Overview of Cryptocurrency Litigation for Investors

The rapid growth of cryptocurrencies and other digital assets has opened up new and potentially lucrative investment opportunities. However, the same factors driving innovation in this space have also created fertile ground for scams and fraudulent practices. Bad actors often exploit the general lack of understanding surrounding blockchain technology, using cryptocurrency’s anonymity and gaps in regulatory oversight to their advantage. In this relatively nascent industry, regulations remain unclear; therefore, regulators and private litigants must apply existing laws to a continually evolving landscape. The lack of traditional investor protections further complicates the recovery of losses, leaving investors vulnerable to losses. As a result, investors involved in cryptocurrency litigation need the support of experienced attorneys who not only understand the legal complexities but also the unique nature of digital assets and the rapidly changing regulatory environment.

Cryptocurrency Litigation Generally

Cryptocurrency is a form of digital currency in which transactions are verified and recorded using cryptography and distributed ledger technology (DLT) rather than through centralized authorities such as banks or governments. Bitcoin, arguably the most well-known cryptocurrency, is stored in digital wallets as a computer file. While these assets exist entirely in a digital space, traditional currency must still be exchanged to acquire them. Blockchain networks track the movement of digital assets, but unlike traditional financial systems, these networks do not typically record the details of the transactions themselves, adding an extra layer of privacy and complexity.

With the proliferation of Bitcoin, other virtual currencies, related assets, and new products have emerged, such as stablecoins, tokens, and non-fungible tokens (NFTs). Alongside these assets, a host of platforms and services have developed, including cryptocurrency exchanges, payment service providers, crypto brokers, wallet developers, staking platforms, crypto mining enterprises, and decentralized autonomous organizations (DAOs).

Because the development of the cryptocurrency industry has far outpaced regulatory frameworks, disputes in this area are frequent and legally complex, often leading to litigation. Cryptocurrency litigation can address a wide array of issues, from outright Ponzi schemes and fraud to disputes over unregistered coin offerings. The volatility of the crypto market also contributes to bankruptcy filings, as seen in the high-profile collapse of cryptocurrency exchange FTX, further complicating litigation.

Recouping Losses in SEC Cryptocurrency Litigation

The Securities and Exchange Commission (SEC) currently plays a prominent role in policing the cryptocurrency industry. While the SEC has yet to establish comprehensive cryptocurrency regulations, it has been actively pursuing enforcement actions to regulate the space. In 2023, the SEC initiated 46 enforcement actions against participants in the crypto industry, most commonly involving allegations of securities fraud and unregistered securities offerings. Also on the rise is the scrutiny of trading platforms for failing to register as exchanges, broker-dealers, or clearing agencies.

Investors should note that the SEC can generally only pursue enforcement actions if the crypto assets in question are considered “securities.” While the agency adopts a broad interpretation of the term “security” to protect investors, its cryptocurrency application is still being refined by ongoing court rulings.

In cases where the SEC successfully brings an enforcement action, courts may order the wrongdoer to forfeit ill-gotten gains. These funds, known as disgorged funds, may then be distributed to investors harmed by the misconduct. In certain circumstances, courts may also impose monetary penalties aimed at both punishing the wrongdoer and deterring future violations. These penalties may be added to a “fair fund,” which can be used to compensate affected investors.

While SEC enforcement actions offer a pathway for some investors to recover losses, the process can be lengthy and complex, making it critical for investors to stay informed and work with experienced legal counsel.

Pursuing Private Crypto Lawsuits

In addition to regulatory enforcement, investors may also pursue private legal action. Class action lawsuits account for a large percentage of private litigation involving cryptocurrency. In these cases, one or more plaintiffs bring a lawsuit on behalf of a larger group or “class” of similarly affected individuals.

Most class action lawsuits involving cryptocurrency allege violations of securities regulations or consumer protection laws. Common claims include negligent misrepresentation, fraud, misleading marketing tactics, “pump and dump” schemes, misappropriation of customer funds, and undisclosed self-dealing transactions. Investors also frequently assert securities law violations related to the sale of unregistered securities. In these cases, the lack of necessary disclosures deprives investors of the information they need to make informed decisions.

Investors are also increasingly targeting individuals and entities that facilitate the sale of unregistered or fraudulent crypto assets. Following the collapse of FTX, for instance, class action lawsuits were filed against influencers who promoted the exchange, alleging their involvement in the offer and sale of unregistered securities.

Crypto Crime Investigations Can Result in Restitution

In addition to civil litigation, criminal investigations often play a role in crypto-related disputes. The Department of Justice (DOJ) leads efforts to prosecute crimes involving cryptocurrency, with assistance from agencies such as the Internal Revenue Service (IRS) and the Federal Bureau of Investigation (FBI).

The DOJ commonly investigates offenses such as cryptocurrency investment schemes, price manipulation, unregistered exchanges engaged in fraudulent activity, and insider trading. During these investigations, government agencies seek to freeze or seize cryptocurrency assets linked to criminal activity. Upon securing a conviction, the court may issue a restitution order, requiring the defendant to compensate victims.

However, due to the anonymous nature of cryptocurrency transactions, it is often difficult to recover the exact amount of cryptocurrency stolen or lost. In such cases, courts may order the defendant to pay an amount equivalent to the value of the stolen assets, based on either the date of loss or the date of sentencing, minus the value of any returned property. Seized assets may also be used to satisfy restitution orders.

In recent years, the DOJ has secured several high-profile crypto restitution awards, such as the return of $17 million to approximately 800 victims of the BitConnect cryptocurrency scheme. Despite these successes, recovering funds in crypto-related cases remains challenging due to the difficulty of tracing assets.

Avoiding Crypto Recovery Scams

As the prevalence of cryptocurrency scams rises, so too does the number of fraudulent businesses claiming to offer cryptocurrency recovery services. These schemes prey on victims who have already lost significant sums of money to fraud, scams, or theft. After charging an upfront fee, the scammers either cease communication or provide inaccurate reports, often requesting additional fees to fill in any information gaps.

As highlighted in an FBI Alert, fraudulent recovery companies may falsely claim affiliation with law enforcement or legal services to appear legitimate. Investors need to understand that private recovery companies do not have the authority to issue seizure orders. Investors must work directly with law enforcement or experienced crypto attorneys to pursue legitimate civil remedies.

Our Commitment to Crypto Investors

The cryptocurrency market offers both opportunities and risks for investors. Before committing to an investment, it is critical to conduct thorough due diligence on both the asset and the entity offering it. If you have fallen victim to cryptocurrency-related fraud or require assistance with cryptocurrency litigation, the attorneys at Scarinci Hollenbeck’s Blockchain Offerings, Cryptocurrency Defense & Investigations Practice are here to help.