the expectation of a traditional investment contract signed before the IPO, so ID tokens are in this situation like security. ” [7]
After determining the ID tokens that make up the security payable to the plaintiff under the relevant contract, the court applied existing Delaware law that provides for the calculation of damages for failure to deliver the security. Applying the New York rules adopted by the Delaware court, the court finds the highest ID token value three months after EverID fails to offer, calculates damages based on it, and finally diamonds. He gave the fortress over $ 20,000,000 and the hatcher over $ 5,000,000. [8]
The court’s opinion provides a useful analytical framework for determining how crypto assets are categorized, and as some cryptocurrencies are widely adopted, they become a securities-to-commodity classification. We acknowledge that there is a possibility of migration. However, early-stage cryptocurrencies whose use is associated with a particular platform may constitute securities, at least under the analytical framework presented by this court. In essence, court tests ask whether the purchase of cryptocurrencies is based on a belief in the value of the token itself or on the blockchain platform on which the token in question is based. Here, the court is not because Diamond Fortress and Hatcher believe in the intrinsic value of ID tokens, but EverID’s blockchain platform is on a wider scale.
Important to the court’s analysis in this case was the fact that plaintiffs reached an agreement with EverID prior to the ID token ICO. In short, plaintiffs’investments, like securities purchases, were inevitably speculative based on future performance. It is not a purchase of an existing product. Under the court framework, pre-ICO agreements to buy cryptocurrencies are unlikely to be properly classified as securities. However, even post-ICO purchases may constitute securities under the framework of this court, where the value of the cryptocurrency itself is largely related to the performance of larger products that use the cryptocurrency blockchain. If the value of cryptocurrency fluctuates depending on the performance of the product that utilizes its own blockchain, the purchase of cryptocurrency represents an investment in a larger product and may therefore constitute the purchase of securities.
However, this court analysis shows that as cryptocurrencies grow and become widely adopted, they may move from security to assets. The court in this case did not accurately describe when such a transition would occur, but the independent use of currency as a unit of exchange is probably a good indicator. Under the court framework, Bitcoin or Ethereum (a unit of exchange for a blockchain platform accepted and widely adopted by some vendors) compared to the currency associated with the performance of a particular application or company. There is a clear difference between the currencies that function as) in this case using your own blockchain such as ID tokens. The largest and most used cryptocurrencies can be classified as assets, but small tokens created by startups are more likely to be securities, especially if purchased before the ICO.
Cryptocurrency issuers and companies considering ICO events are aware of this court’s decision and are capable of fluid evolution rather than other courts and regulators classifying cryptocurrencies as assets or securities. It should be noted that it is possible to examine the individual situation of each case as well as the gender. Companies wishing to achieve a particular classification must make efforts to demonstrate whether cryptocurrencies are secure within the framework of a court. At the same time, investors need to leverage the court framework to assess potential cryptocurrency investments and the protection they have available. The court’s opinion provides an important explanation in the vague territory of cryptocurrencies, while acknowledging that cryptocurrencies are novel and evolving and resist categorization.
[1] –A.3d-, CA No. N21C-05-048, 2022 WL 1127217 (Del. Super. Ct. April 14, 2022).
[2] Id. * 13.
[3] Id.
[4] HR 4741, 117th con. (2021).
[5] 2022 WL 1127217, * 6-7 (original emphasis).
[6] Id. at * 7 (“Investment contracts” are “contracts, transactions, or schemes that lead people to invest money in ordinary companies and expect profits only from the efforts of promoters or third parties.”) (Quote SEC vs WJHoweyCo.. , 328 US 293, 298-99 (1946)).
[7] Id. * 11.
[8] Id. * 15.
