Updated: Sep 7, 2020
Originally Published on Page 68 of Volume 36-3 of the American Bar Association's Entertainment and Sports Law Journal: https://www.americanbar.org/content/dam/aba/publications/entertainment_sports_lawyer/summer-2020/esl-36-3.pdf
Blockchain, far from being a new phenomenon, as it initially burst onto the scene in 2008[i], has been recently making waves in everything ranging from cryptocurrencies to sports. Blockchain is essentially a chain of blocks that contain data, which is held together in a specific order that creates the Blockchain ledger, with each new block representing a new transaction. Blockchain then is a record of transactions in which the users can not only make but also verify each transaction.[ii] It is easier to visualize Blockchain as a spreadsheet. Traditionally, collaborating users would have to send the documents back and forth for revisions and edits. The problem is that the first user has to wait until receiving a copy in return before they can see or edit it because they are locked out editing the document until the other person finishes. Blockchain solves that problem in the same way GoogleDocs spreadsheets would, both users have access to the document at the same time, meaning that no user is locked out. Therefore, collaborating users can see and edit the document at any time, and the entire document is visible and accessible to the users at all times. Blockchain essentially functions this way as opposed to how traditional databases and banks work.[iii]
There are three main pillars or principles which are the foundation of Blockchain. The three main pillars are decentralization, transparency, and immutability.[iv] Decentralization means the information is never stored by a single entity; therefore, the network of users owns all the information, and if one user needs to interact with another, they can do so without going through a third party, as opposed to how banks operate, for example. Transparency is a two-fold concept in Blockchain, users’ real identities remain hidden with the use of complex cryptography, while the transaction information is visible to all users on the Blockchain by way of users’ public addresses. Immutability, the third central pillar of the Blockchain, achieved through ‘hashing’, means that once a transaction is entered into a Blockchain ledger, this transaction cannot be tampered with, changed, or deleted.
Blockchain is far from perfect, and recent developments have proved that it is not the ‘cure-all’ many thought it would be. Early in 2019, Blockchain was hacked, and the hacker was able to ‘double-spend’ more than one million dollars.[v] Blockchain was supposed to be the solution to the double-spend problem, Blockchain’s pillars were supposed to be indestructible; 2019 has proved that idea wrong. Blockchain, however, remains a reliable alternative. With better coding and stronger regulations, Blockchain will develop and prevent future hacks, the key to avoiding these problems is understanding, which will only happen with continued use of the technology. The idea behind Blockchain is to provide a safe alternative to transactions, where a decentralized, transparent, and immutable ledger, provides security to users.
Blockchain in the NBA
NBA player, Spencer Dinwiddie, signed a contract extension with the Brooklyn Nets, beginning October 2019, for three years and $34 million, with the last year being a player option.[vi] In September 2019, Dinwiddie, a self-described “Tech guy with a Jumper,”[vii] revealed his plans to tokenize his NBA contract, which runs from 2019-2022. Although the NBA has momentarily silenced talks regarding contract tokenization[viii], Dinwiddie’s attempt, and possible success could be the first of many, in the NBA and other major sports leagues.
Tokenizing is the act of using digital tokens to prove ownership of real assets, such as shares.[ix] A tokenized contract is a contract that is broken down into tokens, and those tokens are sold just the way shares would be, each token representing a share of the contract. Tokens can be either utility or security tokens, with the most common form being utility tokens.[x] Utility tokens are “coins backed up by a project.”[xi] Typically, users that invest in utility tokens receive “some definable benefit in return.”[xii] Security tokens, however, instead of offering a “tangible benefit” to the user investing in it, represent shares in the company that issued it, comparable to buying shares on the stock market.[xiii] This fact essentially means that security tokens are, by definition, more regulated by the government than utility tokens.[xiv] Security tokens offer “the speed and ease of blockchain without sacrificing strong legal protection”[xv] and “enhanced protection against fraud and misselling.”[xvi] The United States Securities and Exchange Commission (SEC) regulates anything denominated as a ‘security’ within the U.S., which includes security tokens.[xvii] A transaction can be classified as a security if the four criteria of the ‘Howey Test,’ established by the United States Supreme Court in 1946, are met. The four conditions of the Howey Test are; (i) an investment of money, (ii) an expectation of profits, (iii) the investment is in a common enterprise, and (iv) revenues come from the efforts of a third-party.[xviii] Tokenizing a contract into security tokens, therefore means, the act of diving a contract into tokens that will be sold to investors in an SEC-regulated transaction, where investors will expect a return on investment from the efforts of a third-party.
