The life-cycle of blockchain startups is fraught with legal uncertainty and their volatility makes them particularly prone to claims for compensation both in and outside of the courts. As this new frontier of investing keeps expanding, litigation monitoring could be a useful metric for investors when doing due diligence on crypto assets and used as part of a screening process.
Innovate, propagate, litigate, repeat
Investors may be assisted, in that regard, by the “MoCo cryptocurrency litigation tracker”, recently unveiled by New York law firm Morrison Cohen (who specialize in cryptocurrency and blockchain litigation). According to the tracker (which is regularly updated), there are currently 63 ongoing cases in the US, and 24 of those are class action or other private litigation.
There are some significant industry players currently caught up court actions: Coinbase, Ripple Labs, Bitconnect, Bitfinex and Satoshi Dice among them.
One of the most recent and egregious charges is against the unregistered Bitcoin-denominated exchange Bitfunder based in Texas and its founder and operator Jon Montroll.
In February this year, the Securities Exchange Commission (SEC) brought charges against them for having “defrauded exchange users by misappropriating their funds and failing to disclose a cyberattack on BitFunder’s system that resulted in the theft of more than 6,000 bitcoins.”
“Montroll also sold unregistered securities that purported to be Case 1:18-cv-01582-PGG Document 1 Filed 02/21/18 Page 1 of 20 2 investments in the exchange, but from which Montroll also misappropriated investor funds and failed to disclose the cyberattack and bitcoin theft.”
Among the many charges, Bitfunder and Montroll are also accused of selling “virtual shares” in various virtual currency-related enterprises through the Bifunder platform. One of the “shares” was the “Ukyo Note”, an unregistered security that was purported to be raising funds for private investment purposes. Montroll sold them with the promise of a 0.05 percent daily return, but in reality the funds were used to repay Montroll’s business expenses and replace some of the misappropriated Bitcoin on the Bitfunder exchange.
Of the cases, Morrison Cohen partner Jason Gottlieb says a pair of cases related to the same ICO – U.S. v. Zaslavskiy (a criminal case) and SEC v. ReCoin and DRC World Inc. (a civil case), are particularly noteworthy, as they will be the “first high-profile, well-briefed test of whether cryptocurrency can be classified as anything other than a security.”
In its U.S. v. Zaslavskiy filing, the FBI alleges Maksim Zaslavskiy breached US securities laws with two ICOs in 2017 – one to create a token back by international real estate purchases (ReCoin https://101recoin.com), and the other to release a token backed by investment in diamonds (https://drc.world).
The FBI records ReCoin’s Whitepaper as stating “ReCoin is led by an experienced team of brokers, lawyers and developers, and invests its proceeds into global real estate based on the soundest strategies … 100% of our proceeds from ReCoin sales minus maintenance costs are invested into real estate.”
However, the agency says after raising $300,000 Mr Zaslavskiy had not purchased any real estate and had never hired or consulted any brokers, lawyers or developers – nor had he minted any tokens. Similarly, he had not purchased any diamonds. Mr Zaslavskiy’s lawyers have filed a motion to dismiss the criminal indictment and the civil complaint on the grounds that the cryptocurrencies in question were not securities, stating:
“First, as currencies, these assets are statutorily exempt from the definition of securities – even under the 1933 and 1934 Securities Acts. Second, cryptocurrencies are not ‘investment contracts’ within the meaning of the law – a key requirement should the SEC argue that cryptocurrencies are securities. Since the cryptocurrencies at issue in this case – REcoin and DRC – are not securities, they are not subject to securities law upon which all of the charges are based. Therefore the indictment charging Mr. Zaslavskiy is defective.”
Customer crypto complaints outside the courts
However, not every crypto investor can afford to go to court and instead consumer watchdog agencies worldwide have seen surges in complaints about crypto-related scams. Coinbase customer complaints to the Consumer Financial Protection Bureau (CFPB), for example, skyrocketed at the start of the year as the price of Bitcoin broke down from its parabolic rise.