On May 19th of this year, Binance’s platform suffered major technical flaws that caused millions of dollars in losses. As the markets began to tumble in response to the Chinese regulators tightening restrictions on crypto services, traders around the world discovered that they were unable to close their positions. The accounts of potentially thousands of individuals were frozen for hours, meaning that various types of futures, margin and leveraged token products were completely untradeable. Individuals trying to take profits or minimise losses found that they were unable to do so. Many discovered that, not only were they unable to trade, but that their accounts ended up being completely liquidated – reducing balances, some of millions of dollars, to zero. Francis Kim, a tech startup founder residing in Melbourne, lost $171,000 when this happened to him:
“I was shorting Bitcoin. I had big profits on the position. When I decided to create a take profit target on my short position, the app stopped working. I quickly wanted to close out my position however my position could not be closed. I was ultimately liquidated.”
When those affected sought recompense from Binance, however, they found that the company’s terms and conditions made pursuing compensation incredibly difficult and expensive. As per the user agreement which all customers have to sign in order to open an account, no country in the world has jurisdiction over Binance. The only place where it is possible to pursue litigation against Binance is in the Hong Kong International Arbitration Center. Just to raise a claim in this court costs $65,000. This effectively means that those who have lost less than $65,000 have no recourse at all. When you also take into account the time and expense involved in travelling to Hong Kong, as well as securing legal representation, the costs can easily head into the hundreds of thousands. This is simply unfeasible for the vast majority of Binance users. To make getting lost money back even harder, Binance also caps the amount of damages they can ever pay a client for any loss they incur. The only money that is recoverable is the small commission they take on each trade made on their exchange over the last twelve months.
Is this type of contract legal? Is it legally permissible for a company to avoid responsibility in this way? So far Binance has avoided these questions given its complex structure, which operates “through a complex global network of legal entities”, and has no formal HQ anywhere in the world. But now a group of 700 traders, backed with at least $5 million from Swiss litigation finance firm Liti Capital, are taking Binance to court in Hong Kong in an attempt to recover the losses they have suffered and get an answer to these important questions.
A critical moment
David Kay, the CEO of Liti Capital, spoke to us at DisruptionBanking about the case and what he hopes this “critical moment for the crypto community” will achieve. He first outlined how this legal action came about and how it is to be structured:
“The massive crash on May 19th impacted a lot of traders and ultimately caused hundreds of millions of dollars’ worth of damage. There are 700 people that got together after that event and organised themselves, with a steering committee of six people that are leading the effort. That group had $20 million worth of claims and came to us at Liti Capital. We have cut a deal with them to finance at least $5 million to bring a claim against Binance. We’ve hired White & Case, which is the number one firm in the world for international arbitration cases, and we have hired their lead partner, Abby Cohen Smutny, along with Darryl Lew, to run the case.
“We want to let the world know that, to the extent that you have been harmed by Binance’s actions, there is a group that you can join, allowing your claim to be heard, and it will cost you nothing. There’s no out of pocket cost. It will be akin to a US class action, though there’s no such thing as a class action in international law, but it will be akin to that. All people would need to do is sign up and give us their information – and once your claim is accepted, you’re all set. If we win, you will get a cheque in the mail. And if we lose, you’ll never know. Because it doesn’t cost you anything and won’t take up any of your time. To our knowledge, this is the first third-party funded case in crypto.”
This is likely to be a landmark case in the evolution of the crypto industry. So far, regulators and governments around the world have failed to catch-up with developments in this space. This has meant that companies such as Binance have arguably managed to avoid proper legal oversight. Whilst many are attracted to the libertarian philosophies from which crypto and DeFi emerged, this lack of regulatory scrutiny causes problems when things go wrong – as they did, spectacularly, in May. As David explained:
“I think this could be a defining moment for the crypto community, the blockchain community, and the decentralised finance (DeFi) community. Binance has positioned itself as a company that cannot be regulated. No laws apply to it, no rules apply to it, they can simply go out and do whatever they want to do. Regulators all around the world are trying to figure out if and how to deal with it.
