Crypto Caselaw Minute #48: 8/8/2019

Nelson M. Rosario
Aug 8 · 11 min read

This week’s CCM digs deep into three questions that have been keeping us up late at night.

First, are crypto credit card purchases cash advances? A guest post from our friend Steve Middlebrook with the Womble law firm in Atlanta looks at a new decision from a federal court in New York that deals with that very question.

Second, what exactly is disappearing XRB and is it really a $170 million problem? Nelson looks an amended complaint in a YUGE putative class action that says it’s a really big problem thank you very much. He explains.

Third, and batting cleanup, Palley looks at a new ruling in the Berk v. Coinbase case that asks (and answers) this question: does Coinbase owe users a tort duty to maintain a market that isn’t disfunctional?

So grab a snack and a drink and snuggle up by the air conditioning for today’s latest and greatest Crypto Caselaw Minute.

Disclaimer: Crypto Caselaw Minute is provided for educational purposes only by Nelson Rosario and Stephen Palley. These summaries are not legal advice. They are our opinions only, aren’t authorized by any past, present or future client or employer. Also we might change our minds. We contain multitudes.

(As always, Rosario summaries are “NMR” and Palley summaries are “SDP”. Our Image credit: https://pixabay.com/photos/gin-tonic-strawberry-herbs-thyme-2381859/(Pixabay license). Diclaimer:

Tucker v. Chase Bank USA, N.A., 2019 U.S. Dist. LEXIS 128834 (S.D.N.Y Aug. 1, 2019). [STM]

When the price of bitcoin skyrocketed in late 2017, lots of people began to buy it on their credit cards. When the price plummeted in early 2018, credit card issuing banks got nervous about whether their card holders would default on their accounts. Out of caution, some banks blocked crypto purchases all together. Others started treating crypto purchases as cash advances which are subject to additional fees and higher interest rates. Cardholders didn’t like that, and the change in treatment led to class action lawsuits being filed against Bank of America, Chase and State Farm Bank. While a fight over whether you can buy bitcoin with your credit card is fairly tangential to the core legal issues facing cryptocurrencies today, these cases are still important to follow because they require courts to define crypto and struggle with how to deal with this stuff in the context of standard financial agreements. Case in point is last week’s decision in the Chase litigation.

In this case, Plaintiffs alleged they used their credit cards to buy crypto in 2016 and 2017 from Coinbase and the transactions appeared as normal purchases on their statements. Starting in January 2018, however, the transactions were classified as cash advances, and cardholders were charged additional fees and higher interest rates. Plaintiffs sued the bank, alleging it had breached the cardholder agreement and violated various provisions of the Truth in Lending Act (TILA) governing credit cards.

Chase filed a motion to dismiss and last week the court dismissed two of the four claims against Chase and decided the other two could go forward. Because this case is at the motion to dismiss stage, the court wasn’t evaluating the facts of the case; it was merely determining whether, assuming everything Plaintiffs has said is true, there was a valid cause of action on which to proceed.

Plaintiffs asserted that by categorizing the crypto purchases as cash advances, Chase breached the cardholder agreement. That document explains that cash advances are subject to special rules and defines the term this way:

The following transactions will be treated as cash advances: purchasing travelers checks, foreign currency, money orders, wire transfers or similar cash-like transactions.

Plaintiffs argued that the term “cash” refers to physical currency and thus “cash-like” only refers to goods that represent a legal claim to fiat currency. Chase countered that crypto transactions were “cash-like” because, like traveler’s checks, money orders, foreign currency and wire transfers, crypto may be used as a form of payment. In order to survive a motion to dismiss, Plaintiffs have to put forward a reasonable interpretation of the contract and because the court found their view of “cash-like” was plausible, it allowed the breach of contract claim to go forward. The court did not conclude that Chase’s interpretation was not reasonable or was less reasonable; merely that Plaintiff’s argument was reasonable. The court even noted that Chase cited to a number of external documents to support its assertion that crypto is effectively cash, but the court did not consider them at this stage.

The rest of the opinion isn’t nearly as interesting. Given the ambiguity in the terms described above, the court allows a claim under TILA that terms and conditions are not clear and conspicuous. The issues there will likely overlap with the breach claims and turn on whether it is reasonable to read “cash-like” as encompassing crypto. In addition, the court rejected ideas that the bank changed the terms without notice and that the monthly statements were inaccurate.

This case is worth following because in the next round, the court won’t just assume the Plaintiff’s pleadings are true, it will review the evidence not considered in deciding this motion and determine whether crypto is in fact “cash-like.” That will be an interesting exercise given that the court summarizes Plaintiff’s description of cryptocurrency as “units of computer code, created by private computer programmers, that may be used as forms of currency by some private individuals.” This bizarre definition is apparently an attempt to make crypto purchases look like buying a video game or a copy of Excel. It seems like a dangerous gambit given the repercussions if this definition were to become binding precedent. Let’s hope that in future proceedings the court rejects this notion of crypto transactions as exchanging units of computer code.

