ÇWith investors around the world looking at a collective $1.5 trillion in recent cryptocurrency losses, a flurry of class-action lawsuits are brewing. A big question is: who, if any, is to blame – and who can be held accountable?
With inflation and interest rates soaring, the best-known cryptocurrencies have been hit with heavy and ongoing losses: Bitcoin has lost more than 50% of its value this year; Ethereum, its biggest rival, is down 65%; and the total value of crypto assets has dropped to less than $1 trillion from its November 2021 peak of $3 trillion. US federal regulators say 46,000 people have reported losing $1 billion worth of crypto to scams since January 2021.
Given the millions invested in promoting cryptocurrencies – often with celebrity endorsements – legal action after the crash was inevitable. Class action lawsuits are already underway. Kim Kardashian and boxer Floyd “Money” Mayweather Jr are being sued for alleged false statements promoting the smaller cryptocurrency EthereumMax.
The lawsuit alleges that they encouraged followers to join the “EthereumMax community” and that the token itself was a “pump-and-dump” scheme that misled investors.
Charles Randell, head of the UK Financial Conduct Authority, said in a speech at an economic crime symposium that he could not say whether the particular token was a “scam…new tokens on the back of pure speculation”.
EthereumMax described the legal claim as a “misleading narrative”.
Kardashian and Mayweather were hardly the only celebrities to bet on cryptocurrencies. Last October – at the height of the market, when bitcoin had a market cap of $1.14 trillion – actor Matt Damon made his debut as the pitchman of Crypto.com, advising viewers that “luck favors the brave ones”. The announcement was seen as a turning point for cryptocurrency – 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 of OpenSea NFT Marketwith wire fraud and money laundering in connection with a scheme to trade NFT [non-fungible tokens] active.
“NFTs may be new, but these types of criminal schemes are not,” said US attorney Damian Williams. He said the charges demonstrate the prosecutors’ determination to “eliminate the use of inside information – whether in the stock market or on the blockchain.”
But prosecuting fraud in the cryptocurrency arena is notoriously difficult. Several lawsuits have been filed for theft, but prosecuting digital fraud faces a central and unresolved question: are cryptocurrencies securities?
The US definition of what a security is depends on something called the “Howey test” and derived from a Supreme Court decision, Securities and Exchange Commission (SEC) v WJ Howey Co., ruled in 1946, long before the cryptocurrency era.
There are four pillars that support whether or not a financial asset qualifies as a security: (1) an investment of cash; (2) in a joint venture; (3) with expectation of profit; and (4) that profit must be derived 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 felony, with up to five years in prison. But the law is far from clear.
“Crypto is a strange bird – is it a currency, is it buying a dollar or the right to invest in a dollar?” says Charles Elson, an authority on corporate governance issues. “It very much depends on what was represented to people and whether any federal law was violated in the exchange of these things. Normally, the SEC will always argue that something is a lien and let the courts decide.”
The question of whether celebrities can be held responsible is an open question. First, the courts would have to decide whether cryptocurrency is a security, and then whether that security was fraudulently promoted.
“They said, ‘Oh, this is an easy investment, don’t worry about it?’ Did they lie to attract investment?” says Elson. “There will be lawsuits and courts don’t like fraud and will usually find a way to punish a fraudulent individual.”
“But if the law around the area is confusing, and these things aren’t a security, how do you get recovery? You may have the satisfaction of winning, but you will not receive any money. Where did the money go? Why do criminals use bitcoin and ransomware? It is not traceable.”
As commentators pointed out this week, when cryptocurrency markets crashed, no cryptocurrencies were registered as security; and exchanges or creditors they may go through are not supported by the government’s Federal Deposit Insurance Corporation (FDIC) insurance guarantees.
The US Financial Crimes Enforcement Network (FinCEN) does not consider cryptocurrencies to be legal tender, but considers cryptocurrency exchanges to be money transmitters based on the fact that cryptocurrency tokens are “another value that replaces currency”.
The SEC ruled in a letter in 2019 that bitcoin failed Howey test, meeting only 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 that most cryptocurrencies should be registered as securities with the agency. But there are also efforts in Congress to write legislation for the cryptocurrency industry that could compromise oversight by industry regulators.
As cryptocurrencies work in different ways through different exchanges that charge different ways for trading, establishing any liability is complicated and most have an army of lawyers ready to argue that exchanges are “safe havens” and not exchanges.
On Monday, cryptocurrency exchange Binance halted bitcoin withdrawals for several hours after cryptocurrency lender Celsius Network also blocked customers from withdrawing, exchanging and transferring on its platform. Binance blamed a “stuck transaction” for its suspension.
The next day, the SEC launched an investigation into whether cryptocurrency exchanges have adequate safeguards to prevent insider trading. The investigation is believed to include the most well-known exchanges – Binance, Coinbase, FTX and Crypto.com, Kraken, Bitfinex and Crypto.com.
Ultimately, says Elson, the law on cryptocurrencies and their exchange systems will come down to disclosure. “Did you tell people the truth about the thing, and was it based on fair business practices or was it a trading system that was rigged against the investor?”
But since cryptocurrency exchanges are not regulated by the SEC and it is notoriously 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,” said Elson.