Civilising crypto: Why the crypto world needs a legal framework for disputes moving forward

About a month ago, Singapore’s Supreme Court issued an injunction blocking the sale of a Non-Fungible Token (NFT). It was a landmark ruling that set a precedent that NFTs could be classified as digital assets, and be afforded protections under the law. 

While NFT owners may have just won protection for their assets, not everyone in the crypto world is happy.

Just a month after the landmark ruling, crypto was once again in the spotlight: Bybit — among other crypto companies — was planning to reduce their headcount, prominent crypto companies like Three Arrows Capital and Celsius faced crises, and the Monetary Authority of Singapore (MAS) stated that the plan for the crypto winter was to let companies fail if they had to, because market prices were unhealthy. 

And just a few days ago, Luna investors launched a class action lawsuit, but not against Terraform Labs. Instead, the target was Binance, and Binance’s promotion of Luna as a safe investment.

With the courts now deciding that they have the competency and jurisdiction to rule on crypto assets, what is next for crypto regulation, legally speaking? What, if anything, can the crypto world take away from the legal principles and precedents?

Does the Luna Lawsuit have merit?

According to Shaun Leong, a lawyer at Withers Worldwide who served as lead counsel in the landmark NFT court case, there might be some difficulty.

For one, cryptocurrency exchanges are not investment advisors — losses and profits accrue entirely to the trader, with the exception of some transaction fees. So can there really be a case for exchanges having to compensate traders for losses when trades result in losses, when they do not share in the profits when trades go well?

But this is just the first point of contention. Investors must also prove the extent of their losses to the court if they hope to have a case for compensation.

While this sounds easy, it may actually be a nightmare of a rabbit hole to dive into.

Investors would have to be prepared for a complex battle over valuation of their tokens. For example, the investor claiming there are losses suffered may have to prove that Luna 2.0 tokens, including those that are staked and vested later, are either worthless or worth substantially less than the Luna tokens held before UST’s collapse.

On top of this, Luna 2.0 is also being actively traded, and there are still users who are actively investing in the old Luna tokens. Valuation itself could thus prove difficult or even impossible.

This is just the latest when it comes to legal disagreements over crypto assets — more legal questions have also been asked about other events in the crypto space as well.

LUNA investors were asked to vote on a proposal to create a new blockchain for LUNA 2.0, which passed with 65 per cent approval from the community. However, this vote was the subject of furious contention as well, not least because of accusations that Terraform Labs had strong-armed the vote to ensure that the proposal would pass.

This too presents a legal issue: investors might be able to bring a class action lawsuit here as well, depending on several factors.

Investors may be questioning the legality of the vote. It could be important to understand what the legal basis of the vote is. For example, what are the governance parameters of the Terra protocol?

Is there power to call for a vote to create a genesis blockchain? And if there is, where is and when was such power expressed? Were investors given proper notice of the vote? Were investors adequately informed of the options and consequences around the vote? And was there adequate opportunity given to investors to pose questions around the vote? These are questions that may be relevant in understanding the legality of the vote.

In addition, which jurisdiction the investors bring the lawsuit to might also matter. Some countries might not recognise class action lawsuits, and international courts might have different principles to adhere to.

And if these are concerns for just investors in a single country, what happens when crypto crosses borders?

Perpetual war

We live in a world of sanctions and red tape — the recent invasion of Ukraine and resulting sanctions is just one example. There are also active sanctions against Iran, North Korea and many other regimes.

And cryptocurrencies with their offer of anonymity are quickly becoming a means for illicit funding — an American citizen was recently found guilty of sending US$10 million in Bitcoin to a blacklisted country.

Therefore, financial institutions now have a need to be careful not to run afoul of such sanctions, and find better ways to fulfil their know-your-customer obligations. 

As can be expected, this can quickly turn into a nightmare. While transactions in crypto are not private and the blockchain never forgets, finding out the true identity of the person behind the crypto wallet can be difficult to say the least. 

“Crypto users may take advantage of enhanced encryption that comes with privacy coins to make it difficult to track transactions. There are also coin mixers or mixing platforms, which allow transactions to be swapped and mixed to obfuscate the paper trail,” he explained.

And lest we forget, even when the law compels actors to behave in certain ways in the crypto space, there is no guarantee of this in perpetuity. The injunction by Singapore’s Supreme Court was obeyed by OpenSea in the US, but can we be sure that they will always do so? Enforcement is also an issue that must be tackled alongside creating a legal structure.

As we can see, there are a myriad of factors to consider when dealing with assets as fluid as crypto. While many jurisdictions have decided that they are able to hear such cases, it’s clear that there isn’t a single, unified code that crypto is adhering to. This may well be something that the crypto space will need as it grows. But where can this possibly come from? 

A global crypto legal system

While Shaun remains agnostic as to whether the NFT and crypto world would require its own set of legal practitioners, he does believe that lawyers would have an increasingly important role to play in helping to shape the development of laws around crypto assets. 

Stakeholders in the Metaverse ecosystem — from investors and collectors to marketplaces, auction houses, brands, artists, and creators — each would have a part to play in developing the principles that would govern the resolution of NFT disputes. In this regard, I can imagine that principles of respecting ownership rights and fair play would be relevant.

Such a system, while not in place today, is sorely needed. The crypto world so far reflects a situation where far too often, might make a right. Is this really the environment where investors can entrust their livelihoods, especially when recourse to protection, legal or otherwise, is difficult or even impossible in many cases? 

Legal structure, offering investors some standardised recourse for when either disputes arise, or when companies like Terraform Labs act against their interests in plausibly illegal ways, would go a long way towards establishing consumer rights in the crypto space and providing security to participants.

This can provide benefits to the ecosystem beyond just allowing consumers to be secure about their investments. New players, including businesses, are more likely to enter the crypto space and provide innovation in the space.

In Thomas Hobbes’ seminal essay Leviathan, he argued that “whatsoever therefore is consequent to a time of war, where every man is enemy to every man, the same consequent to the time wherein men live without other security than what their own strength and their own invention shall furnish them withal. In such condition there is no place for industry, because the fruit thereof is uncertain.”

While he certainly was not referring to the crypto space, it is not difficult to see how his war of all against all is reflected in the crypto world today — scams are widespread, disputes are increasingly common, and there is no law to speak of. At least, not one that can be said to be respected by most members of the community.

While the crypto world remains in such a state, exploitative and unproductive behaviour will continue, whether by corporations or by individuals.

Legal codes are a necessity, and enforcement of these codes should be a priority for the crypto world. If the wild west of the crypto world is allowed to continue on its path, the crypto winter may become a permanent crypto exodus.

Featured Image Credit: Blake Harris Law