The Case of Spencer Dinwiddie
In September 2019, Dinwiddie announced his plan to tokenize his new contract with the Brooklyn Nets, a 3-year $34 million contract. Dinwiddie launched his site for investors (https://dreamfanshares.com/sd8/), in which he outlined his plan for investors to “[i]nvest in the first-ever security represented by a Professional Athlete Investment Token (PAInT).” [xix] Dinwiddie believes that Blockchain “technology offers the potential to help generate and preserve wealth for athletes, artists, and influencers.”[xx]
As envisioned by Dinwiddie, people could invest in his three-year, $34 million contract, just like they can invest in treasury bonds or corporate bonds. In monthly installments, investors would be paid back their principal, plus interest. Meanwhile, by receiving investors’ funds upfront, Dinwiddie would essentially be paid earlier than he’d be paid by the Nets. He could use those funds to invest in other ventures, ideally earning enough to payback investors and take home a healthy profit for himself.[xxi]
Dinwiddie plans to offer “a minimum of 33 tokens worth $4.95 million to a maximum of 90 tokens worth $13.5 million”[xxii] to “qualified investors.”[xxiii] Dinwiddie is giving up future income in return for a smaller lump sum payment; however, he would then have more money to immediately invest, thus potentially getting an even greater profit, although attached to a higher risk.[xxiv] “The idea is that the investments received by Dinwiddie will be reinvested. By the time the money is to be paid out in the future, the investments— if all goes well— will have grown to a larger amount”.[xxv] Qualified investors would need a minimum investment of $150,000, paid through U.S. dollars, Bitcoin Hot (BTH), or Etherium (ETH), utilizing blockchain.[xxvi]
The issued tokens, backed by Dinwiddie’s contract, are considered debt instruments that require fixed scheduled payments to investors in the form of payback of the principal and payback of the interest.[xxvii] The interest paid on the principal, is the main attraction for investors, but it might be just one of the benefits of investing in Dinwiddie. Investors “might also be entitled to special premiums based on whether Dinwiddie earns bonuses, negotiates a new contract and other factors,”[xxviii] conditions that would need to be specified in the investor contracts. The prospect of additional benefits besides interest payments would make the risk of investment much more appealing.[xxix] One of the main attractions of investing in Dinwiddie’s contract, however, is the player option it contains in 2021.[xxx] Dinwiddie’s player option is worth $12.3 million for the 2021-22 season, and as he pointed out;
" With the way mine works, if I play well in that player option year and we split the profits up the first year of my new deal, it greatly appreciates the return on this investment vehicle. It allows you to get up in that 15-percent range in a return, like a growth stock, and that'll be something most guys won't beat."[xxxi]
If Dinwiddie plays well enough to warrant a pay raise, he could opt out of his 2021-22 contract and sign a more lucrative deal that would create a significant return for both him and his investors.
Dinwiddie plans that his “contract will be tokenized, and bond-backed security tokens will be sold,”[xxxii] meaning that SEC compliance will be essential. “Rule 506 of Regulation D of the Securities Act of 1933 would govern the selling of security interests tied to Dinwiddie’s contract. Among other things, Rule 506 would obligate Dinwiddie and his business partners undertake reasonable steps to verify that its investors are accredited investors”.[xxxiii] Under the SEC rules, an accredited investor is a person who, among other things, possesses a net worth of more than $1 million or has earned more than $200,000 in annual income over the last few years with an expectation to make the same amount in the future. Alternatively, an accredited investor can also be a business that has assets exceeding $5 million, among other characteristics.[xxxiv] SEC rules also establish that Dinwiddie would need to prove that they are taking reasonable steps for verification, which often include a “review of financial statements, including tax returns, credit reports and W-2 wage forms”.[xxxv]
While no investment goes without risk, Dinwiddie has taken all the necessary measures to ensure that investors feel safe in the product, his contract. There are always risks, NBA contracts are no exception, Spencer Dinwiddie’s investment site states (in all caps); “INVESTMENTS IN PRIVATE PLACEMENTS ARE HIGHLY SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK. INTERESTS SHOULD NOT BE PURCHASED BY ANY PERSON WHO CANNOT AFFORD THE LOSS OF ITS ENTIRE INVESTMENT”.[xxxvi] While the circumstances that would give rise to a guaranteed contract in the NBA not being paid out are remote, they still have “a greater than 0% chance of occurring”.[xxxvii] Yet, Dinwiddie, as a crypto tech enthusiast, has taken all the necessary measures to ensure investors that this investment is worth the risk.
