Cryptocurrency and blockchain are terms that have repeatedly found their way into legal headlines recently. But many practitioners and judges aren’t yet familiar with what they are or the legal implications they present. In this episode, Jody Sanders and Todd Smith join Nelson Ebaugh, a litigator and appellate attorney in Houston, to discuss this technology and the legal issues it raises. Nelson has found himself on the forefront of cryptocurrency litigation and provides a history and understanding that’s accessible to laypeople. He also offers insights into areas of the law that have started affecting cryptocurrency (like securities, criminal law, and privacy), where legal issues will continue to develop, and how attorneys can position themselves to have an impact.
Our guest is Nelson Ebaugh, who has his own firm in Houston. Thanks so much for joining us.
My pleasure.
If you would maybe spend a few minutes and talk about your background, your path to the law, and what you do now.
I graduated from the University of Texas in 1991. I first worked on Capitol Hill for the Republican Study Committee. It was a fascinating experience. That is when I decided I wanted to look into law school. I enrolled in the University of Tulsa Law School in 1995. I’m one of the few people that went to law school that enjoyed the experience.
Afterward, I worked as an Assistant District Attorney in Colin County. I enjoyed that, but I also wanted to get involved with business litigation. I worked for a couple of years with a business litigation firm in Addison near Dallas. I earned my Master of Law in Securities and Financial Regulation in Washington, DC. I enjoyed that too. The best part about it is that it is where I met my wonderful wife. She is also a lawyer. She was earning her master’s in Securities and Financial Regulation at the same time.
By coincidence, we both happened to be from Houston. After we finished the program, we moved back to Houston. I worked for a firm in Houston for several years doing business litigation. I decided to hang my own shingle. I have been doing that for several years. I do a mix of both business litigation and criminal appeals. Amongst the business litigation cases that I handle, I do a lot of securities litigation and securities arbitration. Through that work, I became interested in how cryptocurrencies and the law work together. That is what brings me here.
We were glad you reached out to talk about cryptocurrency because Todd and I, before we started the interview, had both admitted we were novices in that area. Everything that we know we learned from our friends Karen Delaney and Jennifer Judges’ podcast Lawyers Behaving Badly. They did a deep dive on crypto and FTX for the first couple of episodes. If you wouldn’t mind spending a few minutes breaking down crypto and blockchain and simplifying it for guys like Todd and me who don’t understand what it is.
I had a steep learning curve when I was first presented with a cryptocurrency fact pattern, but the more I learned about it, the more I found out that the concepts are easy for a lawyer to get their arms around. You keep on hearing about blockchain, and at first blockchain sounds mysterious, but it is a simple concept. It is a method of record keeping. A good analogy is that the real estate records are all recorded here in Harris County for Houston. That is a detailed record of all the real estate transactions in the county, but it is centralized. In other words, it is all in one place.
The way blockchain is different is imagine if you have over 10,000 copies of the Harris County deed records spread out across the world. That is what the blockchain is like. In other words, instead of having all the records in one spot, you have them spread out throughout the whole world. All the 10,000 people that have that record have to agree that they all have an exact copy of the other 9,999 copies that are out there. That is one way to describe a blockchain.
Another way to describe it is like an Excel spreadsheet that over 10,000 people have the same copy of. They all agree that there are over 10,000 copies that are the same. The reason that the system was developed was to get away from the centralized record-keeping system that you have with deed records or, more specifically, banks. We are all familiar with how our banks keep track of all of our assets and liabilities. I hope that gives you a general idea about what a blockchain is.
In cryptocurrency, each cryptocurrency transaction is recorded on this blockchain. In other words, it’s these over 10,000 different ledgers. As long as everybody agrees on the accuracy of all of them, theoretically, you have a system where you can exchange cryptocurrencies here and there. I can elaborate a little bit more about why this system came into existence. That will help put it in perspective. Would you like me to do so?
Yes, that is great.
The whole thing makes me think about it as a common server, as it were. People have access to the same bits of information and can make changes within that environment.
Yes, with one caveat. One of the big buzzwords in blockchain and cryptocurrency is that the blockchain is immutable. In other words, it can’t be changed unless everybody agrees it is changed.
I was going to ask about that. How changes are made if you have 10,000 copies of it, and everyone has to agree?
