Coinbase Lawsuit Continues

This is a reprint from my Crypto News Over Nonsense newsletter going out today.

Which Exchange You Use Matters.....A LOT

Unless you are a miner, most of us use exchanges to buy our cryptocurrency whether we HODL or trade or sell. But where you buy your Bitcoin matters, and not just because of price.

This week we look at the developments for Coinbase and crypto exchanges in the US from the arbitration decision in the Berk lawsuit. Bloomberg describes the origin of the suit pretty well in this short article.

The Background

In August 2017, Bitcoin Cash (BCH) forked off the Bitcoin blockchain. Any and all holders of Bitcoin (BTC) were entitled to the same number of BCH due to something called Replay Protection. Replay Protection means that transactions on one fork BCH, are not valid in other fork BTC (and vice versa). This is to protect transactions from posting on both chains.

Since BCH wanted to start operating right away, they awarded all BTC holders with the same amount of BCH to trade on their own chain. This is a common practice for forked chains. So if you had 10 BTC in a verifiable wallet on this date, then you would get 10 BCH as well when you claim them.

So What About if You Hold Your Coins on an Exchange?

This is one of the first questions that comes up in this case. And before we go any further, this one point is vitally important:

If you leave your coins on the exchange, they are vulnerable to ANYTHING that can happen on that exchange including hacks and thefts. The only way to protect your investment is to hold them in your own private wallet.

So does holding your coin at Coinbase or Kraken mean you get BCH too? At Coinbase, at first, the answer was No, leading to a big uproar.

Finally, in December almost 5 full months later, they awarded the BCH to account holders while ‘briefly allowing trades for more sophisticated investors’ per the Bloomberg article. That trading lasted only a few minutes when Coinbase stopped it for significant volatility.

And what about non-sophisticated investors at Coinbase? They didn’t get their BCH in August, only in December. And when they got it, they couldn’t trade it on the Coinbase platform.

A group of investors filed suit for negligence and fraud for

  • this preferential treatment of sophisticated investors
  • the inability for other customers to trade it and
  • the speculation around the announcement of BCH availability connected to insider trading

Coinbase and their mishandling of the BCH launch on their platform is the basis for the suit.

The Motion to Dismiss

This week, the judge in federal court in Northern CA declared that Coinbase was incompetent but not fraudulent in his decision. This arbitration decision said that Coinbase botched this launch to the detriment of customers but there was not enough evidence to prove they were trying to manipulate markets or insider trading.

The judge’s decision outlined briefly in this CCN.com piece, means that cryptocurrency buyers, but NOT sellers, are able to move ahead with their negligence suit against Coinbase since as buyers they had to pay artificially higher prices for BCH during the limited time BCH trading was open for them.

So the trial moves forward. Some claims dismissed on the seller side and for market manipulation, but the negligence claim remains.

The Legal Analysis

I’m not a lawyer and I don’t play one here either. Thankfully, there are a few excellent legal minds in the crypto-economy who did have something to say on this decision and its impact for Coinbase and for exchanges operating in the US.

David Silver, a securities fraud attorney, called this decision ‘a landmark decision for crypto users’ while starting a long, informative thread about what this decision really means.

According to Silver, these are the highlights:

 

Exchanges that think they can hide behind voluminous Terms of Service may be in for a surprise.

 

As summarized by Stephen Palley, securities attorney (and more from him coming up):

 

So tort liability attaches itself to crypto exchanges based on this decision.

Silver sums up his thread, which is well worth a read, here

 

Now we see more about what Palley has to say on this decision

 

This dysfunction marketplace piece is important. As a crypto exchange and marketplace, for Coinbase to create this dysfunction is the source of the negligence.

In other words, these exchanges have responsibilities on this and we as exchange users have some rights on what to expect from them.

We talked about the Kik case and Defend Crypto in a previous edition and Palley mentions it here as they recently answered the latest inquiry from the SEC.

 

Securities attorney Drew Hinkes sums up a couple of these important parts in his thread.

 

This is where Coinbase may be liable in spite of its user agreement, which Silver also said will likely be altered in the future in Tweet #5 of his thread above.

 

Clickwrap here means when you click on an agreement indicating you understand so you can use that platform whether its Google, Dropbox, Salesforce or Coinbase.

How Do You Protect Yourself?

What we can see in this analysis is that Coinbase is open to a negligence suit. We can also see that it may have tort liability (be liable for a wrong they’ve committed) to buyers of crypto on their exchange and that maintaining function/lack of dysfunction is considered an important part of their job as a marketplace.

Here are the other pieces we learned:

  • Torts are independent of the user agreement customers sign. So unlike many tech companies that use their user agreement as a legal weapon, exchanges have less power in their agreements with customers.
  • Exchanges now take on greater risk of tort liability and have a tort duty to maintain their marketplace (this includes things like flash crashes that happen too and is the source of the lawsuit against Kraken)
  • Are exchanges going to have less limited liability from what they expected from their user agreements? It looks like this answer to that may be Yes and other tech companies can be affected as well.

And here is what else you can do to protect yourself

  1. Read the user agreement on the exchanges that you use and try to understand them especially for events like outages, flash crashes and other events that may limit your access.
  2. Hold all your coin you don’t intend to trade in your own wallet
  3. Track your trades, diligently. Exchanges track them for you but you need to track them for yourself. For instance, if you make a market order, which means to sell immediately at the market price, and your exchange does not fill the trade right away, this is something you need to note and be aware of. It could be manipulative behavior. Track your amounts, date, time of order, time order is filled and do so independently of the exchange doing it for you. This will help you during tax time as well.
  4. Follow your exchange and their support team on Twitter and Telegram if you can. Sometimes updates online are faster than over email and you can see in real-time if the problem is just you or not

Exchanges have a tough but important role in the crypto-economy. They have to face securities regulation and compliance but still need to be easy to use to provide the gateway between government-issued currencies and cryptocurrencies.

I believe some of them, including Coinbase, do a pretty good job. I use them myself. But that doesn’t mean that we shouldn’t be watching them and what they do. Every company makes mistakes and when their mistakes can cost you money, then you need to be diligent about watching for their mistakes too.

What exchanges do you use and how do you like them?

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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