Crypto Litigation & Arbitration - Trends to Watch in 2023
Whether or not the "crypto winter" thaws this spring, the legal repercussions will reverberate for some time. As well as attracting greater interest from regulators and legislators, the events of 2022 are likely to generate significant volumes of civil litigation and arbitration as investors and consumers seek to recover losses. Below are some key trends to watch out for in 2023.
1. Crypto insolvency and bankruptcy proceedings
Last year's market conditions saw a raft of collapses of exchanges, investors and miners. While FTX made front page news around the world, there were also a number of other high-profile Chapter 11 filings in the US (Celsius Network, Voyager, BlockFi, Compute North and now Genesis) as well as major proceedings in BVI (3AC), Singapore (Zipmex) and the Bahamas (FTX). These are complex cross-border proceedings that are moving at speed as insolvency officials race to locate and secure assets. They have already given rise to cross-border enforcement issues, such as the Singapore Court permitting 3AC's liquidators appointed by the BVI court to conduct investigations in Singapore. These proceedings (and more that may follow in 2023) will likely go on for some time and generate satellite litigation concerning specific assets or groups of creditors. Claims against auditors of insolvent entities may also emerge given the high levels of scrutiny now applied to proof of reserves reports and other aspects of audits and annual accounts.
2. Digital asset investor class action claims
2022 brought another year on year rise in the number of class actions launched in the US by purchasers of digital assets alleging breach of US securities laws, including claims against Bitconnect and Solana. The claims targeted coin issuers, developers, exchanges, miners, founders and promoters, including high-profile celebrities. Group arbitration claims have also been launched (such as the very recent claim against Genesis by a group of Gemini Earn investors in AAA arbitration). Claims of this type have often fallen foul of limitation issues, class action waivers or jurisdiction challenges but those challenges have not stopped claimants trying. Boutique law firms and litigation funders are investing in this area so this trend is likely to continue, particularly if market conditions remain volatile. The increase in crypto class action claims also extends beyond the US. Last year, class actions were launched in Australia against the entity behind the QOIN token, which included claims under Australian securities legislation; in Spain against those behind the Biosca Ponzi Scheme; and in Korea and Singapore in relation to the Terra/Luna collapse.
3. Digital asset fraud claims
The courts of global financial centres (London, Hong Kong, Singapore) and offshore financial centres (BVI, Cayman Islands) have all seen steady growth in claims by victims (or their insurers) of crypto-related frauds, scams, hacks and ransomware attacks. Recent market conditions have contributed to the exposure of fraudulent schemes and the related claims. The experience of courts in these jurisdictions with complex cross border frauds has made them natural hubs for international crypto-fraud disputes. They have powerful tools at their disposal, such as injunctions freezing digital assets in the hands of the fraudsters or third parties, such as exchanges. Many of these courts have shown willing to adapt their procedures to deal with specific issues arising from the technology and the nature of the market, such as permitting service of claims by non-fungible tokens (NFTs), relaxing rules on ordering overseas entities to provide information and permitting security for costs to be paid in cryptocurrencies.
4. Crypto arbitration
As arbitration is typically a private and confidential process, it is harder to gauge the volume of claims and identify key matters and trends. However, there is a trend of high-value commercial disputes being referred to arbitration. Major reported arbitrations in 2022 included Genesis suing Three Arrows Capital (3AC) for $2.4 billion in ICDR arbitration and CoinFLEX suing one of its users (going by the name of Bitcoin Jesus) for an $80 million unpaid margin call in HKIAC arbitration. At the other end of the scale, in a consumer context, arbitration is arguably the preferred dispute resolution mechanism for exchanges, custodians, coin issuers and other service providers. While B2C arbitration is well understood and widely used in the US, users continue to challenge the validity of arbitration agreements where it is in their strategic interest to do so. In 2023, the US Supreme Court will hear an important appeal brought by Coinbase on the issue of whether litigation should be stayed where a court refuses to uphold an arbitration agreement but the decision is appealed. Outside of the US, arbitration agreements are likely to be subject to even more challenges based on local consumer protection legislation. Last year, the English Court of Appeal heard a high-profile dispute between a UK-based NFT collector and the New York based Nifty Gateway (see our briefing here), in which it held that only the English Courts could decide whether the New York arbitration agreement was valid under UK consumer protection legislation. This forceful decision will likely lead to further similar challenges by users claiming to be consumers (e.g. see Chechetkin v Payward Ltd).