Let me back up a step, and I will talk about how cryptocurrency came into existence in the first place because it is a fascinating story. In 2008, we remember the financial crisis. When that occurred, there were a lot of bank bailouts. Quite a few people were upset about all these banks being bailed out. They were frustrated in trying to think of alternatives.
The people that came up with the idea of cryptocurrency are libertarians. They don’t like centralized institutions like big banks and government. They wanted to come up with a system that got rid of the middleman like big banks. That is the whole thrust of cryptocurrency. What is interesting about it is that cryptocurrency is almost like a religion. It is fascinating to see these cryptocurrency proponents talk about the system and what it is about. This whole idea of cryptocurrency is like a religion or a political movement. They cannot stand big government or big banks. Having this distributed ledger system is appealing to them because they don’t have to rely on a fiduciary like a bank to have transactions conducted.
Back up to 2008, this is where the story gets interesting. The person or people that invented cryptocurrency—we don’t know who they are. It is an anonymous group that goes under the pseudonym Satoshi Nakamoto. He is probably not a real person. They have tried to identify who Satoshi Nakamoto is without any success.
This person named Satoshi Nakamoto came up with this new alternative financial system. He did so by publishing a white paper that he spread amongst people on the internet. People on the internet that liked it decided they would help Satoshi Nakamoto create this cryptocurrency system and blockchain by using the cryptocurrency called Bitcoin. Bitcoin is the first cryptocurrency in existence.
I love this explanation of what cryptocurrency was all about in 2008. They have described it as, at first, an anarchist project, like what I have been talking to you about it. It morphed into a get-rich scheme. Now it has morphed into a solution and search for a problem to solve. That is a brief quick history of cryptocurrency since 2008.
How does it work technologically or practically that if someone wants to make a new transaction on the ledger, you need to get all the people to agree to that? How does that work?
My thinking is, what is the dispute resolution system?
I have a bachelor’s degree in Economics. I feel like I can approach that part of it, but I do not have any education in Computer Science. I can’t tell you exactly how technically it works, but I can explain the general concept.
That is what we want. If you went to Computer Science, it would probably go over our heads too. That is completely fine.
There is a verification process. Have you ever heard of these miners with cryptocurrency? What have you heard about the miners?
That is a thing that they do. I know Texas has had a bunch of people come in and set up Bitcoin mining operations to uncover the new Bitcoins and set up all the computers. Everything runs through the process of finding new Bitcoins.
The miners are essential in the verification process for transactions. Let’s say that Nelson is sending one Bitcoin to Jody. I would make that arrangement on my laptop. These miners would verify that transaction. That verification process involves solving complex math problems. I hit the limit on how that portion of it works. They compete against each other. Whoever can verify the transactions first and solve these problems that are part of the system earns a reward of Bitcoin. There is an incentive there.
Let’s contrast it with your normal bank account. I have a bank account at Chase. Chase is a fiduciary that watches over my money and makes sure the transactions I engage in are accurate. Let’s switch back to the blockchain and cryptocurrency system. In the blockchain and cryptocurrency system, you don’t have a centralized record-keeping group or entity.
Instead, it is all these thousands of miners that maintain the blockchain. They verify these transactions. If they are the first to do so, they get a reward and get paid a certain amount of Bitcoin. There are a lot of miners who have migrated to Texas over the past few years. The reason for that is that energy is cheap here. You have probably heard in the news about how mining is energy-intensive. That is why they are here in Texas because it is cheap energy for them to verify all these transactions.
How are the miners set up? Are these guys in the basement like the usual hacker types? Are these legit companies coming in, setting themselves up, and taking advantage of our general business-friendly climate, aside from low energy cost?
They are legitimate companies. In order to be a successful miner, you’ve got to have an enormous operation going on. For instance, there is a little town only about an hour’s drive from Austin called Rockdale. There used to be an Alcoa aluminum plant there. They went out of the aluminum business and converted it into an enormous mining facility.
The reason they chose that location is that when it was owned by Alcoa, they had already hooked it up with a lot of electricity from power lines. It provided a good infrastructure for this miner to operate under. These mining shops can be enormous and require a large investment to get going. I have heard about some of these small-time miners that maybe have a laptop running in their basement, as you referred to, but I don’t think they are what is keeping this whole system together for the most part.
It seems like there has to be a large scale of operation to make it work efficiently and to have any prospect of earning the reward.
