The Rise of Cryptocurrency Litigation

As cryptocurrency has become more prominent in both digital and financial realms, it has also given rise to potential and actual lawsuits. Because cryptocurrencies cannot be separated from the digital platforms and coding that create and sustain them, legal battles involving digital currencies often draw their expert witnesses from both the tech and financial worlds.

Here, we explore the recent increase in cryptocurrency litigation and how these lawsuits affect the search for expert witness testimony.

What Is Cryptocurrency?

Cryptocurrency is a digital-only token that can be used in financial transactions or to carry out other tasks within the currency’s native platform, which is built on its blockchain. Each block in the chain contains a copy of transactions made in the digital currency, making it nearly impossible to manipulate the transaction history without control of at least 51% of the computing power running the chain.

Imagine if every dollar bill in the world listed every pair of hands it passed through since its creation. Discrepancies between bills are settled by majority vote: the “discrepancy” that appears on the most bills is the “real” transaction. In order to steal a dollar bill, you’d have to change the lists on a majority of the bills in existence. That’s akin to how cryptocurrency tokens work.

When Bitcoin was first envisioned by Satoshi Nakamoto in 2008, it was touted as a more secure way to transact business than fiat currencies. “Code is law” became its motto, indicating it was immune to human tampering.

In fact, cryptocurrencies have revealed a number of vulnerabilities in their uses – and a number of ways in which aggrieved participants might seek legal relief.

How Cryptocurrencies Give Rise to Lawsuits

Current cryptocurrency litigation tends to focus on one of three areas: initial coin offerings (ICOs), cryptocurrency trading sites, and smart contracts.

Tezos: Where are the Coins?

An Initial coin offering, or ICO, works similarly to an IPO, raising money for a new cryptocurrency. ICO investors exchange existing crypto tokens like Bitcoin or Ethereum for tokens of the new cryptocurrency, then use those tokens when the new currency’s project launches.

Tezos currently faces at least two lawsuits after its ICO raised $232 million, only to delay delivering on its promise to launch its proposed token and transaction system. Plaintiffs claim they were misled by Tezos’s failure to explain that acquiring rights to the code might take years and by the fact that what they thought were investments were registered as non-refundable donations.

Kraken: A Flashpoint of Trade Litigation

In July 2017, aggrieved traders filed a class action lawsuit against cryptocurrency trading hub Kraken, alleging that they lost a combined 3,414.08669 Ether (worth about $328,000 at the time) when Kraken failed to suspend trading during a DDoS attack on May 7, triggering a flash crash.

The DDoS attack triggered an automatic liquidation by Kraken of the five plaintiffs’ accounts, which were holding Ether on margin. Had Kraken shut down, say the plaintiffs, the liquidation would not have been triggered.

The Ethereum DAO: Smart Contract Outsmarts Itself

At the center of the Kraken dispute is the system’s use of “smart contracts”: digital contracts which execute themselves when one or more conditions are fulfilled. Introduced by Ethereum in 2009, smart contracts promised to revolutionize business – but often end up causing conflicts.

One such flashpoint of conflict is Ethereum’s 2016 Decentralized Autonomous Organization (DAO) hack.

A DAO runs on the same principles as smart contracts but serves a slightly different purpose: it allows users to pool their funds to achieve certain ends, similar to buying shares in a company. To buy in, users exchange cryptocurrencies for DAO tokens, which act as digital “votes” to decide what the DAO will do.

In 2016, over 11,000 users bought in to a DAO set up by Slock.it, exchanging their Ether for DAO tokens. Exploiting a recursive function in the code, however, a hacker managed to drain about 3.6 million Ether into a “child DAO” held by the hacker.

Since the attack, talk of a class action lawsuit against Ethereum, Slock.it, or both has risen in the cryptocurrency community, and several commentators have offered possible ways in which such a lawsuit could proceed.

The Rise of the Crypto Expert: Likely Witnesses in Future Lawsuits

While cryptocurrencies seem cryptic to those familiar with their fiat counterparts, lawsuits focused on the loss of funds bear several similarities to pre-digital-currency suits. Claims of breach of contract, conversion, and fraud are often on the table, as are pleas for damages and injunctive relief.

The primary difference is that in many cases, plaintiffs and defendants alike will need to turn to blockchain programming experts in order to make their respective cases. Experts will need to be carefully prepared to break down the details of blockchain for juries and explain how certain exploits, such as the DAO’s recursive Ether drain, occurred.