Digital Asset Disputes – A Brief Taxonomy

Digital assets and blockchain technology are increasingly being adopted globally. Clyde & Co’s traditional clients, e.g. insurers, are now adopting these, and new market entrants are also appearing.

Part A – New Technology

The market capitalisation stands in the trillions, and the sector receives increasing political, policy and regulatory investment. While this presents an opportunity for existing and new businesses, there is also the potential for major disputes.

Forewarned is forearmed, and in this article, we provide a taxonomy of blockchain disputes we have seen arise.

Part B - On-Chain Disputes

Smart Contract Vulnerabilities

Exploits and Hacks: If a smart contract has a bug or vulnerability, malicious actors might exploit this to drain funds or disrupt the contract's operation, leading to disputes over ownership and restitution.

Unexpected Outcomes: Smart contracts execute exactly as coded, which sometimes results in unintended or unfavourable outcomes for the parties involved, leading to disputes over whether the contract should be voided or altered.

Forks and Chain Splits

Consensus Disagreements: If the community or validators of a blockchain disagree on protocol upgrades or governance decisions, it can lead to a hard fork, where the blockchain splits into two separate chains. Disputes may arise over which chain is the "legitimate" one and how assets on the old chain are treated on the new chain.

Replay Attacks: In the event of a fork, transactions valid on one chain might be replayed on the other chain, leading to potential disputes over unauthorized or unintended transactions.

Governance Disputes

Voting Discrepancies: Disputes can arise over the outcomes of on-chain governance votes, particularly if there are allegations of manipulation, collusion, or other irregularities.

Proposal Execution: Even after a proposal is passed via on-chain governance, there might be disputes regarding its implementation, especially if different stakeholders interpret the proposal differently.

Transaction Disputes

Double Spending: Disputes over double spending, where the same cryptocurrency is used in two transactions, can arise, particularly in networks with lower security or when a blockchain experiences a 51% attack.

Stuck Transactions: Sometimes, transactions get stuck due to low fees or network congestion, leading to disputes between parties over whether the transaction should be re-sent or whether it is still valid.

Asset Ownership Disputes

Private Key Theft: If someone’s private key is stolen and their assets are transferred on-chain, disputes can arise over ownership and whether the transaction should be reversed.

Multisig Wallet Disagreements: In wallets requiring multiple signatures (multisig), disputes can occur if one or more signatories refuse to sign a transaction, effectively blocking the movement of funds.

"Oracle” Disputes

Incorrect Data Feeds: Disputes can arise if an oracle, which feeds off-chain data to a blockchain, provides incorrect or manipulated data, leading to the erroneous execution of smart contracts.

Oracle Downtime: If an oracle service goes down or becomes unavailable, it can cause delays or failures in smart contract execution, leading to disputes over the validity of the contract’s actions.

Token Issuance and Distribution

ICO/IDO Scams: Initial Coin Offerings (ICOs) or Initial DEX Offerings (IDOs) sometimes lead to disputes if the project fails to deliver on its promises or if the tokens issued are manipulated.

Airdrop Controversies: Disputes can arise over the fairness and transparency of token airdrops, especially if some eligible participants are excluded or if there are allegations of favouritism.

DeFi Protocol Exploits

Flash Loan Attacks: In decentralized finance (DeFi), flash loan attacks can be used to manipulate markets or exploit vulnerabilities in protocols, leading to disputes over the legality and rectification of such actions.

Liquidity Pool Discrepancies: Disputes can arise over the distribution of rewards or fees within liquidity pools, especially if there is an imbalance or if one party feels they have been shortchanged.

Part C Off-Chain Disputes

Regulatory Compliance and Legal Disputes

Regulatory Violations: Disputes arise when crypto projects or companies fail to comply with local or international regulations, such as securities laws, anti-money laundering (AML) rules, or know-your-customer (KYC) requirements. Regulatory bodies may impose fines, sanctions, or legal actions against non-compliant entities.

