On 21 November, the first litigation involving Bitcoin began in Singapore, in a case that has the potential to establish legal precedent on the fiduciary responsibilities of cryptocurrency exchange operators with regards to completed transactions and the rights of investors affected by technical malfunctions.
B2C2 Ltd v Quoine Pte Ltd
Singapore’s International Commercial Court is set to decide whether seven cryptocurrency transactions were wrongfully reversed in April 2017 by Quoine, the defendant, and the operator of crypto exchange platform Quoinex.
The plaintiff, an electronic market maker known as B2C2, alleges that Quoine abused its role as exchange operator and acted in “breach of trust” as a custodian, when it reversed trades that had already been completed at prices around 10 BTC for 1 ETH, resulting in a net position for B2C2 of approximately 3085 bitcoins. (Market prices at the time were ~0.04 BTC for 1 ETH.)
In its opening statement, Quoine said a technical glitch that caused the order book to become completely empty was responsible for the “absurdly priced Abnormal Orders” being executed at “250 times higher” than the average price at the time, in fulfillment of forced and/or erroneous liquidation of two other clients’ positions due to margin calls.
“It was in these circumstances … that the Defendant reversed the trades executed pursuant to the Abnormal Orders placed by the Plaintiff (as it was entitled to do so),” Quoine’s opening statement read.
Relying on contractual terms
The case raises the question of whether, and in what circumstances, a crypto exchange operator has the right to reverse completed transactions. Given the lack of regulatory guidance or an industry standard to follow, the court will have to make its judgment based on contract law, which has highlighted the need for clarity in the contractual terms under which exchanges operate.
B2C2 says it agreed to Quoine’s 2014 terms and conditions, which say that “once an order is filled, you are notified via the Platform and such an action is irreversible.” In Quoine’s view, a risk disclosure statement updated in March 2017 forms part of the contract, allowing it to cancel transactions that take effect “based on an aberrant value” caused by a platform malfunction.
According to B2C2, the glitch occurred as a result of Quoine’s own inability to place orders as a market maker and did not cause the platform on which customers were trading to generate an “aberrant value”. B2C2 is arguing that Quoine sought to “abuse its role as operator of the Platform” by reversing the trades.
Quoine, on the other hand, says B2C2 acted fraudulently, is “being opportunistic in seeking to take advantage of forced and/or erroneous liquidations on the counterparties to the trades”, and would be “unjustly enriched” if the trades were upheld.
The traditional exchange model
On traditional stock exchanges, the issue of whether trades can be unilaterally reversed or cancelled is well settled. For instance, the SGX (Singapore Exchange) may cancel error trades, but only in limited circumstances, and only where either both parties to the trade agree on the cancellation, or where SGX itself deems the transaction to be an error trade.
According to SGX, this may include considerations around whether a material mistake led to the error trade, there is evidence of fraud or wilful misrepresentation in relation to the contract, or canceling the contract would serve to protect the financial integrity, reputation or interests of the markets.
In the case of Quoine, the glitch is said to have occurred in its “quoter programme”, which stopped creating and/or placing new orders, a market making function. Operators of traditional stock exchanges do not place their own orders or conduct market making activities, so the same model may not currently apply to the crypto sector.
Regulatory and contractual clarity
But this raises an important issue – should a crypto exchange be allowed to be its own market maker and liquidity provider, given the potential for conflicts of interest? And if so, should there be an obligation to disclose such market making activities?
Indeed, the New York Attorney General issued a report in September in which it raised concerns that an exchange conducting market making activities on its own platform with no formal rules in place can potentially hide the true liquidity of the exchange and present a major conflict of interest.
Given the lack of regulatory guidance on how exchanges should operate, clarity has to be sought from their contractual framework, which currently differs from exchange to exchange. Does it provide for segregation of assets? How is forced liquidation handled? When should it be triggered? Who is liable in the event of a ‘glitch’ or malfunction?
The B2C2 v. Quoine decision is expected by the end of the year. The main issues will likely be whether the reported glitch entitled Quoine to reverse or cancel trades, and if so (or if not), to what extent is it liable to the customer. Ultimately, the decision will raise questions for regulators on how certain rules should be applied to crypto exchanges.
Existing regulatory frameworks
Existing rules for crypto exchanges in Singapore, recently formalised in the Payment Services Bill, focus on KYC (know your customer) and AML (anti-money laundering) processes.
The MAS (Monetary Authority of Singapore) is also said to be in the process of reviewing its regulatory framework for RMOs (recognised market operators). It plans to introduce a three-tier system for approving exchanges, partly in recognition of the emergence of cryptocurrency platforms.
Meanwhile, the Hong Kong SFC (Securities and Futures Commission) recently came out with new conceptual framework to explore more comprehensive regulation for crypto exchanges. Platform operators willing to be supervised can opt-in to allow the SFC to observe their operations in a sandbox environment.
Based on this exploratory work, the SFC will decide whether licensing and supervision are appropriate, where new requirements could include intensive reporting and monitoring obligations.
The next set of rules
It is possible that the outcome of B2C2 v. Quoine will inform, to some extent, regulators’ considerations for the next set of rules for exchange operators, as they seek to enhance safeguards for investors and ensure they have recourse.
Notably, the case is in the spotlight because of the value of the 3085 bitcoins in question. On 19 April 2017, the position was worth in excess of USD 3.7 million. At today’s prices, even after the recent plunge in bitcoin prices, it would be worth in excess of USD 12 million, justifying B2C2’s pursuit of the matter in court.
But more comprehensive regulation at crypto exchanges will not only offer clarity for players like B2C2. It would also provide greater clarity and possible recourse for smaller retail players who may not have the resources or incentives to hire teams of lawyers to help them pursue their interests.