The city of Fort Worth got into the Bitcoin mining business on a small scale. I don’t know if they were gifted or they bought some mining machines, but they set them up. My city is in the Bitcoin mining business to a small extent.
I’m going to ask another question. We are hearing a lot, aside from Bitcoin and blockchain, in the news about artificial intelligence. I wonder how the emergence of AI as a player in the legal industry impacts the Bitcoin mining business.
My answer is I have no idea. This whole generative AI hype we have been hearing about over the past several months is a fascinating topic. I’m not a computer scientist, not even close to it. What I thought was interesting about the machines that these miners use to verify these transactions was they rely heavily on these video game computers. Video games require an enormous amount of horsepower to process all the graphics and the like. Apparently, that is the best thing you can use when you are trying to solve these complex mathematical problems to verify the transactions on the blockchain.
Let’s switch over a little bit. I can imagine that this only came online in the last several years. It was unregulated for most of its lifetime, but it looks like from reading an article that you sent us that you did, there are some places that are dipping their toes into regulation, particularly Texas. How has regulation developed for Bitcoin or any cryptocurrency in that regard?
It is still very much the Wild Wild West. That is an accurate description that they dip their toes into regulation. That is all the regulators have done. It is understandable. Cryptocurrencies are strange new fruit. Lawmakers and regulators don’t know what to do with it.
What have we seen in Texas in terms of starting to regulate or at least thinking about regulating cryptocurrencies? There are probably some legal implications on whether or not they can too.
There is a Texas Blockchain Council here in Texas that is based in Austin. They are a lobbying group trying to guide the development of laws in Texas blockchain and cryptocurrency. They have proposed some legislation. Some of it has been passed. A couple of years ago, the Texas legislature amended the UCC so you can have a security interest in cryptocurrency. That is one step. At the same time, the legislature also formed a blockchain working group to explore possibilities of encouraging blockchain development here in Texas and encouraging the growth of that ecosystem.
You mentioned securitization. Have you seen people using these as securitized assets? I don’t necessarily mean as a security but as a backup asset for any other types of transactions. Is their fluctuating value something that scares people away from that?
Because I do litigation appeals, I haven’t gotten involved with the transactional work on that. I’m sure they have recorded financing statements where they identify cryptocurrency as collateral. Without getting too much into the regulation yet, I have heard that oftentimes cryptocurrency can be a big issue of all things in Family Law cases. For better or worse, it is the way it is. The majority of cryptocurrency investors are men.
It is not unusual for these crypto bros to be experimenting and dabbling in cryptocurrency. Law, all of a sudden, maybe they have $700,000 worth of Bitcoin. If they get divorced, understandably, their ex-spouse wants half of that. In Family Law cases, there have been a lot of CLEs on how to make discoveries to find cryptocurrency that a crypto bro has to distribute equitably upon the divorce.
That brings up a question I have had about this for as long as I have heard about it. How is it that cryptocurrency is valued? What sets the market value of a unit of Bitcoin? You hear about it wildly fluctuating. We are going to get into the FTX issues here, but is this an unregulated open market that is worth what it is worth, a willing buyer, a willing seller, and so forth? How is the value determined?
It is whatever somebody will purchase it from you for. That is how the market is set. There are a lot of skeptics about cryptocurrency investing for some people with good reputations. For instance, Warren Buffett refers to cryptocurrencies as rat poison squared. He doesn’t have much confidence in cryptocurrencies. His colleague, Charlie Munger, talks about trading cryptocurrencies as trading turds. What is interesting is that those two guys think that the underlying technology, blockchain, has a lot of potential. It is worthwhile investigating, but they have no interest whatsoever in cryptocurrencies themselves.
They made their money the old-fashioned way. It is not that surprising that they would not fully embrace crypto. It is interesting that they have commented on the potential worth of blockchain itself.
Their perspective is that the market value is determined by whether you can find a greater fool to buy your Bitcoin. That is their perspective.
Can you find somebody who is even dumber than you? It is something worth trading for this Bitcoin.
Going back to market value, the value of cryptocurrencies, specifically Bitcoin and Ether, it is amazing to me how valuable they can be. I was looking at the value of Bitcoin. One Bitcoin is worth between about $29,000 and $30,000. To me, that is incredible. Several years ago, somebody bought a Papa John’s Pizza for thousands of Bitcoin. At the time, they were worth less than a penny. It has been an amazing appreciation over the past few decades.
