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Decentralized crypto platform can be sued as general partnership, judge rules

Decentralizing ownership of a trading platform to token holders means token holders may be liable for damages from a 2021 hack.

(CN) — A decentralized finance platform for margin trading and lending in cryptocurrencies can be sued as a general partnership, a federal judge said in allowing a putative class action by victims of a $55 million hack of such a platform to proceed.

U.S. District Judge Larry Burns in San Diego mostly denied the motions by the founders and investors of bZx, a decentralized autonomous organization, or DAO, to dismiss the lawsuit that seeks to hold them liable for negligence over the 2021 hack.

In a DAO, according to bZx users' complaint, there is no formal corporate structure, no explicit liability protection, and no distinction between managers and directors, or between general and limited partners. Instead, holders of specific tokens, in this case BZRX tokens, have governance rights that allow holders to suggest actions that the DAO will take. These suggestions are then voted on and implemented if enough token holders support them.

On Monday, Burns rejected the argument by the defendants that by treating each and every BZRX token holder as a plausible co-owner of a business, with management authority and unlimited personal liability for any losses connected to the platform, he would be a radically expanding and altering of long-standing principles of partnership law.

"When transitioning control of the bZx protocol from bZerox LLC to the bZx DAO, the partners elected to forgo registering the DAO as an LLC or other legal entity with limited liability," Burns wrote, referring to the 2021 switch of the platform from the co-founders' company to a decentralized entity controlled by owners of BZRX tokens issued by the DOA.

He noted the Commodity Futures Trading Commission previously concluded that bZx co-founders Kyle Kistner and Tom Bean decided to transition their limited liability company bZerox to a DAO in order to insulate the platform, or protocol, from regulatory oversight and accountability for compliance with U.S. law.

Citing legal precedent, Burns said courts do not countenance partnerships which attempt to afford all the advantages of commercial intercourse without corresponding liabilities, and an agreement which contemplates such evasion will be construed and enforced as a general partnership.

The judge also rebuffed the defendants' argument that they didn't have a duty of care to the plaintiffs, a legal requirement to claim negligence, because the stolen funds were technically in the plaintiffs' own custody.

"A successful phishing attack on a bZx developer allowed a hacker to gain access to all of the funds supposedly in plaintiffs’ custody, rendering the distinction between custodial and noncustodial meaningless here," Burns wrote.

The Commodity Futures Trading Commission, as part of a $250,000 settlement, last year accused the platform and its co-founders of illegally offering leveraged and margined retail commodity transactions in digital assets, of engaging in activities only registered futures commission merchants can perform, and of failing to adopt a customer identification program as part of a Bank Secrecy Act compliance program.

When announcing that bZx was changing to a DAO, Kistner told users it was being done to make sure that when regulators asked then to comply, they could respond that there was nothing they could do because they had "given it all to the community."

"The court's opinion confirms that cryptocurrency creators and investors cannot evade accountability by hiding behind so-called 'decentralization,'" Jason Harrow, an attorney for the bZx users, said in an email. "Corporations exist for a reason: to limit liability. When people intentionally refuse to incorporate and then lose tens of millions of dollars of customers' money, the court system is fully capable of holding them accountable. This is a strong signal in that direction."

Attorney for the defendants didn't immediately respond to requests for comment on the ruling.

Categories:Business, Courts, Financial, International

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