The cryptocurrency market capitalization peaked in January at $835 billion and then promptly lost nearly half of its value by the following month. After $400 billion vanished, lawsuits quickly filled the void, including two class actions filed in the Southern District of Florida.These cases present the Southern District of Florida with an opportunity to serve as the first federal court to publish decisions on digital currency issues, including whether these currencies are securities, commodities, or an altogether new class of assets.

Centra Tech

The first cryptocurrency-related class action filed in the Southern District of Florida alleges that Miami Beach's Centra Tech violated federal securities law by selling unregistered securities. The class claims that Centra Tech raised over $30 million by hosting an ICO (initial coin offering) of CTR tokens. According to Centra Tech, CTR tokens enable its holders to access and navigate Centra Tech's product line. The product line boasts a variety of audacious digital currency financial products under development, none of which would be more revolutionary than a prepaid card purportedly capable of holding any major digital currency (i.e., Bitcoin, Ether, Ripple, etc.), transacting on any existing payment card network (like Visa or MasterCard), and exchanging digital for fiat currency in real time.

The class seeks a determination that CTR tokens are securities, entitling the class to certain rights and privileges under federal securities law. However, it is unlikely that the court will weigh in on that issue for quite some time. Centra Tech has moved to compel arbitration, and separately, it argues that the class representative lacks standing because he did not suffer a monetary loss.

In arguing that arbitration should be compelled, Centra Tech claims the class representative signed an agreement containing an arbitration clause and a class-action waiver provision. Centra Tech contends that the “main way” customers, including the class representative, purchased CTR tokens was by registering on Centra Tech's website. To register, users necessarily clicked through a series of online pages and links, including digitally signing an agreement containing an arbitration and class-action waiver provision. Centra Tech points to its possession of the class representative's personal information as proof of his participation in the registration process.

In response, the class representative counters that he did not register on Centra Tech's website. Rather, he claims he purchased his tokens from a “smart contract” address. Smart contracts are automated, self-executing protocols that control the transfer of digital assets in accordance with specified conditions (analogous to a vending machine). Digital currencies are platforms on which developers build and host smart contracts. In practice, this means the class representative would not have to visit Centra Tech's website to purchase CTR tokens. Instead, he could purchase CTR tokens by sending Ether (ETH) from his digital wallet to a smart contract address on Ethereum's blockchain and avoid visiting Centra Tech's website altogether.

Resolution of this arbitration issue will require an examination of the facts, and might provide an opportunity for the court to discuss smart contracts.

The class representative's standing is also at issue. Centra Tech argues that the class representative did not suffer a loss. The class representative purchased approximately 8,000 CTR tokens valued at $0.42 per token. He then sold those tokens three months later at $0.50 per token, apparently reaping a profit of nearly 20 percent. However, the class representative counters that he suffered a loss of 2.38 Ether (ETH) or nearly $2,000. He says he purchased his 8,000 CTR tokens with 16.1 ETH and then sold them three months later, receiving 13.72 ETH in return. (ETH rose in value by more than 30 percent during that timeframe, hence the smaller payout.) In other words, if the class representative had never purchased these unregistered securities and merely held onto his ETH, he claims would have 2.38 ETH more in his pocket. This issue presents an opportunity to render an early decision on the proper mechanism for measuring damages when assessing these volatile currencies.

Utility Tokens

Ultimately, if the class representative overcomes these initial obstacles, the ultimate question is whether CTR tokens are securities under the Howey test. Under the Howey test, a security is an investment of money in a common enterprise with an expectation of profits predominantly from the efforts of others. Centra Tech is positioning itself toward arguing that CTR tokens are not securities because they are “utility tokens.”  In other words, Centra Tech will argue along the lines that CTR tokens are assets with functional utility beyond serving as, for example, digital stock certificates. Centra Tech has yet to describe the CTR token's functional utility in detail, but any judicial decision on this argument will garner intense scrutiny by all interested parties for guidance. For an idea of what constitutes a utility, two contrasting examples are useful.

Codex Protocol

Codex Protocol is developing the Codex Title token that could serve as a strong example of a pure utility token. Codex Protocol aims to build a digital, decentralized title registry to track ownership of art and collectibles. To track art and collectibles on this digital registry, owners of artwork or collectible will acquire discrete, nonfungible Codex Title tokens. Each token will correspond to discrete, non-fungible artwork or collectibles. In other words, each Codex Title token serves as a digital record of title and ownership, like a certificate of title or bill of sale. Thereafter, anytime owners sell their art or collectible, they will also transfer their Codex Title token to the purchaser. Using Codex Title tokens, anyone can verify an items ownership and provenance on a public, immutable ledger to better ascertain an item's authenticity. Altogether, Codex Title tokens exemplify utility tokens because they serve the functional purpose of registering ownership, recording provenance, and facilitating the exchange of property.

Munchee

As distinct from the Codex Title token, Munchee's token—the MUN Token—presents an example of a token that will likely not be deemed a utility token. Toward the end of 2017, the SEC ordered Munchee to cease and desist from hosting an ICO to publicly sell MUN Tokens. Munchee represented that MUN Tokens would serve as utility tokens on its decentralized application (commonly known as a DApp). Munchee developed a restaurant-review DApp (like Yelp), which required the use of MUN tokens to access and navigate. Under  its model, MUN token holders would draft restaurant reviews and upload content on Munchee's DApp. Munchee would reward reviewers with MUN tokens. In return, MUN Ttoken holders would then pay for meals at participating restaurants with MUN tokens or exchange them for a share of Munchee's advertising revenues.

The SEC concluded that profits from MUN tokens would primarily come from the entrepreneurial and managerial efforts of Munchee “and its agents” because Munchee would “revise the Munchee app, create the 'ecosystem' that would increase the value of MUN,” “and support secondary markets.” (In contrast, Codex Protocol is “open source” meaning that anyone can modify its code, somewhat like the way anyone can modify content on Wikipedia.) Consequently, the SEC argued, “Investors had little choice but to rely on Munchee and its expertise. At the time of the offering and sale of MUN tokens, no other person could make changes to the Munchee app or was working to create an 'ecosystem' to create demand for MUN tokens.” The SEC also pointed to the sale of MUN Tokens on secondary markets as evidence of investors expecting profits.

Conclusion

Although the cryptocurrency market lost an eye-popping $400 billion in value over the past month, it still boasts a $435 billion valuation. It has continued to persevere and gain mainstream adoption, notwithstanding a corresponding increase in skepticism. Indeed, the SEC, the Chinese Communist Party and the South Korean Financial Supervisory Service have both encouraged regulated development of blockchain technology, central banks in England and Saudi Arabia have announced experimentation with digital currency projects, and even Venezuela launched a national cryptocurrency supposedly backed by oil and other commodities. It is only a matter of time until the Southern District of Florida will play a pivotal role in contributing to this rapidly developing space.

Todd Friedman, an associate at Kenny Nachwalter, focuses his practice on business litigation. He has second-chaired several trials in Florida's state and federal courts and first-chaired an appeal before a Florida appellate court. In addition to his trial and appellate experiences, Todd also has participated in several arbitrations, mediations, settlement conferences, hearings and other court proceedings.