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The Most-Watched Litigation on Crypto’s Biggest Questions

March 30, 2022, 8:45 AM

The law is old, only the technology is new. Courts, regulators, companies, and investors are wrestling with the blockchain revolution and the novel challenges posed by a cryptocurrency market that has exploded to a value of $2.2 trillion in just over a decade. With significant questions likely to be decided by litigation, here are several cases that attorneys tell us they are watching.

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What Is a Cryptocurrency?

Regulators everywhere are trying to set boundaries for digital assets, which first requires defining them.

In the U.S., the Securities and Exchange Commission’s December 2020 lawsuit against Ripple Labs Inc. contends that the payment company’s XRP cryptocurrency should have been registered as a security when it was sold because the tokens qualify as “investment contracts.” Ripple argues that XRP is a commodity, and thus beyond the agency’s remit.

Security or commodity? The SEC’s assertion, if it holds up in court, will buttress the agency in its battle for primacy in crypto regulation. A victory for Ripple would play into the hands of the Commodity Futures Trading Commission, which is also seeking a leading crypto role. Of course, it may ultimately fall to Congress to set the rules.

The case is SEC v. Ripple Labs, Inc., S.D.N.Y, No. 20-CV-10832.

When Is Crypto Taxable?

The Internal Revenue Service in 2014 made clear that crypto transactions are taxable. The agency said in Notice 2014-2 that virtual currency would be treated as a capital asset, provided it’s convertible into cash. The industry continues to clamor for more guidance.

It may be up to the courts to decide another question: When should staking rewards—new tokens minted and distributed in return for validating blocks on a blockchain—be taxable?

Tennessee couple Joshua and Jessica Jarrett demanded a refund with interest after the IRS taxed them for income gained from staking their Tezos coins. The Jarretts argue that the new coins should be taxable only when they’re sold, not when they’re created—as a baker is taxed only for selling bread, not baking it.

The IRS eventually gave the Jarretts a refund. The couple is demanding that the agency explain why it returned their money. The agency says the question is moot, since the Jarretts got their money back. The outcome of this case could provide a little more of the clarity sought by the industry.

The case is Jarrett v. United States, M.D. Tenn., 3:21-cv-00419.

Retroactive Property Rights?

Nonfungible tokens, or NFTs, have raised new questions in intellectual property law. Among the most interesting cases currently is Miramax’s lawsuit alleging copyright infringement by the film director Quentin Tarantino.

The litigation centers on the question of who has the right to sell NFTs that link to the “Pulp Fiction” screenplay. Tarantino retained the right to publish the screenplay under a 1993 agreement, but Miramax’s 2021 complaint contends that those rights don’t extend to NFTs, which didn’t exist at the time.

Other closely watched cases in this space include Nike’s trademark infringement lawsuit against Stockx, and Hermès suing Mason Rothschild over Birkin bag NFTs.

The case is Miramax, LLC v. Tarantino, C.D. Cal., 2:21-cv-08979.

Lawyers Squabbling Over Digital Money

Where the stakes are high, disputes over money are sure to follow. In one of the latest, law firm Roche Freedman is facing a second court battle involving another former partner in a fight over cryptocurrency tokens said to have ballooned in value to $250 million.

Paul Fattaruso said in a complaint filed March 22 in Florida that the firm stiffed him out of nearly $1 million in compensation related to his 2% equity stake after leaving Roche Freedman last year. He resigned from the firm in protest, saying his colleague Jason Cyrulnik was kicked out after crypto tokens the firm received for payment became incredibly valuable.

The case is Fattaruso v. Roche Freedman, Fla. Cir. Ct., 2022-005345-CA-01.

Tether, and Everything Else About Stablecoins

And then there are stablecoins. By definition, these are supposed to be tied—or “pegged”—to a fiat currency like the U.S. dollar, or to an asset like gold. Their perceived reliability amid the volatility of other digital assets gives stablecoins a critical role in trading between cryptocurrencies, comparable to the role played by the U.S. dollar in global financial markets.

The largest stablecoin, Tether, has a market cap of $81 billion, and the next largest, USDC, is valued at $52 billion—numbers that put them in the company of some of the world’s biggest financial institutions. But there are numerous skeptics, who say the numbers don’t necessarily add up.

Central bankers and finance officials the world over have raised questions about the impact that stablecoins could have on the financial sector, with many suggesting that they should be regulated as banks.

The Commodity Futures Trading Commission in November fined Tether $41 million. Regulators said the company incorrectly claimed for several years that it had sufficient U.S. dollar reserves to back every one of its tokens in circulation with the “equivalent amount of corresponding fiat currency,” and that funds that were “safely deposited” in its accounts.

However, according to the CFTC, “Tether failed to disclose that it included unsecured receivables and non-fiat assets in its reserves,” and it falsely claimed that its reserves would be regularly audited when they were not. A separate settlement with the New York Attorney General’s Office resulted in an $18.5 million fine.

For now, the class action lawsuits are swirling, and the official scrutiny is intense. Watch out for Tether and its stablecoin peers.
—With assistance from Rose Acoraci Zeck, Roy Strom, and Samantha Handler.

To contact the reporter on this story: David Jolly at djolly@bloombergindustry.com

To contact the editors responsible for this story: Meg Shreve at mshreve@bloombergindustry.com; Rachael Daigle at rdaigle@bloombergindustry.com