Partner Mark Kenkre examines the legal implications stemming from crypto exchange system outages, in The Fintech Times.
If, as many believe, cryptocurrency trading represents a new kind of wild west in the grip of a full-on gold rush, there seems to be a worrying lack of sheriffs in town.
Cryptocurrencies offer the potential for spectacular returns for those brave enough, to invest and trade. Cryptocurrency trading has grown at an almost unbelievable rate. The biggest exchange, Binance, founded in 2017 is reputed to be worth a staggering $300 billion. And it is not a one off. Coinbase, another exchange, has been valued at $100 billion in a recent IPO.
However, as readers will be aware, not all is well in the world of cryptocurrency trading. More and more traders are now looking for a lawman to recover losses that they claim have been caused by the crypto exchanges. If the usual candidates, governments and regulators, are not providing a route to redress, could class actions be the hero in the white hat riding to the rescue?
Before considering that it is necessary to understand how traders suffer unfair losses. One of the principal ways is through ‘outages’ where the exchange itself goes down rendering a trader unable get onto the platform to protect their position. Let’s break it down by way of example. Let’s say that I am a trader betting against the market and taking a position that Bitcoin will not fall below £25k. I see bad news on my screen. Bitcoin is dropping fast and is in danger of sinking well below £25k. I desperately want to shore up my position. The only way to do that is to move funds across from a linked account. However, if the exchange experiences an outage when I need to transfer funds, I am effectively locked out of my account. My position is liquidated, and the exchange takes the remaining funds. That of course is activity that breaches the terms and conditions of the exchange I signed up to. Simple solution, I take it up with the exchange and get redress for breach of contract? No, not simple at all. The exchanges operate as companies without a state. Incorporation structures can be opaque and changeable, and their terms and conditions often require traders to pursue litigation inexpensive jurisdictions.
It is not surprising that there has been a clamour for regulation forcing the exchanges, for instance, to shut down their platforms as soon as there is an outage, rather than liquidating traders’ positions. In other words, traders want regulators to impose a level playing field so that when things happen that are outside the control of the investor or the platform, such as an outage, the status quo remains, and traders’ funds are left intact.
Why then is class action litigation a potential game changer? A single investor who decides to litigate against one of the exchanges would find themselves akin to the position of a young David minus his slingshot, squaring up to Goliath’s bigger, tougher and far richer brother. The exchanges are hugely wealthy and well-resourced with pretty much bottomless litigation pockets. If thousands are affected by an outage and suffered hundreds of millions in losses, they are relatively easy ‘class’ to identify. If they act collectively, they will have strength in numbers and be able to achieve economies of scale.
Not surprisingly, therefore, class actions are already underway. In late summer the Financial Times and others reported that Liti Capital, a third-party funder based in Switzerland, was intending to fund a class action style arbitration against Binance with as many as 700 claimants. The move centres around the shutdown of significant parts of Binance’s online trading platform on a single and momentous day, 19 May 2021. It was the day that saw one of the steepest percentage drops in Bitcoin’s value. Traders claimed they had suffered enormous losses because they were unable to access their accounts to either limit their losses or post funds to shore up their positions. It has been reported that six traders claim to have lost $20 million in aggregate, and total claims could exceed $100 million.
Of course, none of this would be necessary if regulators around the world had got to grips with cryptocurrency trading and exchanges, and built effective redress regimes. However, not for the first time the lightning growth in technology and the profits it has generated, has outstripped the resources of regulators to keep pace. Some argue that the exchanges have been reluctant to engage constructively with regulators. The UK’s FCA has reportedly requested information on Binance’s global corporate structure and has been refused by its UK entity.
While opaque corporate structures are also a problem for class action litigation and enforcement of any rulings or judgments may prove challenging, it is now inevitable that groups of disgruntled traders who have lost millions will beat a path the doors of specialist lawyers. It may not be how the new wild west is tamed, but class action litigation is likely to become an essential weapon in the legal battles between cryptocurrency traders and exchanges.
The article featuring Mark Kenkre was published in The Fintech Times, 17 February 2022, and can be found here.