As the Cryptocurrency Industry Grows, Will the Amount of Fraud and Lawsuits Grow with It?

Cryptocurrency and the technology it relies on, blockchain, revolutionized both the tech and finance world. A blockchain is a distributed record of transactions, usually managed by a peer-to-peer network of computers that validates the transactions. With companies racing to take advantage of this new industry, it was only a matter of time before some companies would try to take advantage of unsuspecting investors. This is what happened with a company called Compcoin LLC. (“Compcoin”).

Compcoin and its executives allegedly deceived investors when they promoted an initial coin offering (ICO) to purportedly create artificial intelligence for foreign exchange trading (Jennifer Bennett, Bloomberg Law). An ICO is a capital raising mechanism whereby companies sell bitcoins to investors in exchange for funds. Compcoin was able to get an investor by the name of Marland Kaplan to invest $2,500 in exchange for 3,050 of its digital coins (Jennifer Bennett, Bloomberg Law).

In his complaint, Kaplan alleged he was supposed to be able to trade on online cryptocurrency platforms. But when Kaplan attempted to sell his coins at a value of $112,941.50, he was informed that a computer problem prevented him from doing so. Kaplan alleges that he was not allowed to make the trade until the price of the coins was artificially lowered by Compcoin, allowing it to get as much money as possible from the investors. In addition, Kaplan asserted that Compcoin’s artificial intelligence technology never worked, and it was merely employed to defraud unsuspecting investors. (Id.)

This complaint was not the first one filed in the crypto industry. The first fraud prosecution involving an ICO, where a man in New York admitted to lying to about 1,000 investors, ended in a plea agreement (Patricia Hurtado, Bloomberg). Maksim Zaslavskiy said he and his accomplices lied to investors when he claimed his REcoin virtual currency was backed by real estate investments and diamonds that did not exist. Furthermore, he said that more than 2.8 million of his tokens were previously sold (Id.). The judge ruled that an initial coin offering is a security for purposes of federal criminal law. This ruling affirms the SEC’s position that it has authority over ICOs and that market manipulation and anti-fraud provisions in the law apply.

Kaplan alleges that Compcoin violated various Federal securities laws such as §12(a)(1) of the Securities Act by offering and selling unregistered securities in direct violation of the Securities Act. Section12(a)(1) states that barring proof of an applicable exemption, it provides for strict liability against one who offers or sells a security in violation of §77e, which section prevents the sale of a security through interstate commerce unless a registration statement is in effect.

It is increasingly likely we will see more complaints filed over the next few years. A recent study prepared by the ICO advisory firm Statis Group revealed that nearly 80% of ICO’s are scams, and only 8% managed to reach the trading stage on the various cryptocurrency exchanges (Shobhit Seth, Investopedia). This does not bode well for the companies offering these ICO’s and the reputation of the cryptocurrency industry as a whole.