[Twisting Bitcoin] Growing Responsibility of Exchanges... Will Investor Protection Strengthen?

Court Steps Up to Protect Cryptocurrency Investors... Aligns with Global Trends
Gary Gensler, Chair of the US SEC, "Will Regulate Cryptocurrency Exchanges to Protect Investors"

Cryptocurrency is sweeping across the globe. It is even compared to a so-called 'frenzy.' However, the more intense the frenzy, the more necessary it is to pause and observe carefully. If problematic aspects are swept away along with the hype, they are bound to resurface as bigger issues someday. This is a time to calmly review the cryptocurrency market, in a segment called ‘Twisting Bitcoin.’

[Image source=Yonhap News]

[Asia Economy Reporter Gong Byung-sun] On November 22, 2018, customers using the domestic cryptocurrency exchange Bithumb experienced a strange incident. They requested Bitcoin transfers, but for unknown reasons, the Bitcoins were withdrawn to different addresses. Despite no mistakes on their part, they lost their Bitcoins.

Six affected customers gathered and initiated legal disputes against Bithumb. The problem was that no fault could be found on Bithumb’s part. According to industry experts who examined Bithumb’s system, there were no security errors. Because of this, the victims faced difficulties proving Bithumb’s intent or negligence.

So, did the victims eventually give up on recovering their losses? Through the first and second trials, the court raised the question of what role cryptocurrency exchanges should prioritize for investors. The court’s judgment aligns with the recent emphasis on investor protection by cryptocurrency exchanges.

First Trial: Cryptocurrency Exchanges Must Have Security Systems Equivalent to Regulated Financial Institutions

The first trial court held Bithumb responsible. It first regarded the process of investors transferring Bitcoins to other wallets as part of the services provided by Bithumb. This was because the moment investors entrusted their cryptocurrency to Bithumb’s account, a paid deposit contract was considered to have been established. A deposit contract refers to an agreement where a depositor agrees to keep money, securities, or other items for another party.

What is noteworthy here is that the court pointed out that cryptocurrency exchanges must have security systems equivalent to banks. The court explained that although the cause of the address alteration during the withdrawal request process, which led to transmission to another server, was unknown, in banks and other financial institutions, such transactions would be rejected outright. Cryptocurrency exchanges could sufficiently build security systems comparable to banks but failed to make efforts to fulfill this obligation.

Attorney Kim Miri of Dongin Law Firm said, “The significance of the first trial is that customers proved the exchange’s breach of duty of care,” adding, “The court recognized that even if an unforeseen accident occurs, customers should not bear the full brunt of the damage.”

Second Trial: Return the Bitcoins Themselves

The problem was that the victims’ recovery was insufficient. The price of Bitcoin had soared significantly compared to when the loss occurred due to the unforeseen accident. Since the principle of compensation is based on the value at the time of the accident, Bithumb only had to compensate 5,159,000 KRW per Bitcoin.

In response, the victims added a claim for specific restitution. They demanded the return of the Bitcoins themselves, not money. If they received the Bitcoins, they could have been compensated for the price surge had they held onto them. Bithumb argued that Bitcoins are not goods, so specific restitution was difficult. According to Article 98 of the Civil Act, goods refer to tangible objects and electricity or other natural forces that can be managed. In other words, goods are things that have form or, even if formless, can be managed by us.

On the 12th of last month, the second trial court ruled that Bitcoins, being a type of digital information, are not considered goods under current law. This partially reflected Bithumb’s argument. However, the court regarded the contract made by the customer as similar to a contract for a generic obligation. Simply put, it was considered a contract to deliver goods belonging to a certain category rather than specifically designated goods. Unlike wallets, Bitcoins do not have unique values or numbers assigned, so they are not specifically designated goods. The court judged that Bithumb could sufficiently return Bitcoins of the same kind, quality, and quantity.

Accordingly, the court ordered Bithumb to return the lost Bitcoins to the victims, and if unable to execute this, to pay the equivalent amount calculated at the market price of 54,280,000 KRW per Bitcoin at the time of the conclusion of the trial. The victims thus received more than ten times the amount awarded in the first trial. Attorney Kim said, “There was an unfair aspect where victims could not benefit from the price surge of cryptocurrency due to an unauthorized withdrawal incident that was not their fault,” adding, “The court took maximum steps to restore the victims.”

Will 2022 Be a Year That Imposes Greater Responsibilities on Exchanges?

[Image source=Reuters Yonhap News]

Regardless of Bithumb’s fault, the court’s judgment aligns with global trends. It entrusts greater social responsibility to cryptocurrency exchanges. According to the US economic media Bloomberg on the 19th (local time), Gary Gensler, Chairman of the US Securities and Exchange Commission (SEC), stated that in the coming months, the SEC will regulate exchanges to protect cryptocurrency investors.

Chairman Gensler’s intention to regulate cryptocurrency exchanges has been ongoing. Last month, he said that cryptocurrency exchanges should be under the SEC’s supervision. He also urged Congress to take more active steps to regulate cryptocurrency exchanges.

From this year, governments worldwide are expected to accelerate regulations on cryptocurrency exchanges. According to a report by the US blockchain analytics firm Chainalysis, large sums of money are flowing to unknown destinations, such as the $400 million (approximately 477 billion KRW) worth of cryptocurrency hacked by North Korea last year. The reason the Financial Action Task Force (FATF) emphasized the introduction of the Travel Rule for cryptocurrency exchanges is to ensure transparency of funds. The Travel Rule mandates cryptocurrency exchanges to verify the identity of traders and share information with counterparties to prevent money laundering.

The US Treasury Department has indicated concerns since last year that cryptocurrency could be used for illegal funds, hinting at cryptocurrency regulation. In South Korea, although taxation and other measures are currently delayed ahead of the presidential election, if the enactment of industry-specific laws progresses, cryptocurrency exchanges are expected to be regulated more swiftly.