The Block is delighted to bring you expert cryptocurrency legal analysis courtesy of Stephen Palley (@stephendpalley) and Nelson M. Rosario (@NelsonMRosario). They summarize three cryptocurrency-related cases on a weekly basis and have given The Block permission to republish their commentary and analysis in full.
Bitcoin Cash meets the Sherman Act in a lawsuit fresh off the printers, insurance coverage for bitcoin, and moar CFTC enforcement actions. (As always, Rosario summaries are “NMR” and Palley summaries are “SDP”. Nelson’s out this week with something much more interesting than crypto but will be back next, so any complaints this week can be sent to Palley).
[related id=1]Kimmelman v. Wayne Insurance Group, 2018 Ohio Misc. LEXIS 1953 (Oh. Ct. of Common Pleas, Franklin County, 18 CV 1041, 9/25/2018) [SDP]
I know you came here for crypto case law but before I get to that I have a confession to make. I think insurance is interesting. Its history goes back to Rome and Phoenician traders. You can argue that modern industrial capitalism couldn’t have happened without it. One of the coolest tours I had recently was a visit to Lloyds, where I got to see the bell that they ring every time a ship sinks. I mean the stuff is literally soaked in history. And you need it to run a business. It’s also handy if a bunch of your stuff gets lost or stolen
But what in Satoshi’s name does this have to do with bitcoin or Kimmelman v. Wayne Insurance Group? This is actually kind of an historic case. It appears to be one of the first — if not the first — in which the question of whether or not bitcoin is money has arisen in the context of a consumer insurance policy.
The opinion is kind of thin on facts but here’s the gist: the plaintiff submitted an insurance claim for $16,000 in stolen “BitCoin”. We don’t know from the opinion how this happened. The insurance company investigated the claim and paid the plaintiff $200. Why only $200 you ask? The policy had something called a sublimit in it for “money”. A sublimit is exactly what it sounds like — it’s a limit that sits below the total policy limit. So say there’s was a total limit of $50,000 for personal property, there was a $200 sublimit for money. In short, the insurance company said bitcoin is money, so we only owe you $200. The Plaintiff sued. The insurance company moved to dismiss (on the pleadings, if you’re a civ pro maven). In this opinion, the court denied the motion to dismiss.
The insurance company argued bitcoin is money by referring to “articles from CNN, CNET and the New York Times” and a reference to IRS Notice 2014–21. The Court said that the IRS Notice was “the only authority the Court can rely upon in determining the status of BitCoin[.] Under Notice 2014–21, the IRS states ‘for federal tax purposes, virtual currency is treated as property’.” The Court concluded that because “BitCoin” is treated as property by the IRS it’s not money. On this basis, it denied the insurance company’s motion.
I wrote a law review-ish piece on this topic for the American Bar Association over the summer and my conclusion at the time was that Courts would look to other cases involving the money sublimit and also consider what regulators have said. In this case it appears that the IRS is the only agency whose views were considered. Whether the result might have been different if other authority had been cited is hard to say, but the law here is still being written. In short, while this is a good opinion for the policyholder in this case, it’s far from the last time that the issue will arise. I suspect that if crypto losses become more prevalent we will begin to see crypto-specific exclusions added.
[related id=2]United American Corp. v. Bitmain et al., (S.D. Fl., 18-cv-25106, 12/6/2018) [SDP]
Link to Complaint: Bitcoin Cash suit
More history! This new lawsuit allegedly “involves a scheme by a tight knit network of individuals and organizations to manipulate the cryptocurrency market for Bitcoin Cash, effectively hijacking the Bitcoin Cash network, centralizing the market, and violating all accepted standards, protocols and the course of conduct associated with Bitcoin since its inception.” Plaintiff alleges anti-trust violations under the Sherman and Clayton Acts, along with a bunch of common law claims (negligence, negligent misrepresentation among other things.)
Plaintiff is United American Corp. Defendants include several Bitmain entities, Bitcoin.com, Roger Ver, Jihan Wu, Kraken, Jesse Powell, Amaury Sechet, Shammah Chancellor and Jason Cox.
Plaintiff says that it developed new technologies intended to mine the Bitcoin Cash Network, using something that it calls “domes”, and alleges that “to date it has erected four domes and operated over 5,000 Bitcoin Cash-based miners. The Plaintiff’s total investment in development and deployment of this infrastructure exceeds $4 million.”
But to make money, Plaintiff alleges that it has be able to mine “Bitcoin Cash within normal market conditions.” (Narrator: “what are those?”). This didn’t happen because (so the allegation goes) “the scheduled Bitcoin Cash network upgrade was manipulated by Defendants in an effort to artificially take control of the network blockchain moving forward.”
