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September 1, 2023 | CryptocurrenciesLitigation

Can You Sue a Cryptocurrency Exchange?

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Danielle Yurkew

Associate Attorney

Cryptocurrency investments have experienced significant fluctuations over the past decade, leading to a surge in fraudulent activity, scams and negligence.  In 2022, the centralized exchange FTX collapsed, celebrities faced advertising sanctions and major scams were frequently reported.  Pursuing legal action against a cryptocurrency exchange could offer a path to recovering from harms suffered in this space.

Can you sue a cryptocurrency exchange?

Yes, it is possible to sue a cryptocurrency exchange.  However, not all instances are likely to lead to success in litigation, so you should always consult with an experienced attorney to analyze available legal strategies.  If litigation is appropriate, the first steps in suing a cryptocurrency exchange are to determine which claims to pursue and where to pursue them, which depends largely on whether the exchange is centralized or decentralized.

What is the difference between a centralized cryptocurrency exchange and a decentralized cryptocurrency exchange?

A centralized exchange (CEX) is an online platform that facilitates the buying and selling of cryptocurrency, either for fiat currencies, like the US dollar, or between digital assets, like Bitcoin and Ethereum.  CEXs act as intermediaries in trades and custodians who store and protect funds.  CEXs are the most common type of cryptocurrency exchange.  Some well-known examples are Binance (which has also launched a decentralized exchange), Coinbase and Kraken.

CEXs, being owned by private companies, are subject to laws and regulations of the jurisdictions in which they operate.  In the U.S., there is no single central cryptocurrency regulator.  Instead, U.S. regulation comes from a mix of federal and state laws.  For example, licensing is managed both by states and by the federal Financial Crimes Enforcement Network (FinCEN).  CEXs are also subject to Know Your Customer (KYC) procedures and other federal requirements that help prevent money laundering, identity theft and other financial crimes or fraudulent activity.

Decentralized exchanges (DEXs) provide for the secure exchange of crypto assets by using self-executing smart contracts to facilitate direct peer-to-peer transactions.  There is no intermediary or custodial function, and a true DEX has no central point of control.  Instead, DEXs are distributed across a wide network of computers and governed by their stakeholders.  Some of the better-known DEXs are Uniswap, 1inch and dYdX.

The participants in a DEX come and go and are mostly anonymous, thus the regulation of a particular entity, individual or group is a little more complex.  A user seeking to sue a DEX will face several issues arising from the decentralized nature of the exchange, including determining a proper forum in which to initiate the lawsuit.    

How to sue a cryptocurrency exchange

CEXs can usually be taken to court, just like any other business entity.  A plaintiff’s claims against a CEX will generally be based on the exchange’s terms and conditions of use and/or relevant federal and state laws.  The proper forum for a lawsuit depends on various factors, such as the CEX’s state of incorporation, the exchange’s physical location or the specific terms and conditions agreed upon by the user before using the platform. 

There are many recent examples of lawsuits against cryptocurrency exchanges, including the U.S. Supreme Court hearing a case against Coinbase in March 2023.  Many of these lawsuits depend on whether the exchanges are considered regulated “financial institutions” and securities exchanges with certain obligations to their customers.

The government has initiated its own legal action against large exchanges as well.  In June 2023, the Securities Exchange Commission (SEC) filed lawsuits against Coinbase and Binance, alleging that the companies operated as unregistered securities exchanges.  The SEC also alleged that Binance diverted customer funds to other businesses.  If the SEC is successful in these enforcement actions, it could mean individual customers and investors have additional grounds for lawsuits against the companies for harm caused by lack of regulatory compliance.

Conclusion

Given the complexity of these issues, it is important for a cryptocurrency exchange user or investor to consult with an attorney concerning their potential claims and the best way to pursue them.  Contact the team at Romano Law today.

Andres Munoz is admitted to practice law in New York and Florida.

Contributions to this blog by Gabriella Epley.

 

Photo by Behnam Norouzi on Unsplash
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