Don’t Phunk With Copyright Theft

I started this blog to give non-lawyers some insight into what an actual practicing intellectual property litigator saw going on in the space. One of my first articles involved the CryptoPhunk controversy, and how delisting those assets on OpenSea was actually good for users. Recently, CryptoPhunks have made a comeback and, as of writing this, have a 1.25 ETH ($5,650) floor. I think this is the perfect opportunity for a story of something I ran into a few years ago in my practice which I think everybody dealing in NFTs should hear.

This is the story about the textbook copyright litigation business, which has become a cottage industry and has turned some opportunistic lawyers into multi-millionaires, has resulted in billions of dollars being won by textbook publishers, and is a roadmap to what is coming for people who buy knockoff projects when there are millions (soon to be billions) of dollars on the line.

Book Seller Story

To begin the story, I need to provide some background on the firm which I was up against. For the sake of confidentiality, we’ll call the firm Smith & Smithers LLC. Around 2010, Attorney Smith and Attorney Smithers saw an opportunity. With the rise of e-commerce, students had options outside of their university book stores to buy the overpriced textbooks which their professors forced them to buy every semester. This meant for a University of Chicago student, instead of buying a used textbook for $250 and selling it back to the campus bookstore 6 months later for $25, that student could buy the book online for $175 and sell the textbook 6 month later on E-Bay or Amazon for $150+shipping, saving everybody (except the textbook publishers) tons of money.

E-commerce also brought in textbook forgeries. People in China and other countries figured out they could make near identical copies of those textbooks for $0.50 of paper and ink, and sell those same books for $200+. Soon, for every legitimate textbook used in Chemistry 101 classes in universities across the country, there was a near identical copy which was a forgery. These forgeries were so good, that even experts in the field would have a near impossible time determining what was legitimate and what was fake unless they had inside information from the publisher itself on what the publisher confidentially did to weed out forgeries (minor things like exact type of ink used on random pages, or hidden details in images which would be visible in legitimate copies but which were impossible to scan or see in forgeries).

With the rise of e-commerce, people started setting up shops on campus, offering to buy-back textbooks from students at better prices than their campus bookstores, knowing those books could be resold online for a profit. Smart people set up algorithms which would automatically buy certain books when listed below certain prices online, and then store those books in warehouses to later resell online to students and campus bookstores. Students were saving money, small book resellers were making money, but publishers of these textbooks saw a steep decline in sales. Suddenly, when the campus bookstore didn’t have a copy of the book students needed, they could get it online instead of being forced to buy directly from the publisher.

In comes Smith & Smithers LLC. While I don’t know exactly how everything came together, I can make an intelligent guess. Smith & Smithers approached a group of the largest textbook publishers in the United States with a proposal: If those publishers provided a retainer as start-up funds and experts to testify about the books (and their confidential means of detecting forgeries), then Smith & Smithers would solve their forgery and book reseller problem while making both the firm and publishers buckets of easy cash.

And that’s what they did, turning textbook copyright litigation into a multi-billion dollar business. What Smith & Smithers LLC does is they buy books from these independent campus book stores and online merchants, and inevitably find books which are forgeries. It is literally impossible for somebody who is not the publisher to weed out these forgeries. Even the most cautious and good faith seller (one who never bought from foreign seller, who hired an expert to look and compare to new book bought directly from publisher for differences, and who disposed of suspected forgeries when found, etc.) would inevitably have forgeries which slip unknowingly and unstoppably into their inventory.

Once they were able to purchase a few forgeries, it was over. Under the section 504 of the Copyright Act, any person who sells an infringing work, even if that person is a completely innocent actor who had no idea what they were selling violated somebody else’s copyright, is liable for actual damages or statutory damages of $750-30,000 per infringement. If that infringement is found to be willful (i.e., the person knew this was a copyright infringement but sold it anyways) that number bumps up to up to $150,000. This means if a book reseller sold 1,000,000 books, and 100 of them turned out to be forgeries (.01% of total sales), that reseller was looking at up to $3 million in damages for infringement, plus likely attorneys fees and other costs. If they went to court, they would risk getting hit with $15 million in damages. Plus, litigation discovery would likely turn up more accidental forgery sales upping the damages $30-150,000 each time.

I represented one of those small businesses. I have seen this happen first hand. While attorney/client privilege prevents me from telling you the details on everything that happened, I can say the founders of this business had spent years of hard work building it, creating the book buying and selling algorithm, renting the warehouse, hiring experts to examine books, creating all the logistics for listing and shipping those books, etc. After it was all said and done, those founders walked away with no money (even money from their legitimate sales, which undisputedly made up 99.9% of total sales), no inventory, and years of their life and hundreds of thousands of dollars invested in their business wasted with nothing to show for it.

Smith & Smithers LLC catches these sellers and and either forces a settlement, or goes to trial and inevitably wins. Copyright law is a strict liability statute. Trial is not a matter of if they will win, but only how much money they will win. Smith & Smithers LLC takes a percentage of that money, the publisher gets a percentage of that money, and one more small business is put out of business creating less textbook selling competition for the publisher going forward. This has resulted in Smith & Smithers LLC (and the publishers they represent) getting billions of dollars in settlement and litigation damages.