Before the whole FTX scandal and Bitcoin took a nose dive, what was driving the market value of cryptocurrency were celebrity endorsements. I don’t know if you remember Matt Damon and his commercial about fortune favoring the brave. That was on the Super Bowl. There is also Reese Witherspoon. She was promoting it and trying to say, “We can’t let all these crypto bros make this money. The women have to get a piece of the action.” You had all these celebrity endorsements. Several years ago, one Bitcoin got up to about $60,000.
Some celebrities are maybe regretting those endorsements. From what I recall, they are being dragged into some of the litigation about the regulation, lack thereof, and representations that were made that maybe didn’t bear out.
For instance, Kim Kardashian. She has already settled a lawsuit by the SEC without admitting or denying liability over cryptocurrency promotion.
Before we move too far off regulation, the follow-up question I had related directly to one of your practice areas and whether you have seen any movement on the Criminal Law side. If crypto does wind up being regulated, the SEC will have its influence, but I don’t see anything from what I know about blockchain or crypto. Is there an overlay here with Criminal Law specifically when it comes to crypto and blockchain?
As I mentioned here earlier about the distributed ledger system of blockchain, when cryptocurrency was first introduced, it was a criminal’s currency. It started as an anarchist project. They are sick and tired of banks and government regulation so they developed this new system. Criminals love it because it is a way for them to exchange value with other criminals without having to deal with money laundering regulations that we have in the United States or other countries. It was for a while. The law is catching up. Money laundering regulations fly quite a bit now in cryptocurrency transactions.
You may have heard in the news about Silk Road, the dark website. Silk Road was the name of an online merchant that would sell you all sorts of illegal stuff like illegal narcotics or guns. Anything illegal you wanted to buy, you could buy through this website that was on the dark web. I don’t even know how to get onto the dark web. A lot of people did know how to get onto the dark web. The federal government was finally able to catch up with the operator of Silk Road and were able to put the kibosh on that. It is like whack-a-mole. As soon as you catch one criminal operating through the use of cryptocurrency, other people pop up.
I will give you an example. I was at the Baylor Law School, visiting with some of the law students there. One of the law students was telling me that he had a lot of friends in college who were buying fake IDs and paying for them with cryptocurrency. The reason criminals and people try to do an illicit activity like cryptocurrency is that there is a perception that it is anonymous and that you can make these transactions under the radar without getting noticed by the treasury department for illegal payments. That is starting to change quickly. The US government, other governments, and entities are developing something like a phone book that identifies who owns what cryptocurrency addresses.
For instance, an example is FTX. If you don’t go through a cryptocurrency exchange like FTX or Coinbase, which is the largest exchange here in the United States, you can keep your cryptocurrency. You manage your cryptocurrency with a private key that nobody else knows the code for. When you send cryptocurrency, you send it from a bunch of random numbers.
It is like an email address. It is like punching a button. Instead of sending an email, you are sending cryptocurrency. Nobody knows who that Bitcoin address belongs to until they do. Once the federal government finds out who it belongs to, they put it in their own record. Now they know that this unintelligible Bitcoin address belongs to such and such person. Once they do that, it is all over for the criminal because the government has sophisticated means of tracking these transactions through the blockchain.
It is like the Harris County deed records over 10,000 copies spread out across the world, but they are all identical. That is how the system has to work. They are all identical. What the government does is look at the blockchain. They are solving crimes that occurred several years ago using Bitcoin through this analysis.
That is a long answer to your short question, how Criminal Law and cryptocurrency, and what is going on there, but it’s been a huge deal. Law enforcement, admittedly, several years ago, didn’t know what to make of this, the cryptocurrency and blockchain, but that is not the case anymore. They have sophisticated means of tracing these Bitcoin transactions and identifying who is involved in these Bitcoin transactions, and they are for solving crimes.
This may be too technical of a question. With them being able to identify specific locations of Bitcoin addresses, is there a way for the government to take possession of these intangible assets like criminal forfeiture? With a traditional criminal forfeiture of a car, cash or bank account, it is easy for them to levy that. What about Bitcoin or other cryptocurrencies?
