Among the many innovations we have had to confront in a world characterized by rapid technological change is the advent of cryptocurrency, as a social and financial phenomenon. As I have previously noted, the current cryptocurrency craze has also become a legal phenomenon as well, as now nearly a dozen securities class action lawsuits involving cryptocurrency, ICOs, and blockchain technology have been filed just in the last six months or so. The latest of these lawsuits — one involving allegations relating to an Italian cryptocurrency exchange operator nicknamed “The Bomber” and including investor demands for the court to compel a “rescue fork” — may suggest that in addition to technological change, the advent of cryptocurrency could introduce legal changes as well.
The latest cryptocurrency securities class action lawsuit involves the efforts by a Texas company called NANO (f/k/a RailBlocks) to develop, promote, and sell a cryptocurrency called Nano and referred to as XRB. The lawsuit was filed in the Eastern District of New York on April 6, 2018 by investor Alex Brola, who claims to have invested $50,000 in XRB, an investment that by February 8, 2018 had increased in value to $237,000. A copy of Brola’s complaint can be found here. The plaintiff’s lawyers’ April 6, 2018 press release about the lawsuit can be found here.
The complaint names as defendants NANO itself, as well several individuals allegedly involved in developing and promoting XRB. The complaint alleges among other things that the defendants encouraged XRB investors to trade and hold their XRB investments on an Italian-based cryptocurrency exchange called BitGrail. According to the complaint, BitGrail became “nearly the exclusive home for XRB,” and that BitGrail become responsible for over 80% of the trade between XRB and Bitcoin.
The complaint alleges that some XRB questioned NANO’s reliance on BitGrail and its founder and principal operator, Francesco “The Bomber” Firano, NANO’s XRB developers defended Firano and BitGrail and provided assurances on social media that Firano and BItGrail can be trusted.
However, in a February 8, 2018 blog post, the Nano team announced that it had informed by Firano of a “loss” of XRB from the BitGrail wallet. Media reports at the time suggested that the value of the XRB coin lost through “unauthorized transactions” was as much as $170 million. In the blog post, the Nano team backed away from its prior support of Firano and BitGrail: “We now have sufficient reason to believe that Firano has been misleading the Nano Core Team and the community regarding the solvency of the BitGrail exchange for a significant period of time.” The blog post also said that Nano had contacted criminal law enforcement authorities. Firano for his part appears to have disclaimed any responsibility for the loss, trying to blame the loss on defects in Nano’s software.
The complaint alleges that the defendants “directed XRB investors to place their assets at BitGrail,” but that when the XRB assets disappeared, the defendants “disavowed any responsibility for the harm the XRB investors suffered.”
The plaintiff also alleges that though the most direct solution to the problem “lies squarely within Defendants’ hands,” Defendants refused to implement any the solution. The alleged solution, known as a “rescue fork,” would require the defendants to rewrite XRB code and restore ownership to the rightful owners.
According to an April 8, 2018 article on the Financial Magnates website about the new Nano lawsuit, a “rescue fork” or a “hard fork” essentially requires the blockchain transaction record to be split into two paths: “Users receive the new version of the cryptocurrency equal to the amount of the old version held at that moment, and the old version becomes unusable.” By doing this, the article says, the victims of the BitGrail hack “would have had their funds restored.”
The complaint alleges that the defendants have refused to implement the fork because “it is not in their own best interests.” The defendants, the complaint alleges, still own and control millions of XRB, and “do not want to sacrifice any financial advantage they currently holdover the average XRB investor victimized by XRB disappearance at BitGrail.”
The complaint purports to be filed on behalf of all BitGrail investors between January 1, 2015 and March 31, 2018 that relied on the defendants’ reassurances about the exchange. Like many purported class action lawsuits involving cryptocurrencies, this latest complaint alleges that the defendants violated Sections 12(a)(1) and 15 of the Securities Act of 1933 for their alleged unregistered offering and sale of securities. The complaint also asserts claims for negligent misrepresentation; unjust enrichment; and civil conspiracy. Interestingly, though the complaint purports to be filed on behalf of BitGrail investors, neither BitGrail itself nor Firano are named as defendants.
In the Prayer for Relief, the compliant, among other things, seeks a judicial declaration that the defendants offered and sold unregistered securities in violation of the federal securities laws and that the defendants are liable to the plaintiff class for the alleged securities law violations.
In addition, the complaint seeks equitable restitution and “an order requiring NANO to ‘rescue fork’ the allegedly missing XRB into a new cryptocurrency in a manner that would fairly compensate Plaintiff and the Class for each missing XRB and would eliminate all of the ‘missing’ XRB.”
There are many interesting details about the case, including in particular the involvement of and the defendants apparently reliance on an Italian cryptocurrency exchange operator nicknamed “The Bomber.”
However, the thing that interests me the most about the case is the plaintiff’s bid to have the court require NANO to implement the “rescue fork.” I suspect that this is among the first times that a court has been requested to have a blockchain record altered, although I am sure it will not be the last time.
Assuming for the sake of discussion that this case will ever get to that point, the request will raise interesting questions about whether and under what circumstances a court has the power to require a blockchain record to be altered. One of the supposed advantages on which blockchain’s many advocates often rely is the technology’s supposed reliability and imperviousness to hacking. The use of “rescue forks” seems like something that could cause a great deal of havoc if not managed well. (Others more knowledgeable about the technology involved may want to weigh in here, but it seems to me that the use of a rescue fork is something that should be done rarely, simply because of the potential for abuse.)
Even aside from the question of whether or when a court could or should order a rescue fork is the question of how the court would administer and supervise the remedy. The complaint asks the court not only to require a rescue fork but also to have the remedy implemented in a way that fairly compensates the class for the missing XRB. A court would obviously have no ability to assess a proposed remedy nor ability to monitor its implementation in order to ensure that the class members are fully compensated but that no other errors or unintended features are introduced.
It is already clear even in just the short time that cryptocurrency has been a phenomenon in the financial marketplace that the promotion and sale of these digital assets present a host of potential problems both for issuers and investors. The short but growing track record of cryptocurrency-related lawsuits also suggests that the rise of cryptocurrencies could present courts with some interesting new challenges as well. It will be very interesting to see the extent to which the growing numbers of lawsuits involving the new cryptocurrencies cause a legal evolution as well.
It will be particularly interesting to see what happens in the XRB lawsuit to the plaintiff’s request for the court to require a rescue fork. The XRB case may of course never get to the point where the court has to address the issue. But if it gets to that point, it will be very interesting to see what happens.
ICOs and Cryptocurrencies Webinar: On May 1, 2018, at 11 a.m. EDT, I will be participating in the Advisen quarterly claims webinar, which will have ICOs and cryptocurrencies as its main topic of discussion. The webinar will be chaired by Advisen’s Jim Blinn, and the other panelists will include Garret Koehn of CRC Insurance Group and Paul Tomasi of E-Risk Services. Information about the webinar including registration instructions can be found here.