NBA’s Collective Bargaining Agreement
The NBA has been opposed to Dinwiddie’s plan and, after meeting with Dinwiddie to discuss it, has remained opposed to contract tokenization.[xxxviii] The NBA cites Article II of the Collective Bargaining Agreement (CBA) when opposing Dinwiddie’s plan. Section 13(d) of Article II says that “[n]o player shall assign or otherwise transfer to any third party his right to receive [c]ompensation from the Team under his Uniform Player Contract.”[xxxix] The NBA’s version of FIFA’s Article 18ter third-party ownership ban.[xl] It is the opinion of the NBA that since Dinwiddie’s contract acts as a security interest for another person’s investment, the other person should be considered a third-party under the CBA.[xli] The NBA is attempting to find a middle ground with Dinwiddie but has stated that if Dinwiddie goes forward without the NBA’s approval, he could be subjected to contract termination, fines, or suspension without pay.[xlii]
Spencer Dinwiddie has stated that he plans on moving ahead with his strategy because he considers "the NBA's lack of approval is baseless." [xliii] Dinwiddie said;
Even with our desire to partner with the NBA, it is not necessary. And I want to be clear, this is not and never was an ‘assignment’ nor am I in violation of the CBA. By definition an ‘assignment’ would give fans rights towards the Nets/NBA. [On the contrary] this is a third party business transaction between the fans and I beyond the jurisdictions of those entities. Much like the way no one can tell me which home or car I can buy, I am free to use my money the way I see fit.[xliv]
Dinwiddie’s posture is that the success of the deal should be determined by a free market, and disrupting such development would be an abuse of power by the NBA.[xlv] Cryptocurrency and Blockchain technology experts agree with Dinwiddie;
It will be very hard for the league to stop him, legally, because the arrangement is not tied to his contract but to the amounts promised over the three years. Once received, Dinwiddie will use his salary to pay early investors with interest. The league and teams cannot tell players what house or car to buy. And they cannot control what investments or business arrangements they make.[xlvi]
Dinwiddie’s pretension is not to transfer a right to be paid. It is to use his right to paid to secure an investment, something not expressly prohibited in the CBA.[xlvii] Investors in Dinwiddie’s contract would not obtain any rights related to the NBA or even the Brooklyn Nets for that matter; they would only get rights limited to the value of a contract owed to Dinwiddie. [xlviii] Dinwiddie’s plan likely falls in the gray area not covered by the current CBA. The NBA has valid reasons to fear Dinwiddie’s blueprint, especially considering it lacks any oversight over the transactions and the potential liability it could be faced with.[xlix] Both parties seem to have solid arguments and expert supporters, which could lead talks between the NBA and Dinwiddie to go on for a while until a reasonable solution is achieved. Bearing in mind that the current CBA is in force until 2023 at the earliest, any possible conflicts arising out of this situation will most likely be covered by the next CBA. In the meantime, however, the NBA and Dinwiddie will continue to work together to find a temporary solution that appeases both parties reasonably.
Contract tokenization is the future (and the present)
Far from being the first-time professional athletes have ventured into blockchain technology[l], Dinwiddie’s case could define Blockchain’s sports interaction for the future. The way Spencer Dinwiddie has set up his investment strategy will potentially lead to new CBA rules regarding Blockchain. Spencer Dinwiddie’s attempt and possible success will have ripple effects throughout most major sports, not only basketball.
There’s a wide array of professional athletes who’ve ventured in cryptocurrency in some fashion, from global soccer star Lionel Messi to boxer Floyd Mayweather. Messi isn’t alone in the soccer world, as other soccer stars like Didier Drogba, Ronaldinho, and others have jumped in.
Soccer stars adopting blockchain-based currencies shouldn’t be a surprise as European soccer clubs are on the leading edge in the sports world of adoption of the products, including Italian teams Juventus and Roma, French team Paris Saint Germaine, Portugal’s Benfica, and England’s West Ham United, among a slew of others.
Among athletes in the American big four leagues, there are also a variety of athletes who’ve made a splash beyond Dinwiddie.
