WWhen global investors look at $1.5 trillion in collective losses in recent times, a blizzard of class action lawsuits is being prepared. A big question is: who is to blame – and who could be held accountable?
With rising inflation and rising interest rates, the most popular cryptocurrencies have been hit by severe and prolonged 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 fallen to less than $1 trillion from its peak of $3 trillion in November 2021. US federal regulators say 46,000 people have reported losing $1 billion worth of crypto to fraud since January 2021.
With millions poured into promoting crypto — often with celebrity endorsements — legal action in the wake of the crash was inevitable. Class action lawsuits are already in the works. Kim Kardashian and boxer Floyd “Money” Mayweather Jr. are being sued for allegedly making false statements about promoting small 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 deceived investors.
Charles Randell, head of the UK’s Financial Conduct Authority, speaking at a symposium on white-collar crime, said he couldn’t say whether the token in question was a “scam…but social media influencers are routinely paid by scammers to help them in the market.” To help pump and dump new tokens on the back of pure speculation.
EthereumMax has called the legal claim a “deceptive narrative.”
Kardashian and Mayweather weren’t the only celebrities to champion crypto. In October of last year – at the peak of the market when Bitcoin reached a market cap of 1.14 trillion. The ad was seen as a turning point for crypto – a financial investment backed by a Hollywood A-lister.
Other digital assets are also put to the test. Earlier this month, the Justice Department indicted Nathaniel Chastain, a former employee NFT marketplace OpenSeawith wire fraud and money laundering in connection with a plan to trade NFT [non-fungible tokens] Financial assets.
“NFTs may be new, but this type of criminal system is not,” said US Attorney Damian Williams. He said the indictment demonstrates prosecutors’ determination to “root out insider trading — whether it occurs on the exchange or on the blockchain.”
But tracking scams in the crypto arena is notoriously difficult. A number of criminal cases have been filed for theft, but the prosecution of digital fraud raises a key unresolved question: are cryptocurrencies securities?
The US definition of what a security is relies on what is known as the “Howey test,” which stems from a 1946 ruling by the Supreme Court, the Securities and Exchange Commission (SEC) v. WJ Howey Co , long before the crypto era.
There are four pillars that support whether or not a financial asset qualifies as a security: (1) an investment; (2) in a joint venture; (3) with the expectation of profit; and (4) that profit should be derived from the efforts of others.
If cryptocurrency is a security, the SEC – the US’s top financial regulator – has jurisdiction, and fraudulently selling unregistered securities could be a criminal offense with up to five years in prison. But the law is anything but clear.
“Crypto is a weird bird — is it a coin, is it buying a dollar, or the right to invest in a dollar?” says Charles Elson, an authority on corporate governance. “A lot depends on what was presented to the people and whether any federal laws were violated in exchanging those things. Typically, the SEC will always argue that something is a security and let the courts decide.”
The question remains whether the celebrity pitchers could be held liable. First, the courts would have to decide whether crypto is a security and then whether that security was fraudulently promoted.
“Did they say, ‘Oh, that’s an easy investment, don’t worry?’ Did they lie to attract investment?” says Elson. “There will be trials, and courts don’t like cheating, and they usually find a way to punish a cheating person.”
“But if the law is fuzzy in the area and these things aren’t security, how do you get compensation? You can celebrate the prize, but you will not receive any cash. Where has the money gone? Why are criminals using Bitcoin and ransomware? It’s incomprehensible.”
As commentators pointed out this week as crypto markets crashed, no cryptocurrency has registered as a security; and exchanges or lenders they may pass through are not backed 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 because cryptocurrency tokens are “other values that replace currency.”
The SEC ruled in a letter in 2019 that Bitcoin failed the Howey Test that 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 that most cryptocurrencies should be registered as securities with the agency. But there are also efforts in Congress to legislate for the cryptocurrency industry that could jeopardize regulators’ oversight of the industry.
Because cryptocurrencies work in different ways through different exchanges charging different fees for trading, establishing liability is complicated and most have an army of lawyers ready to argue that exchanges are “safe havens” and not exchanges .
On Monday, crypto exchange Binance halted Bitcoin withdrawals for several hours after crypto lender Celsius Network also blocked customers from using its platform for withdrawals, exchanges, and transfers. Binance blamed a “stalled transaction” for the suspension.
The following day, the SEC launched an investigation into whether crypto exchanges have adequate safeguards in place to prevent insider trading. The investigation is believed to include the most prominent exchanges – Binance, Coinbase, FTX and Crypto.com, Kraken, Bitfinex and Crypto.com.
Eventually, Elson says, the law on cryptocurrency and its exchange systems will boil down to disclosure. “Did you tell people the truth about the thing and was it based on fair trade practices or was it a trading system rigged against the investor?”
However, since crypto exchanges are not regulated by the SEC and it is notoriously difficult to find out who is on the other side of a trade, establishing liability for losses becomes difficult.
“The lesson to be learned is don’t invest in an unregulated market,” Elson said.