Fabian v. Nano, et. al, Case №19-cv-54-YGR (N.D. Cal. filed July 25, 2019)[NMR]

This is an amended class action complaint filed recently in the Northern District of California. This case is a doozy. There are eleven counts of malfeasance alleged in the complaint. Also, as one of the headers in the complaint puts it there is a question of “[t]he $170 Million Disappearing XRB Problem.” We previously covered this case in CCM #18, which you can find here. This is the Nano class action lawsuit. Let’s dig in.

First a little refresher. The lawsuit is “against Nano, certain of its top officials, certain influential promoters that received compensation in exchange for selling XRB or soliciting the general public to purchase XRB, and its partner the BitGrail Defendants.” Nano, for those that do not know, is a cryptocurrency that launched in 2015. According to the complaint, the team attempted, and were ultimately successful in, getting their token, then known as RaiBocks, listed on major exchanges. Sounds like a success story. What went wrong, and how did $170 million of XRB disappear? Well, does anyone remember BitGrail? That’s when things changed.

Allegedly, in December of 2016 members of the RaiBlocks team approached the BitGrail defendants to create a dedicated exchange for RaiBlocks. In April of 2017 BitGrail was born. Trading was going along swimmingly on BitGrail until it wasn’t. Due to a bug in the code people were able to double withdraw funds, and that is how you end up with $170 million of XRB disappearing. So, why the amended complaint?

Well, back in January when Palley covered this case he speculated that the defendants would polish off their old motion to dismiss and refile it with the court against what was then a new lead plaintiff, Fabian. It appears that is what happened, and subsequently the judge granted the motion, but with leave to amend the complaint. That brings us to the present filing, and indeed, this complaint has been amended.

The original complaint in this case was 38 pages long. The amended complaint is 67 pages long. What got in to this newly filed complaint? Well, it looks like a lot of evidence related to the control of the Nano faucet, and the allegations concerning the relationship between the Nano team and the BitGrail team. A lot of evidence.

With respect to the faucet, there are multiple reddit posts saying things like this post from 2016 “[t]he short of the story is I think we have a way to make the faucet work and scale. We’ll total up faucet clicks and pay them out in bulk daily or hourly rather than instantly.” That doesn’t sound great.

As far as the alleged relationship between Nano and BitGrail there is a lot of allegations that have now been included concerning the extent of that relationship, communications between the two teams, and when the bug was discovered and who knew what and when. These allegations need to ring true for the plaintiffs to establish liability on the part of the Nano team for the failure of BitGrail.

What happens next? Well, one thing is guaranteed, defense counsel will not be able to use the same motion to dismiss a third time. The case continues, and it’s heating up.

Berk v. Coinbase, Inc., “Order Denying Motion to Compel; Granting in Part and Denying in Part Motion to Dismiss”, Case No 18-cv-01364-V, N.D. Cal., August 6, 2019 [SDP]

Link to opionion: https://www.scribd.com/document/421054454/Berk-v-Coinbase

Before we get to Berk v. Coinbase, how about first year law school in 30 seconds? Sounds like fun, doesn’t it? If you already finished law school you can skip ahead of course (or read so you can accuse me of over-simplifying several hundred years of jurisprudence).

Most first year law students in the United States take at least one contract law class and one tort law class. Tort and contract law are two fundamental building blocks of the legal system. They help define the legal obligations that people have to one another. In a very (VERY) broad brush fashion, you can distinguish between the two by saying that contracts are agreements between parties to perform obligations in exchange for some kind of “consideration” (money, for example). You don’t have a contractual duty to someone unless you enter into a contract. And the nice thing about contracts is that if you know what you are doing you can limit your liability to your counter-party.

Torts are a different animal. They are a category of causes of action that are implied or imposed by law, even where there is no contract. I have a feeling some law professor somewhere is going to quibble with that definition, so let me give an example. If I agree to cut your cut your grass for 10 dollars a week and you agree to pay me 10 dollars, that’s a basic contract. (Yes, I am simplifying, I know, I know). But I didn’t have a duty to you to cut your grass a priori, right? Nor you to pay me 10 dollars for doing so. The reciprocal duties are created by a contract. A tort duty is something different and can be quite a bit more … mushy (a term of art, that). If I shovel my sidewalk, for example, and do a terrible job and you slip and fall on my negligently shoveled sidewalk, you might sue me for negligence (I’ll win, I’m sure, because you were obviously careless). I don’t have a contract with you, as a stranger, to shovel my own darn sidewalk. But courts have said that we have a duty to use reasonable care to prevent harm to foreseeable plaintiffs. And if the breach of that duty causes harm, whelp, you can sue for negligence. There are plenty of other torts besides negligence, by the way, but that’s a for example for you.

