Coinlab v. MtGox: Coinlab Replies to MtGox’s Counterclaims

In the Coinlab v. MtGox lawsuit, Coinlab filed their Reply to MtGox’s Counterclaims on Friday, October 4. [link].


As a brief recap, the primary thrusts of MtGox’s Counterclaims were two pronged: first, MtGox acknowledged they did not perform their obligations under the contract because Coinlab was in breach as they were not “in compliance with all applicable laws” by a specified date. See this post. Specifically, Coinlab was not registered as a Money Transmitting Business with either the U.S. Federal Government, nor with the 47 states that require similar registration. Second, pursuant to the agreement, MtGox credited Coinlab customers’ deposits in the amount of $12.8 million on its site; in turn, Coinlab was supposed to transfer said deposits to MtGox. According to MtGox, Coinlab only covered the first $7.5 million of those deposits, leaving MtGox with a $5.3 million deficit.

Coinlab’s most recent filing advances a handful arguments in an effort to undercut the substance of MtGox’s allegations. Regarding the allegation that they were not compliant with applicable law & regulation, Coinlab asserts, for example, that “sale and exchange of bitcoins is not an ‘unlawful’ business;” “CoinLab has never been found by any state or federal regulatory agency or by any court to be in violation of any law or regulation;” “[r]egulatory authority over these exchanges . . . historically been either non-existent or uncertain, and is only now beginning to take a more coherent shape;” and “application of [FinCEN regulation] to Bitcoin services has not been determined by any court.” Cryptically, Coinlab claims they “registered with FinCEN long before the March 2013 guidance was issued, and, immediately after the guidance was published, CoinLab filed to update its registration, consistent with the guidance.”

Next, regarding MtGox’s allegation that Coinlab has converted $5.3 million in customer deposits, Coinlab asserts that they’re unable to “determine what funds, if any, [are] owed,” and that “CoinLab has complied in good faith with the Agreement by making every possible reconciliation.” Coinlab goes on to claim that MtGox regularly underreported fees due to Coinlab, and attempts to minimize any outstanding debt still owed by arguing that Coinlab is still entitled to exchange fees notwithstanding termination of the contract.


Notably, none of Coinlab’s assertions directly address their regulatory compliance, but instead collaterally attack extant regulation. Likewise, Coinlab doesn’t deny still owing money to MtGox, but avows that its less than $5 million, and goes one step further by averring that MtGox should be paying Coinlab monthly exchange fees.

Once again, one possible interpretation of Coinlab’s evasive responses is that they were, indeed, non-compliant with U.S. regulation, which would constitute breach of the contract. This view is supported by the fact that Coinlab’s Reply spends no small amount of time attempting to explain their non-compliance and marginalize the regulations they failed to comply with, as well as attempts to show MtGox itself was non-compliant (wasn’t that the reason they sought a North American partner?) So the argument goes, Coinlab’s assertion that they couldn’t determine the amount they owed MtGox (“if any”) along with the pretense that MtGox continues to owe a monthly fee payment to Coinlab even after termination of the contract (without citation to relevant contractual provision) lends itself to the notion that Coinlab is grasping at straws.


Coinlab v. MtGox Joint Status Report Update

Pursuant to Docket (“Dkt.”) entry 8 in Coinlab v. Mtgox, the status report & joint discovery plan contemplated by Federal Rule of Civil Procedure 26(f) was originally due to the court on September 20, 2013. However, pursuant to request by both parties, see Dkt. 17, the court extended the deadline to October 10, 2013see Dkt. 20. Similarly, both parties requested additional time for Coinlab to respond to the counterclaims levied by MtGox in their Answer, see Dkt. 16, which the court granted, see Dkt. 19. Consequently, observers will have to wait a few more weeks before seeing further developments.

Legality of Over the Counter Bitcoin Trading in the U.S.

According to FinCEN’s March guidance, any entity “that (1) accepts and transmits a convertible virtual currency or (2) buys or sells convertible virtual currency for any reason is a money transmitter,” and thus provides money transmission services. U.S. federal law requires such entities to register as Money Transmission Businesses (“MTB”) with the U.S. Department of Treasury (“DOT”). 31 U.S.C. § 5330. Does this mean that over the counter bitcoin (“OTC”) traders need to register as MTBs?

Not necessarily. Periphrastically, FinCEN grants an exception for natural persons (human beings) engaged in money transmission “on an infrequent basis and not for gain or profit.” 31 C.F.R. § 1010.100(ff)(8)(iii). However, neither “infrequent,” nor “for gain or profit” are defined in the regulation; thus, the issue is what is the meaning of those terms? More importantly, how does FinCen interpret them?

There isn’t a clear answer. Intuitively, the phrase “for gain or profit” is likely meant to refer to the derivation of income, rather than a psychological benefit or incidental increase in value. In contrast, the term “infrequent” has no such innate meaning. Webster’s defines it as “seldom happening or occuring: rare,” or “occurring at wide intervals in space or time.” Webster’s Third New International Dictionary 1161 (2002). But that definition merely trades one inquiry for another: how seldom or rare? How long a duration in time?

