Cryptocurrencies have exploded in number and popularity over the last few years, and legal practitioners need to start familiarizing themselves with the essentials
In the first Part of this series on what legal practitioners need to know about cryptocurrency, we discussed the recent explosive growth and diversification in cryptocurrencies and reviewed what they actually are. In the second Part, we discussed how cryptocurrencies work and why people use them. In this final part, we review what’s happening legally and what the discovery implications are.
Currently, cryptocurrency is facing a wave of new oversight and litigation from a variety of sources, both domestically and internationally. Over the past year, China and South Korea banned initial coin offerings and China shut down cryptocurrency exchanges. This year, the EU and its member states are considering taking action. There is growing governmental interest all around the globe.
In the United States, the SEC Office of Compliance Inspections and Examinations (OCIE) has announced that cryptocurrency (and ICOs, blockchain, etc.) will be a priority for the OCIE in 2018. According to one report, they may already have issued “more than 80” subpoenas related to ICOs, “possibly hundreds.” The SEC made clear already that it believes some cryptocurrency offerings may qualify as securities under some circumstances, but there is a big open question about exactly where those lines should be drawn. Their current investigative activities seem designed to explore just that. Some entities are attempting to use a framework called SAFT that’s been designed to avoid the issue, but there is no case yet testing it and no consensus in the legal industry on it.
Beyond the SEC, a federal court order has also granted the Commodity Futures Trading Commission (CFTC) authority to engage in fraud enforcement over virtual currency as a commodity. The CFTC has announced several enforcement actions already. The Federal Trade Commission (FTC), too, has begun enforcement actions over fraud related to cryptocurrencies, and the Internal Revenue Service (IRS) has begun investigating tax avoidance related to cryptocurrencies.
In civil litigation, several major lawsuits potentially worth hundreds of millions dollars have already been initiated over alleged fraud and securities violations in certain cryptocurrency offerings. One ongoing case over an options contract between two “financial blockchain companies” is now potentially worth billions of dollars.
Additionally, a patent arms race has begun with more than 700 pending published applications referencing either “blockchain” or “cryptocurrency,” including applications from major players like Microsoft, IBM, Mastercard, Goldman Sachs, and Apple. Interestingly, cryptocurrency’s open source origins and practices may make obtaining or enforcing a patent quite difficult.
Thankfully, despite the many novel legal issues cryptocurrencies may present, discovery for these legal matters is likely to look much like discovery for other types of financial litigation or regulatory proceeding. Discovery and review will require facility and experience with financial documentation, but most sources and source types will be familiar. The two potential exceptions are a user’s “wallet” and the relevant blockchain ledger itself.
For collection of data in a user’s wallet, one expert recently suggested “that litigators could compel an opposing party to submit a hard drive image” of the user’s wallet from which “one could pinpoint files useful for identifying suspicious activity.” Alternatively, relevant data might be recoverable from the active memory of devices the user used to connect to the blockchain network. The blockchain ledger itself will be publicly available and reviewable, but not all information recorded on it may be comprehensible without relevant users’ encryption keys.
Additionally, as we discussed in the last Part, many cryptocurrency systems are designed to facilitate anonymous transactions. In situations where the parties to a particular transaction are not known, piercing that veil of anonymity may be difficult or impossible. The IRS has done so through the use of a “John Doe” summons process, and some experts and researchers have begun discussing techniques for de-anonymizing relevant transaction data. Law enforcement agencies have also made “significant strides in piercing the anonymity of cryptocurrency transactions, leading to several notable prosecutions.”
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