5. Claims for smart contract errors and software bugs
When exchanges experience technical or software issues, or smart contracts contain defects, losses can be extremely large and devastatingly quick. The unforeseen consequences of a trading algorithm lay at the heart of the seminal case of B2C2 v Quoine in Singapore. A major exchange is currently facing a group arbitration claim in HKIAC arbitration relating to an outage of the platform during a period of market volatility. Opensea faces a number of claims in the US arising from alleged bugs in its code that allowed the theft of users' Bored Ape NFTs. However, claims are not all one way and crypto companies are also bringing claims against their own users where technical issues result in unexpected windfalls. Last year also saw reports of cases involving accidental payments, such as the case of Crypto.com suing a user in Australia after accidentally refunding her AU$10m instead of AU$100. Similarly, Coinberry is trying to recover bitcoin paid accidentally to users in Canada.
6. Claimant's relying on novel duties of care to recover cryptoassets
The nature of the distributed ledger or blockchain technology underlying cryptoassets (or perhaps the size of losses and lack of any statutory compensation schemes) has forced claimants to consider novel claims and remedies and claimants are only likely to grow more ambitious. A number of class action and group arbitration claims in the US and Canada are based on complaints that exchanges and wallet providers breached alleged duties to protect users from third parties (e.g. the class action claim against bZx DAO in the US). The unprecedented events of so-called "Hacktober", during which it has been reported that over $750m in digital assets were stolen, will inevitably give rise to litigation. In England, inventive claimants may seek to extend the so-called Quincecare duty owed by banks to customers (to not execute suspicious payment instructions) to crypto exchanges. More ambitiously still, in the Tulip Trading case in the English High Court, Dr Craig Wright has sued the developers of various bitcoin blockchains for $4.5 billion for breach of what he says is a tortious duty to assist bitcoin owners regain control of their lost assets. The High Court said there was no real prospect of establishing that such a duty existed but this has been appealed and the judgment is due soon.
7. Competition and consumer protection law claims
The UK saw a ground-breaking competition case against a number of crypto exchanges in 2022. The case was launched by a group of BSV owners following the exchanges' decision to de-list it and, in some cases, converting BSV holdings into other cryptocurrencies. The case is at an early stage and there will likely be numerous procedural twists and turns before any trial gets underway. Cases based on the conspiracy to manipulate markets in breach of the Sherman Act have also been seen in the US. As the market consolidates, and a number of dominant players emerge, this may be a tool used with increasing regularity. Claims for breaches of consumer protection legislation are also likely to increase given that many retail investors will have suffered losses in recent years. Cases have already been seen in England (the case against Nifty Gateway discussed above), Canada (a class action launched against Wealthsimple and Shakepay in relation to proper disclosure of crypto trading fees) and Australia (the QOIN litigation discussed above includes claims for consumer protection law).
8. Enforcement of digital asset judgments and arbitral awards
Enforcement is one of the most important aspects of any litigation as victories can be short-lived if a defendant does not pay. Reported cases in this area remain scarce but 2022 saw the English courts issue a third-party debt order against a crypto exchange and attempts in Greece and China to enforce arbitral awards denominated in cryptocurrencies (both failed on the public policy ground that it would promote the use of cryptocurrency). However, in Mexico an arbitral award was successfully enforced which had originated in an "on-chain" arbitration procedure (Kleros). There were also examples of "self-help" enforcement, where courts were bypassed by enlisting the assistance of miners and node controllers directly. For example, in response to the BNB Smart Chain hack in October 2022, the developer did not race to court for injunctions but persuaded the majority of nodes to shut down the chain to prevent the hackers from removing BNB coins to other blockchains. The BSVBA and Dr Wright reached an interesting settlement in the Tulip Trading case under which the BSVBA committed to introducing a new code that, if accepted by nodes, would permit them to receive and give effect to court orders. Whether that code deployment occurs, and how it is received, remains to be seen.