As the Securities and Exchange Commission (SEC) brings enforcement actions against major players such as Coinbase and Binance, it’s pertinent to revisit a significant Delaware case from 2022 that tackled the valuation of crypto assets. A fresh look at this case provides valuable context amidst these recent enforcement actions.
The Delaware Superior Court, in a landmark decision, set a crucial precedent in Diamond Fortress Techs. v. Everid, Inc., 274 A.3d 287 (Del. Super. Ct. 2022)). This case examined the valuation of cryptocurrency tokens and associated damages in a scenario involving two contracts. The rationale and analyses deployed by the Court in this situation offer invaluable insights for firms utilizing or analyzing digital assets. In this article, we take a deep dive into the essential facts of this case, explore the Court’s thought process, and discuss the implications of this decision for the categorization and valuation of crypto tokens as securities. Given the current enforcement actions, a re-examination of this case may shed new light on the evolving crypto regulatory landscape.
The Howey Test and Crypto Tokens as Securities: In Diamond Fortress Techs., the Court applied the United States Supreme Court’s Howey Test to determine whether the cryptocurrency tokens at issue should be treated as securities. The Howey Test, established in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), is a three-pronged test used to assess whether an investment contract is a security. The test requires that there is (1) an investment of money, (2) in a common enterprise, and (3) with an expectation of profits derived from the efforts of others.
The Court’s analysis took into account both the intentions of the parties and decisions from other jurisdictions to conclude that the tokens should be treated as securities. It is crucial to note that while the treatment of cryptocurrency tokens as securities is not a novel concept, this decision reinforces the applicability of the Howey Test in the context of digital assets.
Awarding Damages for Breach of Contract: After establishing that the tokens fall under the classification of securities, the Court proceeded to evaluate the damages resulting from the violation of two contracts. This case revolved around a “failure to deliver securities” complaint, and the Court employed the firmly entrenched precedent of Delaware to estimate the damages. To ascertain the value of the tokens at the moment of the breach, the Court utilized CoinMarketCap, a popular cryptocurrency valuation website, a noteworthy step for valuation firms and practitioners.
The Court’s utilization of CoinMarketCap, a widely recognized source for cryptocurrency market data, signifies an acknowledgement of the importance and relevance of such platforms in determining the value of digital assets. This may also be indicative of a trend toward embracing digital asset valuation tools and methodologies in the legal landscape.
Implications of the Decision:
The Diamond Fortress Techs. decision carries several implications for the valuation and treatment of digital assets, which we expand upon below:
Reinforces the applicability of the Howey Test: The decision highlights that the Howey Test remains a relevant and crucial tool in determining whether digital assets, such as cryptocurrency tokens, are securities. The Court’s analysis demonstrates that traditional legal frameworks can be adapted to address modern financial instruments, reinforcing the need for valuation firms and businesses dealing with digital assets to stay vigilant and ensure they comply with the regulatory framework governing securities. Furthermore, the decision emphasizes that substance over form is crucial, meaning that the underlying nature of the transaction or asset is more important than its outward appearance or label.
Establishes a precedent for damages calculations: The case sets a precedent for calculating damages in cases involving digital assets, using widely recognized platforms such as CoinMarketCap as a data source for use in determining the value of the assets. This not only validates the use of such tools but also encourages their adoption in future litigation. It also provides guidance on appropriate methodologies for determining the value of digital assets in legal disputes, which may influence future cases and impact the development of industry standards for digital asset valuation.
Encourages development of digital asset valuation methodologies: The Court’s decision could spur further exploration and development of digital asset valuation methodologies, as more cases involving these assets arise. As the market for digital assets continues to grow, legal disputes involving valuation are likely to become more common. Valuation specialistes could benefit from staying updated on emerging trends and refining their valuation approaches accordingly, in order to provide accurate and defensible assessments of digital assets in litigation and other contexts.
Impacts the classification of digital assets: The decision may prompt companies dealing with digital assets to carefully evaluate their classification and structure, as the classification of tokens as securities could lead to increased regulatory scrutiny and obligations. This, in turn, underscores the importance of accurate valuation and assessment of these assets. Companies may need to consider whether their digital assets may be deemed securities under the Howey Test and adjust their operations and compliance efforts accordingly. This may involve engaging valuation firms to provide expert opinions on the nature and value of their digital assets.
Fosters cross-jurisdictional consistency: The Court’s decision also signals a willingness to consider decisions from other jurisdictions, which may promote cross-jurisdictional consistency in the treatment of digital assets. As the regulatory landscape surrounding digital assets continues to evolve, such consistency may be crucial for businesses operating in multiple jurisdictions.
Promotes awareness of legal risks: Finally, Diamond Fortress Techs. highlights the legal risks associated with digital assets, including potential claims for breach of contract, securities law violations, and other liabilities. This underscores the importance of conducting thorough due diligence and engaging experienced legal counsel and valuation experts when dealing with digital assets.
In the light of recent SEC enforcement actions against cryptocurrency giants Coinbase and Binance, the Delaware Superior Court’s judgment gains even more significance. It provides crucial insights into how cryptocurrency tokens, much like the digital assets involved in the ongoing enforcement actions, should be treated and valued as securities.
The Court’s decision firmly reinforces the relevance of the Howey Test in the digital age, a critical component in determining whether a particular digital asset can be legally classified as a security. The application of this test in the context of cryptocurrency opens doors for further discourse on its suitability and potential adjustments to accommodate the unique nature of digital assets.
The Court also established a pioneering precedent for computing damages in cases involving digital assets. Using a prominent cryptocurrency website, CoinMarketCap, as a data source, the Court broke new ground in acknowledging the use of market data in determining the value of digital assets at the time of breach.
Finally, Diamond Fortress Techs. has significant potential implications for the progression of digital asset valuation methodologies. In light of the growing SEC scrutiny, these insights could prove invaluable for businesses, valuation firms, and regulatory bodies working in the sphere of digital assets.
As the cryptocurrency landscape continues to evolve, and as more enforcement actions are expected, Diamond Fortress Techs. serves as a beacon, guiding the path towards a more structured and defined methodology for treating and valuing cryptocurrency tokens as securities.
As the landscape of crypto asset valuation and enforcement is rapidly evolving, at Eton Venture Services, we are equipped to navigate these changes with our veteran Silicon Valley lawyers and team of CFAs, trained by the Big Four. With our extensive experience with Web3 companies and all types of crypto assets and related transactions, we’ve emerged as the preferred valuation partner for private firms, venture capitalists, high net-worth individuals, and their advisors. Our experience and rigor empowers us to provide precise valuations for even the most unique crypto assets. Contact Eton today.
Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.
