WInvestors worldwide are facing a class action lawsuit totaling $1.5 trillion in recent cryptocurrency losses, with a blizzard of class action lawsuits brewing. A big question is: who is to blame, and who can be held responsible?
As inflation and interest rates soared, the best-known cryptocurrencies suffered heavy and sustained losses: Bitcoin has lost more than 50% of its value this year; Its biggest competitor, Ethereum, is down 65%; and the total value of crypto-assets has dropped from the November 2021 peak of $3 trillion to just under $1 trillion. US federal regulators say 46,000 people have reported losing $1 billion in crypto to fraud since January 2021.
Given the millions poured into promoting crypto – often with celebrity endorsements – legal action was inevitable after the crash. Class action lawsuits are already at work. Kim Kardashian and boxer Floyd “Money” Mayweather Jr are being sued for allegedly making false statements promoting the small cryptocurrency EthereumMax.
The lawsuit alleges that they are encouraging followers to join the “EthereumMax community” and that the token itself is a “pumping and dumping” scheme to deceive investors.
Charles Randell, head of the UK’s Financial Conduct Authority, said in a speech at an economic crime symposium that he could not say whether the token in question was a “fraud”. new tokens behind pure speculation”.
EthereumMax described the legal claim as a “deceptive narrative.”
Kardashian and Mayweather weren’t the only celebrities to step into crypto. In October last year – when bitcoin was at the top of the market at $1.14 trillion – actor Matt Damon made his debut as a Crypto.com seller, advising audiences that “fortune favors the brave”. The ad was seen as a landmark for crypto, a financial investment backed by a Hollywood celebrity.
Other digital assets are also under scrutiny. Earlier this month, the justice department indicted Nathaniel Chastain, a former employee. NFT marketplace OpenSeaWith electronic fraud and money laundering in connection with the scheme to trade NFTs [non-fungible tokens] assets.
“NFTs may be new, but it’s not that kind of criminal plot,” said US attorney Damian Williams. He said the charges demonstrate prosecutors’ determination to “eliminate insider trading, whether on the exchange or on the blockchain.”
But prosecuting fraud in the crypto arena is notoriously difficult. A number of prosecutions have been filed for theft, but prosecuting digital fraud faces a central, unresolved question: are cryptocurrencies securities?
The US definition of what a security is is based on something called the “Howey test” and is derived from a supreme court decision, Securities and Exchange Commission (SEC) v WJ Howey Co. He decided in 1946, long before the crypto age.
There are four pillars that support whether a financial asset is a security: (1) a money investment; (2) in a joint business; (3) with the expectation of profit; and (4) deriving profit from the efforts of others.
If cryptocurrencies are a security, the SEC, the top US financial watchdog, has jurisdiction, and fraudulently selling unregistered securities can be a crime with up to five years in prison. But the law is far from clear.
“Crypto is a weird bird – does it buy coins, dollars, or the right to invest in dollars?” says Charles Elson, an authority on corporate governance issues. “A lot depends on what people represent and whether any federal laws are violated in exchanging these things. Typically, the SEC will always argue that something is security and let the courts decide.”
The question of whether celebrities can be held responsible is an open question. First, courts would have to decide whether crypto was a security and then whether that security was fraudulently promoted.
“Oh, this is an easy investment, don’t they say don’t worry? Did they lie to attract investment?” says Elson. “There will be lawsuits, and courts don’t like fraud and will often find a way to punish a fraudster.”
“But if the laws in the area are unclear and they are not a security, how do you recover? You can enjoy the satisfaction of winning, but you can’t get any cash. Where did the money go? Why are criminals using bitcoin and ransomware? It’s not traceable.”
As commentators pointed out as crypto markets crashed this week, no cryptocurrencies were registered as securities; and the exchanges or lenders they can pass through are not supported by the government’s Federal Deposit Insurance Corporation. (FDIC) insurance guarantees.
The US Financial Crimes Enforcement Network (FinCEN) does not view cryptocurrencies as legal tender, but considers cryptocurrency exchanges as money transmitters on the basis that cryptocurrency tokens are “other currency substitutes.”
The SEC ruled in a letter in 2019 that bitcoin had failed Howey. The test only meets the “investment” criteria. In 2018, Gary Gensler, former chairman of the Commodity Futures Trading Commission, said that bitcoin’s biggest rival, Ethereum, would pass the Howey test, and most cryptocurrencies must register with the agency as securities. But there are also efforts in Congress to write legislation for the cryptocurrency industry that could jeopardize regulators’ oversight over the industry.
Because cryptocurrencies work differently through different exchanges that charge differently for trading, establishing any liability is complex, and most have an army of lawyers ready to argue that exchanges are “safe havens”, not exchanges.
On Monday, crypto exchange Binance halted bitcoin withdrawals for several hours after crypto lender Celsius Network blocked its customers from withdrawing, swapping and transferring funds on its platform. Binance blamed a “stuck transaction” for its suspension.
The next day, the SEC launched an investigation into whether crypto exchanges have appropriate safeguards to prevent insider trading. The investigation is believed to involve the most well-known exchanges – Binance, Coinbase, FTX and Crypto.com, Kraken, Bitfinex and Crypto.com.
Eventually, Elson says, the law regarding cryptocurrency and exchange systems will be exposed. “Did you tell people the truth about it and was it based on fair trade practices or was it a fraudulent trading system against the investor?”
But since crypto exchanges are not SEC regulated and it is very difficult to find out who is on the other side of the trade, it will be difficult to establish liability for losses.
“The lesson to be learned is that you don’t invest in an unregulated market,” Elson said.