Coinbase and Its CEO Hit With New Class-Action Lawsuit

The plaintiffs allege that they were deceived into buying securities and that Coinbase’s business model is illegal.

Coinbase and its CEO Brian Armstrong are facing a new class-action lawsuit alleging that people were deceived into buying securities and that the exchange’s business model is illegal. The lawsuit was filed in a California district court and claims that Coinbase's digital asset sales violated state securities laws, with tokens like Solana and Polygon being considered as securities.

Meanwhile, Alexander Vinnik, co-founder of the BTC-e exchange, pleaded guilty to money laundering conspiracy. Additionally, three former executives of the bankrupt crypto lender Cred were charged with wire fraud and money laundering.

Coinbase in Hot Water

A new class-action lawsuit has been filed against Coinbase and its CEO Brian Armstrong. The lawsuit, filed in the United States District Court for the Northern District of California San Francisco Division, alleges that investors were deceived into buying securities and that Coinbase's business model is illegal.

The plaintiffs also claim that Coinbase's digital asset sales violated state securities laws since the company was started. They believe that tokens like Solana (SOL), Polygon (MATIC), Near Protocol (NEAR), Decentraland (MANA), Algorand (ALGO), Uniswap (UNI), Tezos (XTZ), and Stellar Lumens (XLM) are securities.

According to the lawsuit, Coinbase actually admitted to being a "Securities Broker" in its user agreement and implied that the digital asset securities sold by the exchange qualify as investment contracts or other securities. The plaintiffs pointed out that Coinbase Prime brokerage is functioning like a securities broker.

The plaintiffs want full rescission, statutory damages under state law, and injunctive relief through a jury trial. This is certainly not Coinbase’s first legal rodeo as this lawsuit is very similar to another class-action suit about consumer harm from Coinbase's sale of securities.

Coinbase has argued that secondary crypto asset sales do not meet securities transaction criteria and questioned the relevance of securities regulations.

Coinbase is also already involved in a very publicized legal battle with the U.S. Securities and Exchange Commission (SEC) about the classification of tokens sold on its platform as securities. Coinbase recently filed an interlocutory appeal in response to a judge's decision allowing the case to proceed.

Despite the legal challenges, Coinbase reported an impressive rebound in the first quarter of 2024, driven by improved market performance and the launch of spot Bitcoin exchange-traded funds. The exchange posted $1.6 billion in total revenue and $1.2 billion in net income for the first quarter.

What is a Security Token?

Tokenization is a process integral to understanding security tokens, and involves representing real-world assets or rights digitally. Essentially, anything can be tokenized, like ownership and registration of a car. For instance, a token could signify ownership of a car by tokenizing its vehicle identification number (VIN) along with the owner's details, recorded on a blockchain. Security tokens are created through a very similar process, with a company inputting what the token represents and offering it to investors on exchanges or investment platforms. Ownership of these tokens is then recorded on the blockchain, associated with the owner's blockchain address.

The concept of tokenizing ownership isn't entirely novel, as paper stock certificates were previously issued by companies to investors. These certificates represented ownership or other rights and were very similar to digital security tokens, albeit in physical form. However, digital security tokens are stored and created on a blockchain, offering efficiency and transparency in ownership transfer.

While security tokens and cryptocurrencies share similarities, their fundamental difference lies in their intended use. Cryptocurrencies like Bitcoin and Ethereum are designed for use as decentralized currencies or transactional mediums. In contrast, security tokens mimic traditional investment assets like stocks or bonds and are intended for investment purposes.

Despite this distinction, certain cryptocurrencies, like Bitcoin and Ethereum, have been treated as security tokens by investors because of their trading and investment potential, although they were not originally designed for these purposes. It is important to note that while they may function similarly in the market, they do not inherently meet the criteria to be considered securities by regulators like the SEC.

The BTC-e Money Laundering Conspiracy

In other legal news, Alexander Vinnik, the co-founder of the crypto exchange BTC-e, has pleaded guilty to money laundering conspiracy after an investigation into the exchange's activities from 2011 to 2017.

The United States Department of Justice (DOJ) announced on May 3 that during Vinnik’s time at the exchange, BTC-e processed more than $9 billion in transactions with a user base exceeding one million globally, including many users in the United States. The platform was allegedly used to launder money stolen through criminal activities like computer hacking, ransomware attacks, and drug trafficking.

According to the DOJ, BTC-e operated without any essential legal compliance measures, which made it very attractive to people who were looking for a way to conceal money transactions from law enforcement. It was also revealed that Vinnik established many shell companies and financial accounts around the world. This allowed him to facilitate the illicit transfer of funds through BTC-e, resulting in criminal losses totaling at least $121 million.

Vinnik has been dealing with legal battles for the past five years because of his alleged role in BTC-e. Arrested in Greece in 2017 on money laundering charges, he was later extradited to France in 2020. In France, Vinnik was acquitted of ransomware allegations but convicted of money laundering charges and sentenced to five years in prison. Despite an unsuccessful appeal by his lawyers who claimed he was only an exchange employee with no involvement in illicit activities, Vinnik was extradited to the U.S. in 2022 after serving two years in a French prison.

As a Russian citizen, Vinnik attempted to secure a prisoner swap deal between Russia and the United States, but his attempt ended up being unsuccessful. This case is just one of many that proves that U.S. regulators are scrutinizing crypto exchanges at the moment. Very recently, the former FTX CEO Sam Bankman-Fried was sentenced to 25 years for seven felony charges as well.

Former Cred Executives Charged

Three former executives of the bankrupt crypto lender Cred have been charged with engaging in wire fraud and money laundering before the firm's collapse in November of 2020. Daniel Schatt, the former CEO, and Joseph Podulka, former chief financial officer, face 13 charges each, while James Alexander, former chief commercial officer, is facing four counts.

Mark Mosley, an acting special agent in the U.S. Internal Revenue Service, described the alleged scheme as predatory as it ended up defrauding victims of hundreds of millions of dollars in cryptocurrency.

Cred's bankruptcy in 2020 caused some concerns among users about the safety of their funds. Prosecutors allege that the executives misled customers about Cred's lending and investment practices, falsely claiming collateralized or guaranteed lending and hedged cryptocurrency investments. Despite the claims, prosecutors hold firm that Cred engaged in lending that was neither collateralized nor guaranteed.

Schatt and Podulka appeared in court on May 2 and are scheduled to enter a plea on May 8, while Alexander's court date has not been set yet.