Licensing and Jurisdiction: Companies offering crypto services may face disputes over the legality of their operations in certain jurisdictions, leading to legal battles or the need to acquire proper licensing.

Intellectual Property and Copyright Disputes

Code Ownership: Disputes over who owns the rights to specific code, especially in open-source projects, can arise if contributors or developers claim ownership or if someone forks a project without proper attribution.

Branding and Trademarks: Crypto projects might face disputes over the use of names, logos, or other branding elements, especially if they are similar to those of existing companies or projects.

Business and Partnership Disputes

Contractual Breaches: Disputes can occur if a business partner, supplier, or service provider fails to fulfil their obligations under a contract, leading to conflicts over payment, deliverables, or other terms.

Mergers and Acquisitions: In the event of a merger or acquisition, disputes may arise over the valuation of assets, the distribution of tokens, or the continuation of the project under new management.

Token Sale and Investment Disputes

ICO/IDO Fraud: Investors might claim fraud or misrepresentation if a token sale (ICO/IDO) fails to deliver on its promises, leading to legal disputes over refunds, damages, or criminal charges against the project founders.

Venture Capital Disputes: Disagreements between crypto startups and venture capitalists can occur over the terms of investment, equity distribution, or control of the project, particularly if the project underperforms or pivots in a new direction.

Employment and Labor Disputes

Employment Contracts: Disputes can arise between crypto companies and their employees or contractors over issues such as pay, equity compensation, job responsibilities, or termination.

Remote Work Issues: In a largely remote and decentralized industry, disputes can occur over work expectations, communication challenges, or cultural differences between geographically dispersed teams.

Consumer Protection Disputes

Scams and Fraudulent Schemes: Consumers may fall victim to scams, such as phishing attacks, Ponzi schemes, or fraudulent investment platforms, leading to disputes over lost funds and the pursuit of legal remedies.

Service Failures: Disputes can arise if a crypto exchange, wallet provider, or other service fails to deliver on their promises, such as delaying withdrawals, losing funds, or experiencing prolonged downtime.

Custody and Asset Recovery

Lost Private Keys: If an individual loses their private keys or access to their crypto assets, disputes may arise with service providers or custodians over the responsibility for the loss and the potential recovery options.

Third-Party Custodianship: Disputes can occur if a third-party custodian (e.g., an exchange or wallet service) mishandles assets, leading to disagreements over liability and compensation.

Reputation and Defamation Disputes

Negative Publicity: Disputes can arise if a project or individual believes they have been unfairly defamed or misrepresented by media outlets, influencers, or competitors, leading to potential legal actions for defamation.

Community Conflicts: In decentralized communities, conflicts can occur over leadership decisions, governance proposals, or community behaviour, leading to disputes that may spill over into social media or other public forums.

User Agreement and Terms of Service Disputes

Terms of Service Violations: Users may dispute actions taken by platforms (e.g., exchanges, social media) that result in account bans, fund seizures, or service restrictions, particularly if they believe the terms of service were unfair, unclear or incorrectly applied.

Data Privacy Issues: Disputes can arise if a crypto company mishandles user data, leading to conflicts over data breaches, privacy violations, or the use of personal information without consent.

Taxation and Financial Reporting Disputes

Tax Evasion Claims: Individuals or companies may face disputes with tax authorities over the reporting and payment of taxes on crypto transactions, especially in jurisdictions with unclear or evolving tax laws.

Audit Disputes: Disputes can arise during financial audits, particularly if there are disagreements over the valuation of crypto assets, the classification of transactions, or the interpretation of tax obligations.

Part D – Comment

Understanding the old issues that cause disputes, and the new ways disputes can arise, can assist organisations in mitigating them with the appropriate governance, policies & procedures, and control testing. A considerable amount of time is being spent on building the compliance infrastructure for these businesses, and, in our view, that will only continue in the foreseeable future.