All these attorneys do is textbook copyright litigation. They are the best in the country at it because they have seen everything, know all the relevant experts, and have all the necessary forensics and technical experts needed to locate the sellers and all those sellers’ businesses and funds. The attorneys (and their staff) do all the work, the publisher gets a majority of the damages obtained, and everybody wins (except the small businesses being sued and students forced to buy textbooks again directly from publishers or limited “approved” book stores).

How This Lesson Applies To NFTs and CryptoPhunks

Before the late 2000’s, publishers largely weren’t going after independent campus book stores for copyright violations. These book stores were limited to buying from and selling to students on that particular campus. There were certainly forgeries in those inventories even back then, but it was small potatoes and wouldn’t make financial sense to go after them for either the publishers or the attorneys representing those publishers. However, with the rise of e-commerce when used textbook reselling become big business, the sharks saw blood in the water and they attacked.

The same is going to happen with NFTs. Everybody says it and they are right: we are still so early. If you are in the space now, you are likely far less wealthy than you will be in a year or two if you make smart investments. What this means is right now you may be a small fish, but everybody’s goal is to one day be a whale. While sharks aren’t likely to go after small fish, they WILL go after whales.

Take for example a CryptoPhunk sale I recently saw the seller flex on Twitter. In a post from @ElectionDayMad1, he talks about buying a Phunk for ~$31,000 and selling it for ~$140,000 around 5 weeks later.

Right now, if Larva Labs hired me or any other attorney, it would be one of the easiest cases of willful infringement that attorney had ever handled. This person knows about Punks, he knows about the cease and desist from Larva Labs to OpenSea and subsequent removal of Phunks from that marketplace, and he went out of his way to buy and sell on https://notlarvalabs.com/ despite knowing about the pending infringement claims.¹

This means @ElectionDayMad1 could easily be on the hook for $150,000, plus attorneys fees, plus court costs, plus paying for his own attorney. It would not be hard to locate his identity using a private investigator who has sophisticated knowledge of online forensics. Those funds can likely be tracked to or from a know your customer (KYC) complying exchange (like Coinbase). In this particular example the person posted a selfie shortly after celebrating the big sale while at NFT NYC!

While $150,000 may seem like a lot, that single lawsuit likely is not big enough to be worth a law firm developing and retaining the blockchain, forensic accounting, and other technical experts and support staff needed to successfully litigate that case. But that same group could also go after the person that sold it @ElectionDayMad1 for an additional $150,000. And the person who sold it to that person. And so on, and so on. You get to a point where a single Phunk sold seven times could net Larva Labs (and its attorneys) $1.05 million dollars. And all of these transactions are easily tracible on the blockchain. All these lawsuits could be combined or use the same experts resulting in an economy of scale.

And that is just one Phunk. Think of the other 9,999 Phunks. And now think of SolPunks and all the other CryptoPunk knockoffs. Suddenly it makes financial sense to go after these individuals. While some of these individuals are likely going to be insolvent (meaning they don’t have $150,000 to their name which can be collected) or unlocatable (due to being diligent with anonymity and lack of use of KYC exchange in transaction chain), there is still enough meat on that bone for sharks to go after.

These are all early investors into NFTs, meaning if we are right about NFTs’ future value, these are primarily going to be young, newly rich, and vulnerable defendants. Similar to small book resellers, these individuals will not have sophisticated in-house legal teams in place to defend them, or the necessary accounting or corporate structures in place to protect their unrelated earnings. Sell one CryptoPunk knockoff and you could be looking at years of grinding, risking, and investing down the drain. Sell five and you could lose everything.

Lots of people say “that will never happen” and that Larva Labs or individual holders will never sue because “that goes against decentralized mindset” and “CryptoPunk holders don’t want that” which may be true. But what do you think Larva Labs and CryptoPunk holders want more: their digital renaissance/Web3 freedom ideals, or potentially billions of dollars?

I know which side I’m betting on to win out in the battle between money and ideals.

Conclusion

Most people break the law on a regular basis. It’s a risk/reward analysis. Is speeding 5 MPH and the associated quicker transportation time worth the risk of being pulled over? How about 10 MPH? 20? 30? What about jay walking, or sharing Netflix accounts? Businesses do it too. How much more are the margins if they use a cheap part on their product (more likely to break and result in product liability lawsuit) vs. using an expensive part? Is the juice worth the squeeze?

As for CryptoPhunks and other “derivatives” which are clearly willful copyright violations, I am telling you the risks are substantial. It is up to you to decide if the rewards are substantial enough to be worth it. If you do decide to buy these high risk assets after reading this, I recommend you clear your browser history now. Because if this article comes up in e-discovery when I am across the court room from you taking everything you have earned, the first thing I am going to tell you is I told you so.

If you have any questions or would like me to write about anything else, let me know on either of my twitter pages! As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.

FOOTNOTES:

1. UPDATE 11/12/2021: @ElectionDayMad1 has clarified that this particular Phunk was sold on rarible.com and not notlarvalabs. While this does not change the analysis much (if any) it is a detail that should be noted as previously incorrect.