April 10, 2018
by Daniel M. Payne

2017 was the year that cryptocurrencies went mainstream.  New cryptocurrencies were launched and Bitcoin hit its all-time high on December 17.  Not coincidentally, 2017 also saw increased legal exposure for cryptocurrencies.  Government regulators started bringing more enforcement actions while at the same time securities class actions and other private civil litigation began taking off. 

As the calendar has flipped to 2018, the legal issues specific to cryptocurrencies are beginning to take shape.  Two of the most important are:

1. Are cryptocurrencies obligated to perform “rescue forks” to return hacked funds to investors?

In a putative class action filed on April 6, 2018 captioned Brola v. Nano et al., Civil Action No. 18-cv-02049 (E.D.N.Y.), investors in the Nano cryptocurrency allege that XRB (shorthand for units of the Nano currency) are securities that were offered for sale without registration in violation of Securities Act 12(a)(1).  This has been a common allegation in recently-filed crypto-class actions and SEC enforcement actions. 

However, Brola raises a new question that is sure to confront cryptocurrencies going forward: whether the core team of a cryptocurrency is obligated to institute a “rescue fork” to return hacked funds to investors.  A “rescue fork” means re-writing the code to move the XRB back to investors' pre-hack wallets. In February, Nano disclosed that $170 million worth of XRB was stolen through a hack of an exchange called BitGrail.  The Brola putative class alleges that “Defendants can create a ‘rescue fork’ to protect Plaintiffs and the Class’ property rights,” but assert that Defendants refuse to fork XRB because of their large XRB holdings. 

This is not the first time that a rescue fork has been considered for a cryptocurrency (see Ethereum's 2016 fork involving the DAO).  Although forking a currency can, in effect, “undo” a hack, forking bypasses the "irreversibility" design of the blockchain technology on which cryptocurrencies are built. 

Although a “failure to fork” is not alleged in the Plaintiffs’ causes of action, it is predominantly alleged in the Complaint and the Plaintiffs have asked the court to order the Defendants to perform a rescue fork.  We will provide updates as we continue to monitor this litigation.

2.  Does the CFTC have jurisdiction over all virtual currencies?

One judge has ruled that virtual currencies are “commodities” as that term is used in the Commodity Exchange Act and CFTC Regulations and, therefore, the “CFTC may exercise its enforcement power over fraud related to virtual currencies sold in interstate commerce.”  CFTC v. McDonnell, Civil Action No. 18-cv-361, Dkt. No. 29 at *4 (E.D.N.Y. Mar. 6, 2018).  But, as we have blogged before, the court did not address how virtual currencies could meet the CEA’s definition of commodity, which requires that they be services, rights or interests "in which contracts for future delivery are presently or in the future dealt in,” when Bitcoin is the only virtual currency with a future contract.   The alleged fraud did involve the defendants' dealings in Bitcoin, among other virtual currencies such as Litecoin.

While the McDonnell decision involved a pro se defendant, the defendants in CFTC v. My Big Coin Pay Inc., Civil Action No. 18-cv-10077 (D. Mass.) are represented by counsel who have challenged the CFTC’s assertion of jurisdiction over a commodity without an offered futures contract. (Disclosure: Murphy & McGonigle represents one of the individual defendants in the case.)  Thus, there is a chance that My Big Coin Pay, Inc. will lead to a different and/or more nuanced decision than the McDonnell decision.

And even as the courts decide on the scope of the CFTC's jurisdiction, a jurisdictional conflict may arise with the SEC, which may take the position that cryptocurrencies are securities.

 

About Blockchain Law Center

Blockchain technology utilizes a distributed digital ledger to record and track information, and can be leveraged to gain transparency and certainty in transactions ranging from cryptocurrency to supply chain tracking.  This blog provides information on the legal developments surrounding implementation of blockchain technology, with an initial focus on the financial services sector.