Dealing with a crypto winter in the heat of the summer: a US perspective

At a time when cryptocurrencies have experienced several weeks of tumult, losses in value and in some cases collapses and liquidation, what should participants in the cryptocurrency and DeFi space be doing?  If a “crypto winter is coming,” should participants be getting ready for winter?  Is it a viable approach to sit tight, for now, to “wait and see,” predicting or hoping that they will not be at the center of future storms?

One thing we can say in this situation is that now is not the time for debate.

We can argue whether the US Securities and Exchange Commission (SEC) is correct in its views about whether cryptocurrencies and cryptocurrency offerings are securities that fall under the SEC’s purview.

We can argue whether all, most, or some such tokens are more appropriately viewed as commodities that should fall under Commodity Futures Trading Commission (CFTC) jurisdiction.

We can debate whether either approach - or some other approach - constitutes the ideal policy as society tries to balance the need to foster innovation with the need to protect the public against bad actors.

We can prognosticate the prospects for the Lummis-Gillibrand bill, or similar or competing bills, to pass in their current or modified form and how soon any such legislative change might come into effect.  

But the fact is that, despite all this, we all know the SEC’s views, its enforcement approach, and the current state of the law, as reflected in court decisions. We have seen the positions the SEC has taken and the record of general success it has achieved in pursuing these positions.  

Thus crypto players need to be prepared for these possibilities, regardless of whether they regard these legal rules as ill-advised as a policy matter or technically incorrect as a legal matter. Clients whose tokens are running into difficulties of any kind therefore need to be prepared for potential SEC action, and for the possibility of private class-action lawsuits under the securities laws. Clients also may need to consider potential exposure under the anti-fraud provisions of the commodities laws. These risks affect not only token issuers but also the exchanges and platforms upon which they are bought, sold and traded, who themselves may be targeted when a particular token runs into problems.

A wealth of common law claims may also soon face these parties. These may include claims for torts like negligence, fraud, negligent misrepresentation, conversion or unjust enrichment.  Such claims may be extended to other parties under theories of conspiracy, aiding and abetting and/or agency and de facto partnership. There may also be contractual claims under user agreements and quasi-contractual or other implied contractual claims raised. 

Because problems in one corner of the crypto space can impact many others due to the complex plumbing and inter-relationships among various tokens, parties need to be prepared not just for potential claims by their own customers or investors. A crisis or breakdown relating to one token may spawn large or even catastrophic problems for other tokens with which they are integrated in various ways. Crypto participants thus may face claims by plaintiffs beyond their own customers, by persons and ventures who are connected to them more indirectly. Participants may face vicarious liability claims because of their own token’s role in the ecosystem that supported the now troubled token. Platforms and exchanges may likely be targeted for the alleged misdeeds of users of their systems or persons who were reliant on their systems, who are now judgment-proof or effectively jurisdictionally unreachable.

Crypto’s success in becoming integrated into various DeFi offerings also raises the prospect of regulatory action and investigation from various banking and financial authorities when crypto disruptions threaten the smooth functioning of those DeFi applications and consumers complain that they have been injured. Will various DeFi applications be deemed to fall under the purview of such authorities? Will it be deemed negligent for such applications not to have followed certain protective measures and procedures commonplace in the banking world, which might have shielded customers from such impacts? Will DeFi applications be accused of having promised or implied protections against certain kinds of risks that they did not deliver, or of having given assurances that were not well-founded?  

There is a simple reality that people who suffer losses tend not to take them lying down. They instead tend to reach out in any direction that might offer a prospect of recovery and not be discouraged by debates about whether imposing liability in such situations is fair, reasonable or good public policy from the standpoint of encouraging valuable innovation.

The summer sun may be baking, but if a crypto winter is here, participants need to start preparing for what they might face, not just stand stubbornly hoping to brave the storm.