San Francisco 49ers cornerback Richard Sherman is an avid cryptocurrency investor, from bitcoin to litecoin to ethereum. He’s also a spokesperson for Cobinhood and its coin, COB.[li]
Blockchain and cryptocurrencies have taken the world by storm. Athletes, clubs, and leagues have begun investing in them, and some have started developing their particular blockchain technologies. Spencer Dinwiddie has taken a giant step in going against the league and pursuing his plan. Thanks to Dinwiddie’s attempt to tokenize his contract, the future of player contracts could be nearer than ever before. Contract tokenization brings fans closer to the athletes, especially to those that are not in the top tier of their fields. Is contract tokenization the future of sports contracts? We may not have to wait that long to find out anymore.
[i] Satoshi Nakamoto (2008) Bitcoin: A Peer to Peer Electronic Cash System by Satoshi Nakamoto. https://bitcoin.org/bitcoin.pdf. Last Accessed 3 December 2019. [ii] Ben Rashkovich (2019) Blockchain Explained: A Simple Explanation of How It Works. https://www.fundera.com/blog/blockchain-explained. Last Accessed 3 December 2019. [iii] Birgit Clark (2018) Blockchain and IP Law: A Match made in Crypto Heaven?. https://www.wipo.int/wipo_magazine/en/2018/01/article_0005.html. Last Accessed 3 December 2019. [iv] Ameer Rosic (2016) What is Blockchain Technology? A Step-by-Step Guide for Beginners. https://blockgeeks.com/guides/what-is-blockchain-technology/. Last Accessed 3 December 2019. [v] Mike Orcutt (2019) Once hailed as unhackable, blockchains are now getting hacked. https://www.technologyreview.com/s/612974/once-hailed-as-unhackable-blockchains-are-now-getting-hacked/. Last Accessed 3 December 2019. [vi] AP News (2018) Nets, Spencer Dinwiddie agree to contract extension. https://apnews.com/14d69aa4ea00437497a30cc4ba416911. Last accessed 14 December 2019. [vii] Spencer Dinwiddie (2019). https://www.instagram.com/spencerdinwiddie/?hl=en. Last accessed 14 December 2019. [viii] Mike Chiari (2019) Report: Nets' Spencer Dinwiddie May Face NBA Discipline over Contract Conversion. https://bleacherreport.com/articles/2863401-report-nets-spencer-dinwiddie-may-face-nba-discipline-over-contract-conversion. Last accessed 14 December 2019. [ix] Reza Jafery (2018) Tokenizing Assets for Dummies. https://hackernoon.com/tokenizing-assets-for-dummies-20cb7ccccbb. Last accessed 14 December 2019. [x] The Tokenist (2019) Complete Guide to Security Tokens: How They Work Explained. https://thetokenist.io/security-tokens-explained/. Last accessed 14 December 2019. [xi] Id. [xii] Id. [xiii] Id. [xiv] Id. [xv] Id. [xvi] Id. [xvii] Id. [xviii] SEC v W. J. Howey Co., 328 U.S. 293 (1946). [xix] Spencer Dinwiddie (2019) https://dreamfanshares.com/sd8/. Last accessed 14 December 2019. [xx] Id. [xxi] Michael McCann (2019) Spencer Dinwiddie And Reimagining the NBA With Tokenized Contracts. https://www.si.com/nba/2019/11/05/spencer-dinwiddie-nets-tokenized-contracts. Last accessed 14 December 2019. [xxii] Pat Evans (2019) The Pro Athletes Buying Into Cryptocurrency https://frntofficesport.com/pro-athletes-cryptocurrency/. Last accessed 14 December 2019. [xxiii] McCann 2019, supra. [xxiv] Paul Kasabian (2019) Report: Nets’ Spencer Dinwiddie Can’t Convert Contract Into Digital Investment. https://syndication.bleacherreport.com/amp/2855626-report-nets-spencer-dinwiddie-cant-convert-contract-into-digital-investment.amp.html. Last accessed 14 December 2019. [xxv] Tim Fries (2019) NBA Player Spencer Dinwiddie Set To Tokenize $34 Million Contract. https://thetokenist.io/nba-player-spencer-dinwiddie-set-to-tokenize-34-million-contract/. Last accessed 14 December 2019. [xxvi] McCann 2019, supra. [xxvii] Id. [xxviii] Id. [xxix] Id. [xxx] Kasabian 2019, supra.