Does bitcoin keep appearing in your news feed?
As cryptocurrencies become adopted and accepted by mainstream vendors and consumers, it’s a good idea for attorneys to think about the potential litigation and eDiscovery challenges ahead. While U.S.-based cryptocurrency exchanges are subject to Bank Secrecy laws and anti-money laundering provisions, regulation and enforcement still lag, leaving the door open for manipulation, fraud and litigation.
This past fall, Bitcoin, the most popular cryptocurrency, experienced a massive run on its price –doubling in value within a two week span and ultimately reaching an all-time high of $19,205 per coin before falling sharply (just last February, Bitcoin traded at $902 per coin). Because of its volatile trading nature, and its lack of protections for investors, regulators and high end investment houses are skeptical of Bitcoin’s value and have been reluctant to encourage the cryptocurrency markets, deeming them a speculative investment.
Reticence aside, many notable traders and financial experts agree that cryptocurrencies are likely here to stay and could become an emerging asset class. Nikolaos Panigirtzoglou, JP Morgan global markets strategist, stated last December, that cryptocurrency will likely gain widespread acceptance as a legitimate means of payment and measure of wealth.
What are cryptocurrencies?
Cryptocurrencies are digital “tokens” or currencies used to transfer value directly between two individuals, even if they do not know or trust each other. Cryptocurrencies are not centralized and are not regulated by any monetary or governing authority. They operate through decentralized computer networks using what is referred to as “blockchain” technology to track and record all transactions anonymously. Blockchain is a digital ledger, publicly recording and verifying cryptocurrency transactions. In addition to their anonymity, probably the most attractive features of cryptocurrencies are their low costs and improved speed and efficiency. Cryptocurrencies can be used for foreign exchange transactions without invoking the usual 3 percent (or more) transaction fees, and transactions can be executed much more quickly than traditional foreign exchanges, usually in a matter of seconds or minutes as compared to several days for traditional transactions.
Potential litigation and eDiscovery challenges ahead
Not all cryptocurrencies are anonymous; some have been intentionally architected for transparency (see Ripple/XRP). However, the cryptocurrencies that rely and trade on anonymity will likely pose the biggest challenge in any litigation, but there may be methods for practitioners to attain discoverable evidence. In a recent white paper, author Michael Doran, a senior security consultant at Optiv Inc. specializing in forensic analysis, suggests that litigators could compel an opposing party to submit a hard drive image of the user’s cryptocurrency “wallet.” A cryptocurrency wallet is used to store a user’s transaction history in addition to sending and receiving digital currencies. From this wallet, one could pinpoint files useful for identifying suspicious activity during the discovery process. Doran also notes the possibility of obtaining discoverable evidence by conducting an in-depth examination of the blockchain.
In addition to investigating cryptocurrency wallets and the blockchain, forensics experts have been testing whether cryptocurrency transactions are truly anonymous. Sarah Meiklejohn, an associate professor at University College London, recently discussed techniques to “de-anonymize” bitcoin users and entities. By clustering different bitcoin addresses, one can assign common ownership to a user’s pseudonym(s). International law enforcement agencies, including the Federal Bureau of Investigation, have made significant strides in piercing the anonymity of cryptocurrency transactions, leading to several notable prosecutions, including actions brought against BTC-E, a prominent virtual currency exchange believed to have been involved in international money laundering.
Cryptocurrencies have also seen their anonymity challenged in the courts. In 2016, the Internal Revenue Service (IRS) issued a “John Doe” summons in an effort to investigate potential investors who may have underreported or failed to report income from gains while trading cryptocurrencies.
In November 2017, the Northern District of California granted in part and denied in part a motion by the IRS to enforce a summons served on Coinbase, Inc. Initially seeking all records related to bitcoin transactions between 2013 and 2015, the IRS argued that the summons was necessary to gain transparency into the transactions, as it would be virtually impossible to identify the scale of the underreported income without it. After opposition from Coinbase, which argued that the summons was overly broad, the IRS narrowed the scope of its summons, agreeing not to seek records for users for which Coinbase filed forms 1099-K during the time period in question or for users whose identity is known to the IRS. What’s particularly notable from the ruling is that the anonymity so highly coveted by users of cryptocurrency was somewhat “pierced” by the John Doe summons.
Last week, Bitconnect, a cryptocurrency marketplace, was named in four class action lawsuits. Bitconnect is accused of operating a Ponzi scheme, luring potential investors to buy Bitconnect in exchange for returns on their investment. The plaintiffs obtained a temporary restraining order against Bitconnect, seeking a list of each wallet holder to prevent additional damages to investors. It will be interesting to see what discovery strategies the plaintiff’s counsel utilizes to develop their case.
As the cryptocurrency landscape evolves, litigators and eDiscovery practitioners should become familiar with its underlying technology, as it will affect transactions and give rise to new legal challenges.
