With investors worldwide looking at a collective $1.5tn in recent cryptocurrency losses, a blizzard of class-action lawsuits are being prepared. One big question is: who, if anyone, is to blame - and who could be held to account?
With inflation and interest rates rising, the best-known cryptocurrencies have been hit with heavy and continuing losses: Bitcoin has lost more than 50% of its value this year; Ethereum, its largest rival, is down 65%; and the total value of crypto assets has dropped to less than $1tn from its November 2021 peak of $3tn. US federal regulators say 46,000 people have reported losing $1bn in crypto to scams since January 2021.
Given the millions poured into promoting crypto - often with celebrity endorsements - legal action after the crash was inevitable. Class-action lawsuits are already in the works. Kim Kardashian and the boxer Floyd "Money" Mayweather Jr are being sued for alleged false statements promoting the minor cryptocurrency EthereumMax.
The lawsuit alleges they encouraged followers to join "the EthereumMax community" and that the token itself was a "pump-and-dump" scheme that deceived investors.
EthereumMax has described the legal claim as a "deceptive narrative".
Kardashian and Mayweather were hardly the only celebrities to pitch for crypto. In October last year - at the market's height, when bitcoin had a market cap of $1.14tn - the actor Matt Damon made his debut as the Crypto.com pitchman, advising viewers that "fortune favors the brave". The ad was seen as a turning point for crypto - a financial investment backed by a Hollywood A-lister.
Other digital assets are also under scrutiny. Earlier this month, the justice department charged Nathaniel Chastain, a former employee with NFT marketplace OpenSea, with wire fraud and money laundering in connection with a scheme to trade NFT [non-fungible tokens] assets.
"NFTs might be new, but this type of criminal scheme is not," said US attorney Damian Williams. He said the charges demonstrated prosecutors' determination "to stamp out insider trading - whether it occurs on the stock market or the blockchain".
But prosecuting fraud in the crypto arena is notoriously difficult. A number of prosecutions have been brought for theft, but prosecuting digital fraud runs up against a central, unresolved question: are cryptocurrencies securities?
The US definition of what is a security relies on something called the "Howey test" and derived from a supreme court ruling, Securities and Exchange Commission (SEC) v WJ Howey Co. decided in 1946, long before the era of crypto.
There are four pillars that support whether or not a financial asset qualifies as a security: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profit; and (4) that the profit is to be derived from the efforts of others.
If cryptocurrencies are a security, the SEC - the US's top financial watchdog - has jurisdiction and selling unregistered securities fraudulently could be a felony, with up to five years in jail. But the law is far from clear.
"Crypto is a strange bird - is it a coin, is it buying a dollar, or the right to invest in a dollar?" says Charles Elson, an authority on corporate governance issues. "A lot depends on what was represented to people, and were any federal laws violated in the exchange of these things. Typically, the SEC will always argue that something is a security and let the courts decide."
The question of whether the celebrity pitch people could be held liable is an open one. First, the courts would have to decide if crypto is a security, and then if that security was promoted fraudulently.
"Did they say, 'Oh, this is an easy investment don't worry about it?' Did they lie in attracting investment?" says Elson. "There will be lawsuits and courts don't like fraud and usually they'll figure out a way to punish a fraudulent individual."
"But if the law around the area is fuzzy, and these things are not a security, how do you get recovery? You may get the satisfaction of winning, but you won't get any cash. Where has the money gone? Why do criminals use bitcoin and ransomware? It's not traceable."
As commentators pointed out this week as the crypto markets crashed, no cryptocurrency has registered as a security; and exchanges or lenders through which they may pass are not backed by the government's Federal Deposit Insurance Corporation (FDIC) insurance guarantees.
The US Financial Crimes Enforcement Network (FinCEN) does not consider cryptocurrencies to be legal tender but considers cryptocurrency exchanges to be money transmitters on the basis that cryptocurrency tokens are "other value that substitutes for currency".
The SEC ruled in a letter in 2019 that bitcoin failed the Howey test, meeting only the "investment" criteria. In 2018, Gary Gensler, former chair of the Commodity Futures Trading Commission, said bitcoin's biggest rival, Ethereum, would pass the Howey test and that most cryptocurrencies should register as securities with the agency. But there are also efforts in Congress to write legislation for the cryptocurrency industry that could compromise regulators' oversight of the industry.
Since cryptocurrencies work in different ways through different exchanges that charge in different ways for trading, establishing any liability is complicated and most have an army of lawyers poised to argue that exchanges are "safe harbors" not exchanges.
On Monday, the crypto exchange Binance halted withdrawals of bitcoin for several hours after the crypto lender Celsius Network also blocked customers from withdrawals, swaps and transfers on its platform. Binance blamed a "stuck transaction" for its suspension.
The following day the SEC launched an inquiry into whether crypto exchanges have proper safeguards to prevent insider trading. The inquiry is believed to include the best-known exchanges - Binance, Coinbase, FTX and Crypto.com, Kraken, Bitfinex and Crypto.com.
Ultimately, says Elson, the law across cryptocurrency and their exchange systems will come down to disclosure. "Did you tell people the truth about the thing, and was it based on fair trading practices or was it a trading system that was rigged against the investor?"
But since crypto exchanges aren't regulated by the SEC, and it's notoriously difficult to find out who is on the other side of the trade, it's going to be tough to establish liability for losses.
"The lesson to be learned is that you don't invest in an unregulated market," Elson said.