Yes, but here’s the catch. There are two keys. I’ll back it up a little bit and put them in layman’s terms. Do you remember how I was using the email analogy? My email address is EbaughLaw.com. If I wasn’t using an exchange and I was sending some Bitcoin directly to you, Jody, I would have a Bitcoin address, and I would get your address. In order for me to make that transaction, I have to use my passcode.
It is like whenever you send an email, you have to log into your email account first to do it. For me to send Bitcoin to you, Jody, I have to log into my Bitcoin account and send it to you. There are two codes that the government needs. They need to know what my Bitcoin address is, and on top of that, they need to know my password to use that Bitcoin address. If they have that, for a criminal they are investigating, they are able to do a forfeiture.
Finding that passcode can be difficult. The government can, through deductive reasoning, figure out what the Bitcoin address might be for a suspect. They might have to search their home and look for the passcode written down on a Post-It note next to the computer to complete the forfeiture. Something similar to that has happened in a large forfeiture case. They did a search of the home. They found the password on a piece of paper.
If having the password is the key, how do you even demonstrate to someone else, whether it be a purchaser or anybody who was like, “I own three Bitcoin?” Is that data in the blockchain?
I’m glad you brought that up because it is like having your checking account available for the whole world to see. What is interesting is that people like us who don’t have Computer Science degrees can still easily look at the blockchain and what is going on. You have probably seen the Keanu Reeves movie The Matrix with all those numbers cascading down the screen.
When you look at the blockchain explorer, you can see every transaction in the world on Bitcoin happening at the same time. They are cascading down your screen like that. You do it through what is called a blockchain explorer. They have this blockchain explorer available for cryptocurrency enthusiasts that want to see what is going on behind the curtain. If you go into this blockchain explorer, you can see how much Bitcoin somebody has.
I have only done this once or twice. When Ukraine first got invaded by the Russians, they were accepting donations via cryptocurrency. A lot of people were donating cryptocurrency. I donated cryptocurrency to Ukraine to see if I could follow it through the blockchain, and I was able to do so. It was fascinating. When I got to Ukraine’s donation Bitcoin address, you could see how much and when Bitcoin has been donated to their Bitcoin account. All these people that have these Bitcoin addresses are available for the entire world to see. If you can figure out such and such addresses, you know how much Bitcoin they have.
Your paper made mention of this, but it is a little bit ironic that you have more of a Fourth Amendment right to your centralized bank account records against the government than you do against your Bitcoin.
Because the blockchain is transparent, there is no reasonable expectation of privacy in it. At least, that is what the Fifth Circuit has held.
If you are putting all your ledger transactions out for the world to see in 10,000 different repositories, you can’t claim a privacy interest in that.
What happens if you lose your password? There is no answer to this, but how are passwords maintained typically?
If you are one of these cryptocurrency purists who is like an anarchist and doesn’t want to trust a central organization like a bank and you do it entirely on your own, if you lose your password, it is all over. I’m going back to my Chase bank account. I have a Chase bank account. If I lose my password to go in there and look online, I go through some verification process. They will reissue me a new password. If you are doing these cryptocurrency transactions on your own without the help of an exchange, you’ve got nobody to help you get that password.
When Bitcoin was worth less than a penny over a decade ago, there were some cryptocurrency enthusiasts who collected a whole bunch of Bitcoin. There’s this famous incident where this person in Wales collected a lot of Bitcoin. Now, they are worth billions of dollars. He threw out his hard drive and it ended up in a landfill. He knows now that they are worth billions of dollars, his Bitcoin, but he doesn’t have the password to access them. What he is doing is he is seeking permission from the local landfill to dig through it to see if he can find his hard drive to get his password.
This is a good segue into cryptocurrency, exchanges, and FTX. If you don’t want to take that risk that the guy in Wales had, here’s what you can do. This is what I have done when I have experimented with cryptocurrency transactions. I don’t hold my own Bitcoin account. Instead, there is a company called Coinbase. That is a cryptocurrency exchange that holds my Bitcoin account. If I lose my password, I can go back and get it like I would get it from my Chase banking account.
These exchanges have popped up. They have filled a need for people that need help with holding onto their Bitcoin account and operating it. They have an easy computer interface. When you get onto Coinbase to do a Bitcoin transaction, it looks like you’re getting onto your Chase online account or to your TD Ameritrade. It is user-friendly. That is why companies like FTX got so large.
