In a recent US Security and Exchange Commission filing, an increasingly high-profile car manufacturer announced it had bought $1.5 billion in a major digital currency – bitcoin – and that it would in due course accept the currency in payment for its vehicles.
A US media outlet also recently reported that digital currency also has the power to make you a millionaire by the age of 18.
Digital currencies now appear to have embedded themselves in the financial system, and continue to make headlines, not just in the US but across the globe. Their value and trajectory appears only to be headed upwards, welcomed by investors and the source of intense media interest.
But these currencies are outside the norms for currency: they generally represent monetary value but their value does not equate to any tangible asset in the way that the dollar was once pegged to the value of gold. Their value nevertheless fluctuates like conventional currencies.
So what legal issues do these developments bring for institutional brokers and trading platform providers? What protections do investors have from market fluctuations and also some of the risks of digital trading: identity and cyberfraud? This article briefly considers what point the law has reached on this topic and what may be in store next.
Digital currencies and the regulatory framework
In October 2018, the latest thinking in the UK derives from the Cryptoassets Taskforce: Final Report.
The report identified that digital currencies presented a challenge to existing forms of regulation of the financial markets that required new thought about what additional regulations to introduce to protect consumers and preserve market stability. The need for global coordination of regulation was also emphasised.
In the summer of 2020, the Financial Conduct Authority (FCA) introduced its new regulatory sandbox scheme.
The FCA intended the scheme to create a regulatory micro-climate in which businesses dealing in legitimate cryptocurrency trading activities could work with the financial regulator to create appropriate checks and balances to what remains a relatively unregulated sector of the financial markets.
Throughout, digital currencies are still regarded as virtual assets, but it is not clear what they are nor what their legal status is.
Furthermore, there is ongoing concern about the possibility digital currencies present easier ways to launder money and defraud legitimate investors by using new technology to bio-engineer the identity of fraudsters, amongst other issues.
Initial coin offerings and digital currency derivate products
Most digital currencies start life in much the same way as an organisation seeks funds: by making an initial public offering. For digital currencies however, this is termed “an initial coin offering” (ICO). Instead of raising capital by selling company stock (as an initial public offering does), an Initial Coin Offering (ICO) raises capital by offering tokens of cryptocurrency.
Interested investors buy into the offering, usually by depositing a recognised national currency, and in return receive a token issued by the company behind the ICO, which usually has a new coin, app or service to offer.
As that offering grows in value and profile, derivatives usually multiply too. Frequently, those derivatives include contracts for differences, binary options and futures. These terms will be familiar to existing investors, and each is already regulated.
- Contracts for difference are arrangements in which the difference between the opening price of the position taken by an investor and the closing price is settled by a cash settlement. There is no physical delivery of any goods or other way to realise the result of the trade.
- Binary options are financial products in which the parties to a product each take one alternative outcome that are likely when the option expires at a given date or time. The investor will only profit if the price is on the right side of the outcome taken.
- Futures are contracts between a seller of digital currency and a buyer, which sells at a future date at a specific value unless the buyer closes their position sooner.
Where the law stands
Significant Court decisions on matters concerning digital currencies are infrequent.
The summer of 2019 saw the Commercial Court reach striking conclusions in an unreported case, Robertson v Persons Unknown. The case concerned an investor who, as a result of a fraud, transferred 100 Bitcoin to a fraudster’s digital currency wallet from his holdings on a legitimate digital currency trading platform; that fraudster then removed 80 of those.
The judge did not entertain many of Mr Robertson’s submissions on fraud. Nevertheless, she was prepared to proceed as if Mr Robertson had a proprietary claim over the digital currency – in other words, as if it were his personal property. This was at odds with earlier FCA and Government thinking which had concluded that digital currencies were not personal property.
Subsequently, in a claim against a start-up digital currency trading platform, allegations of fraud arose again. This time, in Blockchain Optimization SA & Anor v LFE Market Ltd & Ors  EHWC 2027 (Comm) it was more a question of whether the start-up platform was a failure or whether its proprietors were in fact conducting a fraud.
The claimant had participated in the ICO for a platform called the London Football Exchange (LFE), the purpose of which was to raise money through digital currency sales to purchase shares in football clubs.
The LFE replaced the tokens it had initially offered in its ICO with new tokens. However, in doing so, the claimant’s tokens were cancelled by not replaced. Accordingly the claimant thought its tokens were misappropriated through an alleged fraud and in the first instance obtained a worldwide freezing injunction. The defendant start-up then sought to strike out the claimant’s claims of fraud through an application which (unfortunately for them) failed. The claimant could then again exercise legal rights over its digital currency, meaning the premise of digital currency as personal property had re-emerged.
The present position
Whilst group litigation in England and Wales remains less commonplace than in the US, it is possible that in the coming years, consumer litigation on exercising various rights over digital currency matters, may increase if trading activity in the new generation of currencies becomes a new norm.
In the meantime, the present position raises more questions than it answers, and both trading platform providers and investors should exercise caution when investing in digital currencies as when conducting any other sort of investment activity.
Investors should consider the following:
- Verify whether or not their broker/trading service of choice is registered with the FCA; the FCA provides an online register of companies for those purposes.
- Consider trading through an exchange rather than privately.
- Always carry out due diligence to ensure you know that you are dealing with representatives of the organisation with which you intend to deal.
- Exercise caution when transferring sums between wallets, and withdrawing funds.
- Always verify requests to deposit or withdraw from your wallet.
- Seek immediate assistance from your bank and obtain legal advice if you detect suspicious activity.
- Seek the assistance of tracing agents to locate any currency that does go missing in order to target any legal route recovery efforts against ascertainable individuals.
Providers of digital currency trading platforms also have plenty of food for thought, including:
- Seeking FCA regulatory approval and complying with FCA requirements, particularly in the changing post-Brexit regulatory framework.
- Adopting high-level transparency with consumers.
- Participating in and working with the FCA on new regulatory initiatives.
- Sharing in the fraud risks of digital currency trading with consumers.
If you require further assistance
If you are considering, already trading in or have traded digital currency and face any issues raised in this overview, or any other challenge and seek assistance, please do not hesitate to contact us using our contact details below.
Streathers Solicitors LLP
19 March 2021
To discuss how we can help you, please call our office on 020 7034 4200 and ask to speak to a member of the Dispute Resolution team.
*The Briefing Note reflects the position as at the date of publication. The information in this Briefing Note is not intended to amount to legal advice to any person on a specific matter or case. You are advised to obtain specific, personal advice from us about your case or matter and not rely on this Briefing Note.