The theft of millions of bitcoins and related failure of cryptocurrency exchange Mt. Gox—recently written about in the Wall Street Journal—provides a perfect example of how cryptocurrency-related issues can blossom into one of our Top Ten Regulatory and Litigation Risks.  The WSJ article chronicles the journey of Kim Nilsson—one of the victims of the $400 million bitcoin theft from Mt. Gox in 2014—as he investigates and eventually uncovers the identity of the hacker who stole his bitcoins.  During his investigation, Mr. Nilsson discovered another concern—one potentially ripe for dispute:

"Mt. Gox had been concealing bitcoin thefts that occurred as far back as 2011 and had been insolvent since at least 2012—two years before it filed for bankruptcy."

Historically, investors and other transferees could be subject to clawback actions where they profited from “false profits,” which had been paid using proceeds from other harmed investors, during periods of insolvency—as demonstrated in Madoff and other frauds.  Given that Mt. Gox was reportedly insolvent years before its bankruptcy petition in 2014, this may spell trouble for investors that cashed out at values above their initial investment cost during the undisclosed period of bitcoin thefts.   In essence, investors who cashed out during the period of insolvency may have received more money than they were entitled to receive, depending on the applicable law.

Mt. Gox should serve as a warning to investors in cryptocurrencies, as fraud and insolvency involving cryptocurrency-related investments or businesses is unlikely to diminish.  Myriad complex issues will arise with respect to the applicable law and the rights and duties of those involved.  The good news is that in the U.S., the law adapts to new circumstances using historical concepts.  The bad news is that the evolutionary process can be rocky and difficult to predict, making it difficult to risk-weight outcomes.  Thoughtful participants in these sectors should assume that Mt. Gox foreshadows a larger trend of fraudulent conduct and resultant litigation, given cryptocurrencies’ meteoric rise and potentially rapid declines.  More specifically, fund managers and others involved in cryptocurrency-related investments should keep in mind clawback actions, and be prepared for disputes.