Interest in cryptocurrency and the blockchain technology behind it has soared since the 2009 launch of bitcoin. However, as with any new and evolving area of law and regulation, cryptocurrency litigation risk is high. If you are interested in investing in cryptocurrency, offering your own currency, or developing technology using blockchain, it is crucial to consult an attorney to understand and mitigate your litigation risks.
How Do Blockchain and Cryptocurrencies Work?
A cryptocurrency is a digital or virtual currency secured by unique digital signatures and complex mathematical algorithms which protect the currency from counterfeiting. The technology that allows cryptocurrencies to function is called blockchain. A blockchain is a database that stores individual transactions in segments or “blocks” that are then linked together. Each block is representative of a particular transaction, and new transactions must be approved by members or “nodes” before being added to the chain. The blocks are timestamped, creating a permanent timeline or ledger of transactions that cannot be altered.
Blockchain can be applied to many types of transactions in addition to digital currencies, including smart contracts, supply chains, healthcare, banking, and voting.
What Legal Issues Arise with Blockchain and Cryptocurrencies?
Those investing or dealing in blockchain and cryptocurrencies should be aware of the significant increase in governmental investigations and enforcement actions, as well as private lawsuits, concerning cryptocurrency. The most common legal issues arising include:
- Fraud and securities regulation. Several federal and state agencies regulate the use of cryptocurrencies to some degree. A key issue is whether the cryptocurrency is an “investment contract,” and thereby subject to security law regulations and registration requirements. Regulatory agencies can investigate allegations of fraud, misrepresentation, or manipulation involving a virtual currency or its offering. Investors may also sue if they have suffered losses due to financial fraud, false advertising, or misrepresentation.
- Taxation. The IRS has stated that virtual currency transactions are taxable like any other property transaction and must be reported on the taxpayer’s tax returns. This includes selling or exchanging virtual currencies, using them to pay for good or services, or holding them as an investment. They are also considered capital assets, so investors must pay capital gains taxes on any profits.
- Contracts. Blockchain technology has been used to create smart contracts, which are self-executing transactions written in computer code that can automatically monitor, execute, and enforce a legal agreement. These contracts raise several legal issues including questions about whether there is a valid offer and acceptance and how to address void contracts.
- Jurisdictional issues. Cryptocurrency exchanges are decentralized and may have no official headquarters, making it difficult to determine which jurisdiction’s laws apply and how to obtain a remedy if there is a dispute over a transaction.
- Privacy. Existing federal and state laws do not address some of the unique concerns blockchain technology presents. Blockchain does not utilize a centralized data processing system that is responsible for ensuring privacy and security. Users generally remain anonymous, however lawsuits are likely because of technological advances that may soon allow for transaction tracking.
- Intellectual property. Trademark and other intellectual property issues may be more prevalent in the cryptocurrency industry than in others because of pervasive anonymity. In most blockchain transactions, the creator is unidentifiable or difficult to determine, which can lead to disputes over authorship versus ownership and licensing of intellectual property.
- Use as currency or payments method. Earlier this year, El Salvador became the first country to adopt a cryptocurrency as legal tender. Some companies already accept it as a form of currency to pay for goods and services. However, the IRS does not recognize it as currency. Further, the federal government has discussed ways to limit the use of cryptocurrency for payments in ransomware attacks and other illicit activities. The volatility of some virtual currency exchange rates to other legal tender may result in payment disputes and litigation regarding payment options contracts and pricing issues.
How Can Blockchain and Cryptocurrency Disputes Be Resolved?
The complexity and global nature of cryptocurrency disputes makes it challenging to resolve disputes. However, there are several methods available to help.
- Contract provisions. Smart contracts allow for a combination of technology and processes for appointing arbiters to resolve disputes. However, it is still unclear exactly how this could work in all jurisdictions.
- Arbitration. International arbitration is already used in commercial disputes globally. It provides a confidential method of dispute resolution using neutral arbitrators that parties may select for their particular expertise. It also allows for global enforcement of arbitral awards under the New York Convention on the Enforcement of Foreign Arbitral Awards.
- Mediation. In mediation, a neutral third party assists parties in resolving the conflict. The mediator uses a wide variety of techniques to facilitate discussion and help the parties find a compromise.
- Courts. Jurisdictional issues can make it difficult to pursue court action. However, when possible, parties can take the traditional method of suing in court.
- Regulation. The government can require that smart contracts and other agreements include a provision that mandates a particular form of dispute resolution.
Cryptocurrencies and blockchain are evolving fields. Before you enter into a transaction, consult an experienced attorney to ensure you understand risks and appropriate mitigation.
