A recent class certification decision out of the Southern District of New York provides insights on how courts will analyze the requirements for class certification, at least at the initial stage, in cases involving cryptocurrency. A crypto-asset is a digital asset designed to work as a medium of exchange or a store of value or both. Cryptocurrencies, utility coins, and security tokens are all examples of crypto-assets. In April 2020, a purchaser of cryptocurrency filed a putative class action against KuCoin, a cryptocurrency exchange, and individual defendants alleging that defendants promoted, offered, and sold ten digital Tokens (a type of cryptocurrency) without registering as an exchange or broker-dealer, and without a registration statement in effect for the securities it was selling, in violation of securities laws. Williams v. Kucoin et al., Case No. 1:20-cv-02806-GBD-RWL (S.D.N.Y. Oct. 21, 2021). However, to be in violation of securities laws, crypto-assets must constitute securities which means satisfying the four-prong test set out by the SEC known as the Howey test – (1) a party must make an investment of money or other valuable consideration, (2) the investment must be in a “common enterprise,” (3) investors must have a “reasonable expectation of profit,” and (4) the profits are expected to be “derived from the efforts of others.” Plaintiffs alleged that defendants worked “to capitalize on the enthusiasm for crypto-assets” in their allegedly improper sales.
In seeking class certification, plaintiffs argued that the class comprised of anyone who bought or sold any of the ten different Tokens available on Kucoin, which, according to the Amended Complaint, was “believed to be in the tens of thousands” customers. The Court granted the motion in part – certifying a class of buyers who had purchased or sold the same Token as the named plaintiff, as opposed to the customers for KuCoin’s full portfolio of Tokens. The Court held that the named plaintiff lacked standing with respect to asserting claims related to types of Tokens he did not purchase. The Court reasoned, to succeed on his claims, the named plaintiff must demonstrate that the specific Tokens that he purchased and sold are securities, which in turn involves applying an individualized and factually intense Howey test. While the Court did not reach a conclusion here, other federal courts have ruled that in certain circumstances, cryptocurrencies may be subject to federal securities laws. See U.S. v. Zaslavskiy, No. 1:17-cv-00647, 2018 WL 4346339 (E.D.N.Y. Sept. 11, 2018).
Establishing KuCoin’s liability thus would require evidence corresponding to each prong of the test for each Token. Although KuCoin issued all the Tokens, they were not “originated” by KuCoin and each purchaser’s right to recover would turn on the individualized circumstances of each Token. These circumstances include whether the cryptocurrency originated from the same issuer, whether different types of currency are substantially similar, and whether the cryptocurrency originated from the same location or different locations. In Williams, the Court considered factors regarding standing in concluding that plaintiff’s incentives were not “sufficiently aligned with those of absent class members who purchased the Tokens that he did not.” Notably, by limiting the class this way, the Court was left with a class comprised of 26 investors versus the class of thousands of investors that plaintiffs originally alleged in their complaint.
After addressing standing, the Court then addressed the Rule 23(a) requirements of numerosity, commonality, typicality, and adequacy of representation. In addition, the Second Circuit considers “ascertainability,” which requires that a class can be defined using objective criteria that establish class membership with definite boundaries. Despite the small class size of 26 investors, the Court found that numerosity was satisfied, as well as the other Rule 23 requirements of commonality, typicality, and adequacy of representation for the class of individuals who purchased the same Token as the plaintiff. While the class size of 26 members fell in a “gray area” under Second Circuit law, the Court found that judicial economy would be served by proceeding in one action rather than 26 individual actions, given the relatively modest amount in controversy on individual claims. The Court acknowledged that the plaintiffs faced some hurdles with respect to ascertainability because KuCoin had not entered an appearance and therefore plaintiffs were unable to conduct discovery on KuCoin’s transactional records to identify the class. While KuCoin is in default, a default judgment has not yet been entered. Absent such discovery, class members would have to self-identify themselves in response to a published notice plan. The Court nonetheless concluded that, “[f]or now, that is sufficient.”
With regard to the requirements of Rule 23(b)(3), the Court determined the suit satisfied the predominance requirement because resolution of some of the legal and factual questions (such as whether the Token constitutes a security) can be achieved through generalized proof. Also, the Court found that the superiority requirement of Rule 23 was met because a class action was superior to the costly and inefficient litigation of multiple individual lawsuits.
The Williams decision further emphasizes additional class certification considerations that courts must undergo in cases involving cryptocurrency and securities in general. While the same general principles under Rule 23 apply, cryptocurrency cases require courts to conduct additional analysis regarding whether the specific cryptocurrency at issue constitutes a security and also whether its attributes can be applied to a larger class.