Speaking to Finextra Research, Liti Capital’s executive chairman and chief investment officer David Kay explains that the action being financed by the firm will be the first of its kind, and could set a precedent for the notoriously challenging realm of crypto regulation.

The May 19th crash

The action is being brought on behalf of Binance customers who found themselves locked-out and unable to trade on the exchange during the infamous crypto-plunge in May this year. At time of writing, six users have become formal claimants, with legal representatives expecting that this number could potentially climb to 700.

The plunge followed a string of negative headlines and regulatory crackdown on crypto-related activity in China, resulting in Bitcoin’s dollar price dropping by over 30% while Ethereum’s fell by over 45%. This was not only one of the largest one-day price declines in cryptocurrency history, but also one of the largest-ever liquidations of traders’ positions. The entire platform crashed at 13.30 UTC, re-opening just after 15.00 UTC by which time crypto prices had recovered to pre-crash levels and short positions were no longer in the money.

As reported by the Wall Street Journal, around 700 frustrated users joined forces and coordinated their strategy over the Discord app, engaging independent Paris-based arbitration attorney Aija Lejniece who then reached out to Liti Capital for assistance with financing the case. The Swiss-based litigation financing firm has allocated $5million toward the case.

Economist and professor at the University of Sussex, Carol Alexander writes about the plunge extensively on her blog, drawing out possible conclusions which suggest that the failures of Binance’s platform on that day may have been the result of a more nefarious scheme rather than a (more forgivable) IT glitch.

“On 19 May the BTC/USDT price fell by more than 30 percent, yet Binance reported liquidations of merely 24 million USDT,” explains Alexander in her latest piece on the saga.

“I do not believe these data because on 19 May other exchanges together reported $8.6bn liquidations, Binance is larger than all the other exchanges combined, the trading volume on Binance’s BTC/USDT perpetual alone reached almost $100bn on May 19, and there are numerous press reports of huge losses experienced through liquidations on Binance on 19 May,” she adds.

She argues that the May 19th crash would have fully depleted Binance’s insurance fund, yet, the exchange reported that it was not. “In fact, if the futures platform has not closed, I believe that Binance would have had to subsidise its insurance fund by a billion USDT or more.” The findings, if true, make the crash of the Binance platform a little too convenient for comfort.

A landmark decision

Kay states that there are a number of factors which make the case unique, first and foremost being that Binance is really the first company to succeed on such a scale without being registered or ‘belonging’ to a state. It will be the first international arbitration to grapple with the issue of a ‘stateless company’ and will be the largest consumer group arbitration in history.

“Multinationals were the first entities to live in multiple states, but they still had headquarters, they had homes and importantly they had places where they could be sued. Binance has succeeded in becoming a behemoth while being ‘nowhere’ - they have no headquarters so they are regulated by no-one.”

Crackdowns on Binance have been seen the world over - regulators in the UK, US, Japan, Malaysia, Thailand, Germany have all made clear that Binance is not regulated in their jurisdiction over the past six months to seemingly no avail.

“What impact does this have on Binance?” Kay posits. “Not a thing. People just continue to go online and continue to trade regardless of where they are.”

He explains that regulators are trying to figure out how to deal with this “financial behemoth,” a leader in the fintech world, which ostensibly can’t be regulated today.

Consumer protection as lead argument

The crux of the group’s argument against Binance will centre on consumer protection, explains Kay.

“The conversation we’re going to lead is asking ‘what about the consumers?’ Is this new type of stateless company judgment-proof? Is it possible to sue them without a governing body of law, and if so, what actually happens? What are the rules when there are events on a mass scale around the world that affect thousands of people - and the entity is subject to jurisdiction exactly nowhere?”

Kay adds that the dearth of precedent for mass consumer international arbitration is simply a result of the fact that companies have always been regulated in at least one jurisdiction.

Kay stresses that every claimant taking part in the case was involved in trading leveraged products and futures accounts. “Not one of the claimants would have been allowed to have traded if Binance was following standard rules and regulations. There was no check to see if they were accredited investors nor were there checks around basic finances before customers were given margin accounts.”

“The entire body of work for developed civilisations over the last 50 years has been based around how to protect consumers from complex financial products so that they understand the risk involved. Binance has thrown that out the window.”

The fundamental concept of decentralised finance (defi) and the cryptocurrencies that come with it is naturally anathema to regulators, but, Kay argues, there comes a point when its existence has to be acknowledged and rules have to be developed.

“I think this is going to be a meaningful decision for the future,” he adds.

The fine print: Binance’s user agreement

Under Binance’s Terms of Use, which must be accepted in order to trade on the platform, any customer seeking compensation must file disputes with the Hong Kong International Arbitration Centre.

Kay argues that this condition alone raises issues around unconscionability - given the sheer cost this would incur on any individual. “The fees at the Centre were an average of $65,000 per case last year on legal costs alone.

“The 700 people that may compile our group would equate to $45.5 million that would have to be paid just to attend the arbitration. Binance’s view of the world, is that they know $65,000 would be completely uneconomical for that person to pursue recourse.”

On top of this, Kay explains that Binance’s User Agreement also caps the amount of damages a user can claim at a total equivalent to 12 months of fees. “Say you've lost $11 million, and the total fees you paid Binance over 12 months are $65,000.00. You therefore have no recourse against Binance whatsoever for the $10,935,000.00.

“The question that we all have to answer is, can a company without borders, without regulation, that is not subject to statutes, legislation, jurisprudence, that is acquiring customers in a way that is not permitted in any of the jurisdictions that those customers actually are in, then hide behind a User Agreement which makes it effectively impossible for anyone to get recourse? Is that something we're going to allow to happen?”