We have mentioned FTX a couple of times. We understand that is a Bitcoin exchange. That organization and its CEO have been in the news regularly for the last couple of months. We have referenced the Lawyers Behaving Badly Podcast. Not only did I learn almost everything I know about cryptocurrency and blockchain from listening to Karen and Jennifer.
They had another episode where FTX was in bankruptcy, and the trustee had issued a report. It does not shine a favorable light on the company or its management. This seems to be a lesson in how not to run a business. Can you give us a quick overview of what went down with FTX and maybe what lessons, not only can consumers learn from that experience? For anyone interested in speculating in Bitcoin, what should they be aware of in light of what’s gone on with FTX?
This goes back to the whole Wild West situation that we have going on. There is not much in the way of regulations of these exchanges. The best way to approach this is to tell you what regulations are there. In the United States, there are eighteen money laundering regulations that apply to these cryptocurrency exchanges. The key principle in preventing money laundering is that these exchanges have to know who their customer is.
I have a Coinbase account. When I signed up for that Coinbase account, I had to provide a copy of my driver’s license and other identification to Coinbase. That way, they know that the Bitcoin address I’m using is related to me. If the government sees some fishy activity going on through the Coinbase exchange, it is easy for the government to get a handle on who is doing those fishy exchanges. Of all the regulations out there, that is the most developed in the cryptocurrency ecosystem. After that, it gets unregulated.
Nowadays, it is unclear whether these exchanges should be regulated as securities exchanges with the SEC or not. Gary Gensler, the SEC Chairman, says, “These exchanges need to come in and register as securities exchanges.” The owners of these cryptocurrency exchanges were like, “This isn’t a securities operation we are running. We are not going to register.” It has been a big point of contention over the past couple of years.
Because there are only these AML regulations that are being vigorously enforced, catching the fraud that goes on in these exchanges can be tough to do. That is what the SEC is there for in the first place. The reason there are so many SEC regulations is to promote transparency, but because it is not clear that these SEC regulations apply to cryptocurrency exchanges investors don’t have transparency. That is why it is hard for them to catch the fraud that’s going on, like with FTX.
Unfortunately, the SEC has some egg on its face because a lot of people are blaming the SEC for not coming in and making these exchanges disclose more. The whole thrust of the SEC’s mission is to put sunshine on these businesses, but now there is no sunshine on these cryptocurrency exchanges. That is why Sam Bankman-Fried can get away with the fraud he has gotten away with.
I’m not sure he is going to get away with it again.
That sounds like that is still up in the air on that.
He has been arrested. As I understand it, he is out on bond now. They extradited him from The Bahamas or someplace.
I’m being generous in giving him the presumption of innocence.
We have talked about government regulation and Criminal Law. What about private civil litigation? Have you seen much impact of Bitcoin on that?
I have seen some of it, but not a lot. I have seen some cases on Westlaw about it and occasionally read about it in the news. One of the difficulties with civil litigation is, a lot of times, after you catch up with these fraudsters, there is no money to recover against them. That could be a stumbling block for plaintiff’s attorneys, but only time will tell.
I would imagine that judgment collection could be a lot more difficult if you don’t have the resources and technology of the federal government.
I’m envisioning a turnover order, Jody, that says, “Turnover your Bitcoin.”
It is great if you have a physical person that you can put in jail when they don’t comply. As we wrap up here, I have learned how much I don’t know about cryptocurrency and blockchain. It is fascinating. I’m curious about your personal views as someone who has delved into this world a lot and maybe implications for lawyers and the future implications of cryptocurrency on legal practice.
I see a lot of lawyers being busy in the securities litigation arena. I see a lot of prosecutors and criminal defense lawyers being involved in this tracking of cryptocurrency and forfeiture of it. We have already talked a bit about the Criminal Law aspect of it, but the securities litigation aspect is going to be huge. It has already created a fair amount of litigation.
The million-dollar question is, with this new strange fruit of cryptocurrency, is it a commodity regulated by the Commodities Futures Trading Commission, the CFTC, or is it a security regulated by the SEC? There have been good arguments on both sides. Whether it qualifies as a commodity or a security has enormous consequences. It is going to determine whether cryptocurrencies are regulated by the CFTC or SEC.
If you saw the movie Trading Places, you are familiar that commodities are like bacon and corn. Are these cryptocurrencies equivalent to bacon or gold? Are they investments subject to regulation by the SEC? Are they a little bit of both? I have heard good arguments all around. These disputes are being played out in the courts now.