“I think this case is the next part of that conversation, which is to say, what about consumers? What happens if you are harmed by Binance? Is there a way, given that no country has jurisdiction over them for you to get compensation in their user agreement? This is something very interesting. Their contract, which forces consumers to undertake an extremely expensive process in pursuing litigation in Hong Kong, and which only allows the small transaction fees to be recovered, means that many effectively have no recourse at all. It also means that Binance caps the amount of damages they can ever pay you for anything. But we have one guy who lost $11 million! It’s absurd. It’s unconscionable. It would not be permitted. That type of contract is not permitted in any of the jurisdictions that Binance would otherwise operate in.”
Responsibility for failure
Many of the individuals Liti are working with lost serious amounts of money on May 19th. For example, Fawaz, a Binance user from Canada, suffered a loss of $6 million. This was because of a fault in the Binance app:
“On May 19th, the “Close Position” button in Binance’s iOS app did not work for about an hour in my case. I tried clicking the button 70+ times in that hour when Ethereum’s (ETH) price was fluctuating between $2,500 and $2,700. I had been trying to close my position or at least put a stop loss. I couldn’t because none of the buttons in the Futures tab clicked. I could not close, hedge, or manage my position.
“I first tried to close my position fully at about 12:00 (UTC) when I saw that ETH had lost a critical price support level and that Open Interest had climbed up. This is never a good sign in the crypto world. I realised then that this would lead to a massive crash across the board. So, I decided to cut my position fully. The “Close Position” button just wouldn’t click. I kept trying for the next 50 odd minutes but none of the buttons in the app clicked […] I tried to click that “Close Position” button between 60 and 70 times, obsessively, to try and close my position. But it never worked. Eventually, my position got fully liquidated.”
But it is not just about the amounts of money involved. It is also about the wider legal and moral principle: can a company be held responsible for its failures? To make this point, the advisory committee that is leading this effort against Binance is made up of people who suffered losses both large and (relatively) small:
“These are normal people who have lost money. Some have lost millions of dollars and some have lost hundreds of dollars. In fact, on the advisory committee that we have formed, we have purposely selected claimants that were at different iterations. So we have a guy with a $12 million loss, and we have a guy with a $125 loss. We’re trying to make the point that everybody matters.”
Rules and regulations
As the crypto and DeFi communities move forward, David believes that assets like Bitcoin and Ethereum, entities “that exist without an organization around to run them and are self-sustaining” need to retain their independence “for the greater good of everybody.” But profit-making companies have arguably coopted these principles and attempted to use them in order to evade responsibility. Whilst David thinks that “we need to fight to save” the ideas that make cryptocurrencies what they are, there is equally “a clear, non-grey, red line” that he believes Binance has crossed:
“There is a line between that need [retaining crypto’s independence] and the actions of companies that are for profit. You cannot equate community resources and how companies treat people using those community resources as the same thing. Binance is a for-profit company that is making money off of these resources. There need to be rules and regulations so that consumers can interact with such companies safely so that the free, unregulated resources can stay protected and continue to be viable.
“We should not have any more than the barest minimum of regulation, but the trillion dollar or $100 billion companies that take our money for profit have a responsibility to their consumers. There has to be rules. There has to be regulations. There has to be some way where, if something goes wrong, you can hold someone accountable.
“I mean, think about this for a minute. This one guy woke up in the morning. He had spent six years building his account up from nothing to having $12 million there. Bitcoin starts to go down, he is pushing “Close Contract.” The website doesn’t work. By the time the website does work, Binance has liquidated his account. And he has $0.00. Is that acceptable? He was trading a Binance product. Binance’s website didn’t work and Binance then made the decision to use their power to liquidate his margin account and take 100% of his money. All while he’s trying to push the button to close the contract. It’s completely unacceptable.”
No matter the result, this case in Hong Kong is undoubtedly going to be critical for the crypto community. This will be the first decision that indicates how this new type of company which has emerged – those without borders, without headquarters, without a single jurisdiction – is to be regulated. It will also assert what type of responsibility exchanges like Binance have to their consumers. It is clear that the crypto industry has now reached a size where traders, companies and regulators need to work out how best to proceed. Retaining the defining features of assets such as Ethereum, whilst having sensible rules that protect consumers, will be crucial for the industry’s development in the months and years ahead. As David argues, if appropriate regulation is not instigated, “consumers and investors are going to get really freaked out” in a manner that will only undermine this space’s long-term viability. The moment has come where, in David’s words, the community needs to look at itself and say “Okay, how is this gonna work?”
Author: Harry Clynch