Special feature from Managing Directors Joao dos Santo, and Stefano Vranca, from JLT Consortium Partner Navigant.
Blockchain technology is showing increasing signs that it will take the financial services, and related industries, by storm. Its disruptive impact has the potential to revolutionize how governments, businesses, and individuals conduct transactions. In fact, much has changed since the publication of the seminal paper in 2008 envisioning a digital currency where a decentralized network of computers kept track of transactions without oversight by a central bank.
Bitcoin, the industry’s pioneer, is now only one of many cryptocurrencies and tokens comprising the cryptocurrency market. As of March 2018, there were over 1,500 available cryptocurrencies. And, at a recent peak, the market for cryptocurrencies was valued at more than $800 billion. In this article, we seek to examine the overall regulatory and litigation landscape associated with the expansion of the blockchain technology.
BLOCKCHAIN AND CRYPTOCURRENCIES
A blockchain, in a nutshell, is a continuously growing ledger of information, called blocks, which are linked and secured using cryptography. This process allows for decentralized networks of computers to be linked via the common purpose of sharing the same sequence of information.
Supporters of the blockchain technology assert that it can eliminate various risks associated with existing methods for settlement and record-keeping of transactions.
Essentially, cryptocurrencies are digital currencies, operating independently of a central bank, which use blockchain encryption techniques to regulate the generation of units and to verify the transfer of funds. Each cryptocurrency operates on its own blockchain. The unique characteristics offered by different cryptocurrencies (i.e. increased privacy and faster transaction times) are based on the unique properties of how each blockchain operates. There are hundreds of cryptocurrencies and related blockchain technology applications available in the crypto-market today. These can be summarized in three main categories:
- Transactional cryptocurrencies: these serve as a way to store and exchange value
- Cryptocurrency platforms: these create the infrastructure to build new blockchain applications, such as smart contracts and
- Cryptocurrency applications: these are built on top of cryptocurrency platforms and represent fungible and tradable assets.
Most altcoins are created from bitcoin’s open-sourced, original protocol and have differentiated attributes. Tokens are created and distributed to the public through crowdfunding initiatives, such as initial coin offerings (ICOs).
REGULATIONS AND LAWS GOVERNING CRYPTOCURRENCIES AND ICOS
Governmental perspectives toward cryptocurrencies are evolving and vary across countries. In the United States, the laws are generally friendly to cryptocurrencies, but their status depends on the state and type of operation. For instance, depending on the jurisdiction, they can be considered as money, securities, an investment tool, or property. In 2014, the IRS determined that cryptocurrencies would be considered property for federal tax purposes. Around the same time, the Financial Crimes Enforcement Network declared that a license is required for the exchange of cryptocurrencies for fiat money, as in other operations with fiat money. In 2017, the U.S. Commodity Futures Trading Commission (CFTC) allowed bitcoin futures to be traded. And the U.S. Securities and Exchange Commission (SEC) equated the collection of money through an ICO to an initial public offering. That is, companies that release tokens and the exchanges that trade them must register the transactions. In the EU, cryptocurrency regulation has not been unified. The European Central Bank has issued a recommendation that banks do not conduct cryptocurrency operations until these become directly regulated. In Japan, cryptocurrencies have recently been authorized as a form of payment by individuals and companies, and incomes from cryptocurrency operations are treated as business income.
A substantial number of cryptocurrency-related lawsuits and enforcement actions have been launched in recent months (see Figures 1a-b). The claims brought forth in these lawsuits span a broad range of laws, including: federal securities, blue sky, anticompetitive, false advertising, and breach of contract. In recent months, the SEC has sent subpoenas to numerous entities that have floated ICOs, seeking information about the assets and organizations behind the offerings. And the CFTC filed charges against three cryptocurrency firms, charging them with practices ranging from defrauding customers to setting up Ponzi schemes. ICOs are not the only trouble spots. Some online cryptocurrency exchanges are finding themselves vulnerable to cybercriminals. Coincheck was sued after hackers drained $530 million from the exchange’s accounts. And a class action lawsuit was filed against Kraken after hackers launched a denial of service attack and crashed the online exchange.
Given the developing state of the cryptocurrency industry and related regulatory framework, it seems that plaintiff attorneys are still refining their litigation strategy. Looking ahead, some of the current realities impacting the cryptocurrency market, such as high price volatility and the increasing number of ICOs, are likely to fuel a rise in the number of regulatory actions and lawsuits involving cryptocurrencies and blockchain technologies in the foreseeable future.
Figures 1a-b describe the current trend in litigation/enforcement volume and category
Blockchain technology and cryptocurrencies represent an exciting, emerging field that is bound to give rise to a considerable number of regulatory actions and wide-ranging legal claims. Developing a sound understanding of their underlying technologies, processes, and markets will be essential for attorneys and litigation support experts interested in gaining a foothold in this field.
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