Specifically, Plaintiff alleges that “During the November 15, 2018 Bitcoin Cash network upgrade, Ver and Bitcoin.com colluded with Jihan Wu and Bitmain (whose electricity rates are subsidized by the Chinese government) to reallocate pools of Bitmain servers from the Bitcoin Core network (“BTC”) to Bitcoin.com’s pools in the Bitcoin Cash network minutes before the implementation of the Bitcoin Cash network upgrade. The effect was to bring pools of servers to mine the upgrade from another network (i.e., “rent” hashing power), that were not previously mining the Bitcoin Cash blockchain, thereby increasing Bitcoin.com’s hashing power by over 4,000%.”
Furthermore, Plaintiff complains that 'The Defendants' collective actions and manipulation of the market by among other things, violating the Nakamoto Whitepaper and consensus rules, and hijacking the Bitcoin Cash network have created significant uncertainty and a lack of confidence in the network. Under normal decentralized market conditions, this type of uncertainty would not exist.” (Narrator: is the whitepaper a contract?)
The lawsuit includes seven counts — (1) Antitrust, (2) Negligent Misrepresentation, (3) Negligence, (4) Equitable Estoppel, (5) Unjust Enrichment, (VI) Conversion, and (VII) “Injunctive Relief” (That’s a remedy, not a claim, in my view, but whatever).
I am immediately skeptical of the tort claims. Negligence requires a duty and harm to a foreseeable class of plaintiffs. That’s a heavy lift in what is essentially a commercial dispute. Those claims maybe get kicked out in a motion to dismiss.
The remedy part is interesting. Plaintiff asks for some standard stuff, including money of course. But there’s this: “Awarding injunctive relief against Defendants to: (1) prevent Bitcoin ABC from continuing to implement checkpoints on the Bitcoin Cash network and any other implementation of the software that would prevent the resulting chains from being able to be re-merged; and (b) requiring them to return the blockchain to its previously decentralized form with the previous consensus rules.” I’m not entirely sure how a federal court would implement this, but I guess Plaintiffs will argue it’s not truly decentralized so should be No Big Deal.
This case is a fresh one and we’re still reviewing. We’ll report back with further analysis after we have time to review in greater detail.
CFTC v. Gelfman Blueprint, 2018 U.S. Dist. LEXIS 205706 (S.D.N.Y, 17–7181, 10/16/2018) [SDP]
Default judgments are what you get when someone sues you and you don’t show up. This opinion is a default judgment in a case brought by the CFTC involving fraud in the sale of bitcoin, under the Commodities Exchange Act. No one showed up to defend, so we only get the government’s argument and the Court’s opinion reflects that. Still, it's one more case in which the CFTC has taken the position that fraud in spot market bitcoin sales are within the CFTC’s purview. Also, notably, this case involves things that happened in 2015. These things take time.
Per the opinion, “Defendants solicited and received more than $600,000 from at least eighty GBI Customers, who invested amounts ranging from a few hundred dollars to tens of thousands of dollars, for the purpose of entering into contracts for sale of Bitcoin, a virtual currency, through electronic web-based Bitcoin trading platforms[.]” Among the false and misleading statements defendants made were:
* that a proprietary “high-frequency, algorithm trading” bot named Jigsaw would generate monthly profits and protect against volatility
* that customers had access to balances, deposits and withdrawals through an interactive website when in fact “figures provided through the dashboard were false”
* misstating investment returns and assets under management in person, in marketing materials and on social media, “internet chat room posts” (what is an internet chat room these days?)
* providing fake documentation from an accountant who the defendants claimed was a CPA and wasn’t
Wait — there’s more! The Defendants also charged customers for fees on profits … that were never actually realized: “consequently, all ‘fees’ deducted from GBI Customers’ funds based on these false profits in fact were GBI Customer funds that Defendants misappropriated from GBI Customers.” Also, in order to cover up investment losses “[i]n or around October 2015, Gelfman told other GBI officers that a computer ‘hack’ had caused GBI to lose all or nearly of GBI’s Customers’ investments.”
This seems like run of the mill fraud, right? There are two big takeaways from this opinion. First, this is yet another case in which the CFTC has taken the position that it has enforcement power over spot market bitcoin transactions, where no contract for future delivery is at issue. Now we have to caveat this by noting that no-one opposed the argument — but it is not the first or last time CFTC has made the argument or that a court has accepted it. Second, some of underlying activity — including the B.S. exchange hack took place several years ago. In other words, lying about an exchange hack involving bitcoin can get you in hot water with the CFTC even if that water takes time to boil.
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