A federal court lays down new law on exchange liability for forked crypto assets

What obligations does a cryptocurrency exchange have with respect to forked assets?

In what may be the first opinion to address this at length, a federal court in Georgia has waded into the figurative swamp to provide some clarity. BDI Capital, LLC v. Bulbul Invs. LLC, 2020 U.S. Dist. LEXIS 41684, is a lawsuit that arose over bitcoin and cash held on the now-defunct CampBX exchange.

Plaintiff set up an account on the exchange in 2013 and deposited a little bit more than 14 bitcoins. After having a problem withdrawing the bitcoin in 2017, they contacted the defendant, which was in the process of shutting down. Long story short: a lawsuit ensued and defendant entered into a consent injunction by which they returned the bitcoin along with some cash.

So if the Defendant didn't steal the crypto and Plaintiff got what they owned returned to them, why is there still a lawsuit, you ask?

This is where things get interesting. One of the allegations in the lawsuit is that the Defendant unlawfully retained "forked" Bitcoin:

• On August 1, 2017, Bitcoin forked at block 478558 (in the Blockchain) resulting in the creation of Bitcoin Cash. For each Bitcoin held on that date, an equal number of Bitcoin Cash was created which BDI contends became tied or linked to the respective Bitcoin owner's wallet;
• On October 24, 2017, Bitcoin forked at block 491407 (in the Blockchain) resulting in the creation of Bitcoin Gold. For each Bitcoin held on that date, an equal number of Bitcoin Gold was created which BDI contends became tied or linked to the respective Bitcoin owner's wallet; and
• On February 18, 2018, Bitcoin forked at block 511346 (in the Blockchain) resulting in the creation of Bitcoin Private. For each Bitcoin held on that date, an equal number of Bitcoin Private was created which BDI contends became tied or linked to the respective Bitcoin owner's wallet

But what is the exchange's obligation to the customer with respect to the forked crypto? The court notes that this is a case of first impression:

"Commentators have struggled to place bitcoin forks into an existing legal framework. For example, "[i]t has been suggested, and disputed, that the hard fork represents a scenario similar to a stock split[,] . . . like a two-for-one stock split, a unit was doubled by the hard fork; holders of Bitcoin received an equal amount of [forked currency] Bitcoin Cash." Nick Webb, Comment, A Fork in the Blockchain: Income Tax and the Bitcoin/bitcoin Cash Hard Fork, 19 N.C.J.L. & Tech. On. 283, 299 (2018) (footnotes omitted). However, "the divergence of the network and the creation of two entirely separate blockchains do not sound like a stock split. Stock splits do not result in the construction of an entirely separate entity.""

Analogizing further to stockbrokers and stock splits, the Court notes that under Georgia law, a stockbroker has no duty to "advise clients of a pending stock split or dividend before processing a sale order."

As a result, the Court says that an exchange will not have a duty to warn its customers in advance of a fork that it will be supporting forked assets. The duty or obligation to a customer will only exist it the company undertakes an obligation to support the fork: "[I]f an exchange, trading platform, or other shared wallet affirmatively undertakes to support forked currency, they have voluntarily assumed the obligation of holding these coin forks for their respective owners. At this point, they must account for the forked currencies upon demand by their rightful owner."

This is a really fascinating example of how courts apply existing caselaw and principles to new and evolving technology and asset classes. The court doesn't just throw its hands up – it reasons by analogy, which lawyers are taught to do starting on the first day of law school.

Thus, the case will continue to be litigated and, if it's ultimately determined that there was no such undertaking, Plaintiff will have to return the value of the forked assets that it received in the consent injunction.

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One of the many things you can do when restricting your travel – whether because of a quarantine or otherwise – is write things. In fact, it's quite possible that the current pandemic will lead both to a baby boom in about 9 months and to a slew of caselaw and new filings in the next couple of months, as people (which includes judges and lawyers) hunker down in home offices or restricted access offices.

In any event, I have yet to see a reduction in the number of new lawsuits involving crypto, which have exploded in the past 18 months from a trickle to waterfall.

Adding to the ICO lawsuit onslaught noted above, I noted another new filingin the past week involving a company called "Hoard" which issued a thing called the "Oar" token. Plaintiff is a Delaware LLC called Crypto Asset Fund, LLC ("CAF"), and Defendants are Hoard, a North Carolina corporation, along with its CEO, Jason Davis. There are also a bunch of John Doe defendants.

According to Plaintiff, this case arises out of an ICO that took place during the tail end of the ICO craze:

"In 2018, Defendants conducted an initial coin offering for "OAR tokens" to be used on the "Hoard" network that Defendants represented to Plaintiff they were building out for launch and eventual widescale utilization and mass market adoption as a means of transferring cryptocurrencies between users. Davis came from a banking background and Defendants billed their beta app as "the Venmo of Crypto.""

Hoard didn't register the tokens with the SEC and Plaintiff says they were securities. Indeed, Plaintiff quotes language from the OAR purchase agreement that specifically says that they are entering into the purchase agree with "the predominant expectation" they will profit from the successful launch of the network and the efforts of the company. While this doesn't say "the tokens are a security" the language is not inconsistent with the language of the Howeycase and its progeny.

Plaintiff says he invested $175,000 in the Hoard ICO in May 2018. When he set an email to Hoard's CEO in July 2019, asking for an update on his investment, the email bounced and the company website was removed. In short, according to the lawsuit, the Venmo of Crypto never actually launched. Bereft of his investment and holding worthless Hoard tokens, Plaintiff sues for the violation of U.S. and California securities laws, and for the violation of California's Unfair Business Act/Practices.

Of course, the facts here are unique to this case, but they definitely have a familiar feel, including the following FOMO sales pitch from Hoard's CEO to the Plaintiff:

"Both rounds are running concurrently. We're open for contributions now. We're closing when they are filled. You've got some time but do not delay. Our broker dealer partners are about to make some big swings in May to close the sale out." Davis continued his aggressive pitch: "Expecting $500k-$1m to come in this week. Double that next week. Middle of May it should be balls to the wall. Your timing is impeccable."

Apparently and allegedly this was complete horse puckey. And so here we are.

"Cases like this do pose a pile of challenges for the Plaintiff, of course. One of them is collection – even if you do win, you still have to collect the judgement. That's not an insuperable problem if the Defendants have assets, but if they have all been spent or squandered it can be hard to get blood from a turnip."

Another issue is timing: a failure to register a claim under federal law is subject to a one-year statute of limitations that begins to run from the date of discovery, with a three-year statute of repose (the outside limit on when a claim can be asserted). It is more than a year since Plaintiff bought the Hoard tokens. In order to plead around this, Plaintiff's lawyer is, I suspect, pegging the date of discovery to July 2019, when the email asking for an update bounced.

Statutes of limitation and repose will remain an issue for Plaintiffs unless and until federal courts extend them. And even then, if you are out of pocket your investment waiting to file a lawsuit and collect may not be a terribly appealing proposition.

My guess is that we will continue to see cases like this filed, both by private plaintiffs and the SEC.