Contracts take a lot of forms. Website terms of services are an example, and that gets us back from first year law school to the Berk v. Coinbase case. We first wrote about this one back in CCM in October and you can read a summary of the facts there. In short, this case has to do with the launch of Bitcoin Cash and its availability to Coinbase customers.

Coinbase previously asked the Court to require the parties arbitrate this dispute, based on an arbitration clause in their on-line terms of service. Coinbase asked again and the Court said no dice. The general rule in the 9th Circuit (which is where this case is being litigated) is that an arbitration clause that applies to all disputes “arising under” the parties’ agreement is interpreted narrowly, and only applies to claims that “refer to disputes or controversies relating to the interpretation and performance of the contract itself.” Those claims by plaintiffs that were “premised on Coinbase’s alleged facilitation of insider trading or alleged market manipulation” did not arise under the Coinbase terms of service, according to the Court, so the arbitration clause didn’t apply. So too is the plaintiff’s theory that “that Coinbase negligently launched a dysfunctional trading market for Bitcoin Cash.” The Court says this is “too collateral” to the user agreement. So the arbitration clause didn’t apply.

The Court then analyzed a motion to dismiss the negligence claims that Coinbase filed. Coinbase cited something called the economic loss rule, which says that “one does not possess a duty to exercise reasonable care against the economic loss of others.” The court rejected Coinbase’s argument and held that under California law it believed that

that Coinbase indeed had a duty to maintain a functional marketplace. First, Coinbase encouraged traders to enter the market following its launch of trading in Bitcoin Cash, so Coinbase’s actions were aimed at the traders as a class. Second, the negligent launch of a digital currency foreseeably impacts those who trade in the resulting dysfunctional market. Third, the buyers suffered an ascertainable pocketbook injury, and fourth, that injury is directly tied to the allegedly negligent launch. As to the fifth and sixth factors, California cases suggest that the defendant’s conduct is morally blameworthy, and a policy of preventing future harm is warranted, when the defendant holds a position of trust, such as Coinbase’s role in processing the transactions of traders on its exchange.

The Court said that for purposes of analyzing the motion to dismiss, in which the facts must be taken as true,

the complaint also lays out a plausible account that Coinbase breached its duty to maintain a functional market. For starters, the fact that Coinbase halted trading within three minutes of the launch is indicative of dysfunction. The buyers have also identified precautions Coinbase could have taken to avert the massive spike in the price of Bitcoin Cash on its exchange. Most prominently, Coinbase could have announced its launch of trading in Bitcoin Cash more than an hour in advance, which would have permitted more buyers and sellers to place limit orders. That way, Coinbase could have ensured the liquidity and market capitalization needed for an orderly market. Id. Coinbase instead launched trading while only purchase orders were pending. And the buyers have alleged a plausible motive for Coinbase’s seemingly rushed decision to launch under subpar conditions: The Chicago Mercantile Exchange opened trading in Bitcoin futures the day before the launch.

At the risk of being accused of being partisan — and I don’t think I am, this is just the most interesting part of the case to me — a bunch of other claims against Coinbase were dismissed, including a fraud aim and a statutory unfair business act claim. But this case is important because it is precedent for the notion that an exchange has tort obligations to users that may be outside of any contractual agreement. Given the state of some exchanges over the last few years — where some have alleged that wash trading, spoofing and all manner of hijinx have been allowed to flourish — we see a court recognizing that liability can’t be entirely limited by a user agreement/click-through-terms-of-service. This means that the exchange can try its best to ring fence its liability in online terms of service but it still appears to have an independent duty in tort (at least under the facts of this case) to maintain a functional market, at least for a newly available asset.

The notion that tort law and its obligations can exist alongside of a contractual relationship isn’t really anew thing, to be clear. But a court saying that a crypto exchange has a duty to maintain a functional market does sound like at least new-ish law. My suspicion is that this is important enough that Coinbase will take the issue up on appeal. This is a federal court and it’s making what’s known in the business as an “Erie guess” about what the California Supreme Court would hold if presented with this issue. So it’s possible it’ll be reversed or modified if taken up. I don’t know. At the moment, though, it’s potentially significant precedent for the crypto exchange industry and a case that I’d expected to see cited in other litigation involving crypto-exchanges and customer losses.

Law of Cryptocurrency

Summaries of legal opinions about bitcoin, virtual currencies and blockchain technology

Nelson M. Rosario

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Thoughts on law, technology, society, and everything else. @NelsonMRosario

Law of Cryptocurrency

Summaries of legal opinions about bitcoin, virtual currencies and blockchain technology

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