NEW YORK: An Introduction

The Rights of New York Investors in Cryptocurrency Platforms 

This last year has seen an increase in regulatory enforcement of cryptocurrency, in conjunction with the high-profile collapse of certain cryptocurrency-based businesses, such as FTX. The legal issues that have risen and are being played out will shape the future of investor rights in the industry, one that is valued at around USD1 trillion. With New York as the center of financial investment and a hotbed for related litigation, regulation and enforcement, it is no surprise that these issues have been percolating in the state.

On March 9, 2023, the Office of the New York State Attorney General issued a press release announcing that it had brought claims against KuCoin, the most recent example of the Office’s “crackdown” on unregistered cryptocurrency platforms. At the federal level, regulatory agencies such as the SEC, DOJ, and CFTC have also increased activity in the cryptocurrency space. These enforcement actions are brought with the stated intention of protecting investors—which begs the question—how can New York investors trading on cryptocurrency platforms protect themselves?

Cryptocurrency platforms, sometimes referred to as “exchanges,” allow users to transact in cryptocurrencies through a website or app. The SEC has cautioned investors that these platforms “may lack important protections for investors.” SEC, Exercise Caution with Crypto Asset Securities: Investor Alert (Mar. 23, 2023). For instance, registered broker-dealers, investment advisors, and exchanges are subject to strict rules regarding standards of conduct, custody of assets, minimum capitalization, recordkeeping, and market manipulation. Yet, the SEC reported that “none of the major crypto asset entities is registered with the SEC” as a broker-dealer or investment advisor, and “no crypto asset entity is registered with the SEC as a national securities exchange.” Id.

However, just because a cryptocurrency platform is not registered does not mean investors are helpless to the whims of powerful institutions.

Old Weapons, New Battlefield 

Cryptocurrency litigation is an exercise in twisting decades old principles into creative shapes in an effort to fit them against novel scenarios. It should come as no surprise that the first place any cryptocurrency investor should look to understand their rights is the contractual terms of the investment itself. In the context of a transaction through a cryptocurrency platform, that contract may take the form of a “clickwrap agreement,” which refers to those terms and conditions that a user must click “I agree” to in order to use the platform. In New York, clickwrap agreements are enforceable. See People ex rel. Spitzer v. Direct Revenue, LLC, 19 Misc. 3d 1124(A) (Sup. Ct., N.Y. County 2008) (“Claims that a consumer was not aware of the agreement or did not actually read it must be disregarded where . . . the agreement was acknowledged and accepted by clicking on the relevant icon.”).

The importance of these contractual terms recently came to a head in bankruptcy proceedings relating to the collapse of Celsius, one of the largest cryptocurrency lenders. See In re Celsius Network LLC, 647 B.R. 631, 649 (Bankr. S.D.N.Y. 2023). There, the key issue was who owned approximately USD4.2 billion in cryptocurrency assets deposited by Celsius’s account holders—the account holders, or Celsius? If Celsius owned the assets, then the account holders were nothing more than unsecured creditors and would not be able to recover their deposits in full. The Court described the question as “a contract law issue” and “based on Celsius's unambiguous Terms of Use,” the “cryptocurrency assets became Celsius's property” when they were deposited by account holders. Id.

Aside from the contract itself, investors may find recourse through traditional New York common law causes of action such as fraud, negligence, breach of fiduciary duty, conversion, and unjust enrichment. Moreover, New York’s General Business Law § 349 makes unlawful any “[d]eceptive acts or practices in the conduct of any business, trade or commerce or in the furnishing of any service in this state.” GBL § 349 (a). To state a claim under § 349, a plaintiff must show that the defendant (1) engaged in consumer-oriented conduct, (2) that was materially misleading, and (3) the plaintiff suffered actual injury as a result. The case law regarding its application to cryptocurrency transactions is not yet fully developed, but the key issue will likely be whether the at-issue conduct is “consumer oriented.” See e. In re Tether & Bitfinex Crypto Asset Litig., 576 F. Supp. 3d 55, 131 (S.D.N.Y. 2021) (dismissing § 349 claims because plaintiffs “do not allege that they are consumers of” the cryptocurrency at issue).

Of course, federal statutory schemes also provide powerful avenues of attack. The Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Securities Acts”) have historically been the most prominent regulatory schemes providing protection to investors. Not all cryptocurrencies, however, fall within their reach. A central issue for any Plaintiff invoking the Securities Acts based on a cryptocurrency is whether that cryptocurrency is actually a security. The inquiry turns on application of the “Howey Test,” named after the Supreme Court case SEC v. W.J. Howey Co., 328 U.S. 293 (1946). The test provides that a transaction is a “security” where a party (1) makes an investment of money or other consideration, (2) in a common enterprise, (3) with a reasonable expectation of profit, (4) derived from the efforts of others. The requirement that there be a “common enterprise” may not be met in the context of certain decentralized cryptocurrencies. For instance, in 2018 then-SEC Director of Corporate Finance, William Hinman, announced that the commission would not be treating Bitcoin and Ethereum (the two largest cryptocurrencies by market capitalization) as securities. Interestingly, Attorney General James’ recent lawsuit against KuCoin argues the Ethereum is a security, highlighting the degree to which the regulatory status of the industry is in flux.

Investors may also bring claims under the Commodity Exchange Act (“CEA”), which protects investors from deception in the commodities market. Courts in the Southern District of New York “have classified cryptocurrency as a ‘commodity’” subject to the CEA. Lagemann v. Spence, 2020 WL 5754800, at *12 (S.D.N.Y. May 18, 2020), report and recommendation adopted, 2020 WL 7384009 (S.D.N.Y. Dec. 16, 2020). Investors might also bring claims under the Electronic Fund Transfer Act, which “provide[s] a basic framework establishing the rights, liabilities, and responsibilities of participants in electronic fund transfer systems.” 15 U.S.C. § 1693(b); Rider v. Uphold HQ Inc., No. 22CV1602 (DLC), 2023 WL 2163208, at *3 (S.D.N.Y. Feb. 22, 2023) (finding that transfers of cryptocurrencies qualified as an “electronic fund transfer” for purposes of the statute.)

As cryptocurrency cases progress and more cases are brought, the law will become more settled and investors will find more clarity. In the meantime, even as regulators increase their activity in the space, it is important that investors know and understand the tools at their disposal to protect their own rights.