7 Tough Legal Lessons for Crypto Entrepreneurs

OPINION
Stephen D Palley
Feb 5, 2018 at 14:10 UTC  |  Updated  Feb 5, 2018 at 22:12 UTC

Stephen Palley is a lawyer in private practice in Washington, D.C. with the firm of Anderson Kill. The views expressed are his alone. You can find him on Twitter at @stephendpalley.


One day you're a crypto-millionaire, the next you're a crypto-defendant.

Initial coin offerings (ICOs) made crypto-news throughout 2017. Announcements of new offerings became a flood as winter turned to spring and then summer.

As 2017 closed, an assortment of ICO litigation has followed.
What's the good news? If I am making lemons out of lemonade, we will have more clarity from regulators and courts.

Some might argue that the clarity was already contained in the rules and cases but the abstraction has been made real by the mistakes of others. And it you're a crypto-entrpreneur in 2018, this is a good thing.

For lawyers, some of what follows may be Captain Obvious territory, but here are seven observations:

The long arm of the law really is long

Think being in Switzerland can stop you from getting served with a U.S. lawsuit? Nope.

And very nope if you use email, Twitter or LinkedIn.

In one of the half-dozen Tezos lawsuits, the plaintiff asked to serve the lawsuit on Swiss defendants using email (the Tezos Foundation and Diego Ponz), email and Twitter (Johann Gevers), and email and LinkedIn (Guido Schmitz-Krummacher, Bitcoin Suisse AG and Niklas Nikolajsen).

The court said yes, finding that:

"Plaintiff has shown (1) the Swiss Defendants are not within any judicial district of the United States; (2) service by electronic means is not prohibited by any international agreement, (3) service by the electronic means specified below comports with constitutional notions of due process and is reasonably calculated to apprise the Swiss Defendants of the pendency of the action and afford [them] an opportunity to respond."

After this order was entered, the parties entered into an agreement by which they asked the court to vacate the order in exchange for the defendants appearing in the case, while reserving all objections to jurisdiction and service.

The tactic had the effect of getting a bunch of Swiss defendants to quickly appear in a U.S. lawsuit. And it shows that a federal judge believes that international social media service is acceptable, which is quite something. (See also Blockchain Jurisdiction, by yours truly).

Scammers gonna scam

If it was a scam before Satoshi conceived bitcoin, it's still a scam today.

If you're a recidivist securities law violator who promises a 1,000 percent plus return on investment in less than a month and doesn't actually do anything with the money that you raise from investors other than renovate your house, the SEC is likely to come calling. (See, for example, Plexcoin).

This isn't really ICO litigation - it's a securities fraud enforcement action where the alleged fraudsters happened to use ICO lingo to raise money.

Lawyers can read

Regulators and class action lawyers know how to read! As someone pointed out in a blog post last year, everything that you write is evidence  - your white paper, tweets, Slack channel, etc.

And as that someone predicted, ICO lawsuits quote liberally from all of these sources. Like, think actual screenshots from Slack in lawsuits.

It's called a 'statute of limitation'

Litigation and regulatory enforcement actions take time. Just because you haven't gotten a subpoena from The Man in the month since your decentralized cheese token went live, it doesn't mean you won't.

Coinbase's tangle with the IRS is a case in point, ultimately addressing accounts in existence between 2013 and 2015. This doesn't mean that the IRS isn't going to go after accounts from 2015 to 2017, it just means that they take their sweet time, as do other agencies.

It's a courtroom, not Twitter

What gets you likes on crypto Twitter doesn't work in Court.

One of my favorite reported cases from 2017 is a late-December New York State Supreme Court (that's a trial court) decision that addressed a challenge to New York's BitLicense regulations. (The case is Chino v New York Dept. of Fin. Servs., 2017 N.Y. Misc. LEXIS 5153, Dec. 21, 2017).

The plaintiff filled out a partial application, but did not include most of the required information and asked for a waiver of the $5,000 application fee.

According to the Court, he "filled out some but not all financial information on the form requested, and he indicated that he had no insurance and kept no financial or accounting books."

For his background report certification, he wrote: "[Could] not obtain in time." He also demanded the depositions of Paul Krugman and former New York Department of Financial Services superintendent Benjamin Lawsky.

Apparently, "but bitcoin" was not good enough for the court, which threw his lawsuit out (and rejected the deposition requests).

Create governance or it'll be created for you

I see companies operating on different sides of the spectrum here.

In some cases, people completely dispense with corporate formalities, raise money and then effectively hope for the best.

Don't be that company.

If you create governance, understand it

It turns out that creating a Swiss foundation to raise hundreds of millions of dollars in an ICO doesn't mean you can actually use the money.

While this would be no surprise to lawyers involved in creating the things, a Swiss foundation is "an autonomous legal entity."

Here's a court filing that says exactly this:

What does it mean to create an "autonomous" corporate entity? It means that you may not really control it!

And as a practical matter, this means that the Tezos founders can't directly access the $1.3 billion controlled by the foundation they created.

I could go on and on about Tezos (and I have, which you know if you follow me on Twitter). For now, I am going to keep it simple.

The trend of U.S. blockchain startups creating Swiss foundations is over. It makes no more sense than a Swiss startup incorporating a U.S. non-profit in Hackensack, N.J.

Conclusions

So what are my predictions for 2018?

I think flying cars are still a couple of years off, but I do expect to see more litigation over botched ICO governance, judgment collection that tangles with private keys, and a healthy lump of workout-related legal work -- that is, fixing businesses that have significant assets but did things the wrong way.

A year from now we will have more precedent, more guidance from the mistakes of others, and maybe even a few genuine successes.

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Coinbase.

Law book and gavel image via Shutterstock

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litigationTokensICOsTezos

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