By Nicholas Feloney
Cryptocurrencies are the talk of today’s financial world as Bitcoin’s valuation soared to a record high of nearly $10,000 after Thanksgiving. Just one year ago Bitcoin was valued around $700; an overall return of nearly 1,300%. Despite insanely-high volatility, controversies involving fraud and other criminal activity, Bitcoin and other cryptocurrencies are becoming increasingly popular.
Cryptocurrencies emerged from the economic crisis in 2009 as an alternative that cut untrustworthy financial intermediaries out of the mix by providing a peer-to-peer transactional platform operating under a highly-complex software coding known as a “blockchain”. The technology’s use in financial services and capital markets is rapidly developing. Blockchain-based venture capital funds known generally as “decentralized autonomous organizations” (DAOs) are one example. Rather than create traditional corporate governance structures, DAOs are governed by “smart contracts” which developers use to encode all terms of the business agreement into a self-executing computer software program. Unlike traditional venture capital funds where selected partners choose how to allocate funds, DAOs operate much like a democracy where investors share voting rights but on a pro rata basis.
In June of 2016, one of these DAO venture capital funds raised over $150 million in crowdfunding using a cryptocurrency called “Ether”. The DAO announced an “initial coin offering” (ICO) of its own “DAO Token” which investors purchased using Ether. The fund was later hacked and over $50 million worth of digital assets were stolen. In response, the SEC issued an investigative report notifying market participants that offers and sales of digital currencies are subject to U.S. federal securities laws. However, the legal rights and remedies for defrauded investors remains to be determined. Investors first face procedural issues like obtaining personal jurisdiction over a defendant who is authorized to receive service of process and who also has standing to represent the DOA in the action.
Who do they sue? Unlike traditional business entities, DOAs have no named representatives. They are run entirely through computer programs. Anyone who is not a legal representative of the DOA will not have standing to defend the action. Whoever created the DOA could possibly be a representative but tracking that person down seems nearly impossible given the pseudo-anonymous nature of blockchains. Obtaining personal jurisdiction is another problem because DOAs have no state of incorporation or principal place of business. Consequently, litigation may require bringing actions in many different jurisdictions which may prove to be too costly. Notwithstanding these procedural issues, litigants will likely sue under both contract and tort law. Contract claims such as fraudulent misrepresentation of material terms such as marketing disclosures seem likely. Likewise, negligence claims for improper or faulty designs in the function and/or coding of DOA software may exist.
Proper regulation should address all of these issues. In addition, the applicability of fiduciary obligations among investors should be determined. Though it seems likely that courts will soon see DOA investors suing each other on the basis of things like improper voting and self-interested behavior as well.
Student Bio: Nicholas Feloney is a 2L student at Suffolk University Law School. He is currently a Staff Member of The Journal of High Technology Law. Nicholas holds a B.S in Business Management & Finance from Providence College.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.