In my opinion, what is fascinating is that the SEC brought its first insider trading case. This cryptocurrency exchange I have been mentioning a lot, Coinbase, there was an employee at Coinbase who was in charge of marketing. He had advanced knowledge about which new cryptocurrencies they were going to allow to be traded on the exchange. He shared that information with his brother and a friend.
As soon it was announced that these cryptocurrencies were going to be traded on the exchange, they shot up in value because, all of a sudden, they were now available to the American market through Coinbase. His friend and brother had purchased it 24 hours beforehand and saw the rewards. Their investment went up about $1 million.
It sounds like insider trading.
That is what the SEC alleged. Coinbase was livid about this action. You would think that Coinbase would be happy about the SEC discovering this fraud and doing something about these fraudsters. Coinbase was upset because Coinbase was like, “These cryptocurrencies we listed are not securities.” It is because Coinbase doesn’t want to go through the onerous registration process to comply with the SEC laws. That is a huge point of contention that is being played out in many disputes. Are these cryptocurrencies securities or commodities? Only time will tell.
The appellate lawyers will be busy for years trying to approach this question on each side. Cryptocurrency lawyers are all well-versed with the SEC versus Howey decision from 1946. It is a significant esoteric securities decision that most securities lawyers don’t talk about. In the cryptocurrency arena, all cryptocurrency lawyers know about the SEC versus Howey decision. The SEC versus Howey decision from the ‘40s says that the securities regulations applied not just the stocks and bonds but also to “investment contracts.” That is a broad catch-all. The SEC says, “This broad catch-all of investment contracts applies to this strange new fruit of cryptocurrency.”
It sounds like a lot of fertile ground for lawyers somewhere for the next several years, criminal and civil, perhaps.
All these SEC actions are always civil. The SEC doesn’t have criminal jurisdiction. It is also going to be a fertile ground for class actions in individual private securities litigation.
Nelson, thanks very much for allowing us to spend some time with you talking about this fascinating topic. We have joked around. I, at least now, have a better idea of how much I don’t know still about cryptocurrency and blockchain, but it certainly piqued my interest. As we have let you know, it is our tradition to have our guests leave us with a tip or a war story. It can be about anything you like, but perhaps the context of our discussion. It would be beneficial to have something related to the topic if you have something.
Because of attorney-client privilege, I’m not going to talk about any of my clients that have run up against some of these regulations we have talked about, but I will give you some more details about this insider trading case that I was telling you about. What is interesting about it is that all the players in this insider trading case involving Coinbase came from Texas. The lawsuit was filed in the federal court that is in Seattle, Washington.
The founder of Coinbase, who is a billionaire now, earned his bachelor’s and master’s degrees at Rice University here in Houston. He had dual degrees. He had Economics and Computer Science. After he graduated from Rice University, he worked for a Buenos Aires company doing some Airbnb stuff. He became interested in cryptocurrency. He has the largest cryptocurrency exchange in the United States, worth over $1 billion. He moved his operations up there to Seattle, Washington, to be next to the tech ecosystem up there.
The people involved in the insider trading all went to Texas colleges too. The guy that was working at Coinbase went to the University of Texas. He graduated from there several years ago. He became friends with somebody else who was at UT’s engineering school. These Longhorns, and I’m ashamed to say it because I’m a Longhorn too, were at the center of this insider trading case. His name is Ishan Wahi. He worked for Coinbase up in Seattle. He is the one that got this information about new cryptocurrencies that were going to be listed for Coinbase. He shared it with his UT engineering buddy and his brother. It was investigated because somebody saw some unusual activity on the blockchain.
You have these people who are scanning the blockchain for trends and whatnot. They notified Coinbase. Coinbase notified the authorities. Ishan Wahi, this Project Manager at Coinbase, agreed that he was going to cooperate with an internal investigation. Six hours before he was supposed to meet with this internal investigation team, he was trying to board a one-way flight to India. The authorities arrested him at the airport. Since then, he has settled criminal wire fraud charges with the Southern District of New York. That is my war story about cryptocurrency insider trading. It was a fascinating case. It is yet to be determined whether the SEC will prevail that these cryptocurrencies they claim are securities are in fact securities.
Thank you again for sharing what you have learned with us. Our readers will learn a lot about it as well.
It is my pleasure.
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