There’s little guidance. One oft-cited document is a report by McGladrey financial services consulting firm on the 12th Annual Florida International Bankers Association conference on Anti-Money Laundering (“AML”) compliance. [Link to report]. (The reason we care about AML is because it is squarely within FinCEN’s regulatory purview.) The McGladrey report states that the exception for infrequent activity is defined as five times per year, but does not cite the origin of that definition. Page 19. There’s no indication that the report was prepared by an attorney, nor does the context suggest this pertains to natural persons, rather than international bankers. As such, little weight, if any, should be accorded.

More helpful is the DOT’s notice of proposed rule-making in the Federal Register. 76 Fed. Reg. 43585. In it, DOT states: “By ‘infrequent’ activities, FinCEN intends to limit the exclusion to activity that is rare,” but goes on to explain in a footnote: “This limitation should be interpreted to mean activities that are not frequent as that term is used in FinCEN’s Guidance On Interpreting ‘Frequently’ Found In The Criteria For Exempting A ‘‘Non-Listed Business’’ Under 31 CFR 103.22(d)(2)(vi)(B), (November 2002).” 76 Fed. Reg. at 43,588 & n.33. That guidance states:

FinCEN interprets “frequently” to refer to the recurring or routine need by an institution’s established business customers to deposit or withdraw large amounts of currency (or engage in any other large currency transaction) in the ordinary course of carrying out business operations.

In a footnote to that guidance, FinCEN identifies the source that it derived its interpretation: 31 U.S.C. §5313(e)(2)(B), which states in relevant part “frequently engages in transactions.” Particularly useful is FinCEN’s discussion of seasonal businesses:

A seasonal business may operate only during a portion of the year, or a business may have a recurring or routine need to engage in large currency transactions “seasonally.” In such cases, the depository institution should engage in the analysis set forth above to determine whether the business has engaged in at least 8 large currency transactions during the portion of time the business operates or experiences increased cash flow.

This illustrates both quantitative (eight) and qualitative (large) components of frequency! While what constitutes “large” is still uncertain, and its applicability to natural persons, rather than seasonal non-listed businesses, is similarly unclear, we have something to work off of. Extrapolating some, “infrequent” could reasonably be understood to mean non-recurring and irregular transactions of limited size. What precisely the size threshold is remains ambiguous, but likely corresponds to FinCEN’s intent that the “exclusion not to be available to persons engaging in [money transmission] for the purpose of monetary gain or other economic benefit.” 76 Fed. Reg. at 43,588.

Ultimately, FinCEN says it best:

whether a person engages in MSB activities depends on all of the facts and circumstances of each case.


DISCLAIMER: This post does not constitute legal advice, and should not be relied upon as such. Consult an attorney licensed in your jurisdiction if you need help ascertaining the legality of your conduct.

Coinlab v. MtGox: Answer to Complaint

On Tuesday, September 10, MtGox & Tibbane, represented by the law firms of Baker & McKenzie and Hillis Clark Martin & Peterson, filed both their answer to Coinlab’s complaint, as well as twelve counterclaims against Coinlab in Coinlab v. MtGox KK, 2:13-cv-00777. The main thrust of MtGox’s argument is that the contract was voided by Coinlab’s failure to comply with its terms, viz., Coinlab failed to register with the federal government and all 47 states as a Money Transmitter by March 22, 2013. [MtGox Answer (“Ans.”)]. For more detail, read on.

The Answer

Pages 1–18 of the Answer constitute the actual responsive pleading; in it, MtGox admits, denies, or claims insufficient information to accusations Coinlab levied in their complaint. [Coinlab Complaint]. Summarizing the highlights, MtGox concedes that they didn’t perform  because Coinlab breached the contract. Ans. ¶ 2. The breaches MtGox alleged revolve around two provisions of the Exclusive License Agreement (“Agreement”) which required Coinlab to be compliant with all laws and regulations applicable to bitcoin exchange. See CounterClaim (“Countercl.”) ¶ 28. Specifically:

“CoinLab shall operate the Services in the Territory in compliance with all applicable laws after completion of the Transition Period . . . .”

Section 2(D). Next,

“The Parties, have to date and will continue throughout the Term to comply with all statutes, codes, ordinances, laws, regulations, rules, orders and decrees of all governmental authorities (including without limitation federal, state and local governments, governmental agencies and quasi-governmental agencies) having jurisdiction over a Party. The Parties specifically agree to fully cooperate and to obey any instructions or requests made by any competent authority with regard to money laundering or other criminal activities.”

Section 6(A)(iv). The transition period was 120 days from November 10, 2012, the duration of which terminated on March 22, 2013. On March 18, 2013, the U.S. Financial Crimes Enforcement Network, or FinCen (the agency charged with “safeguard[ing] the financial system from illicit use and combat[ing] money laundering”), issued guidance stating that exchangers are entities that “engage[] as a business in the exchange of virtual currency for real currency, funds, or other virtual currency,” and are money transmitters under FinCEN’s regulations if they either “(1) accept[] and transmit[] a convertible virtual currency or (2) buy[] or sell[] convertible virtual currency for any reason.”

The issue is that 31 U.S.C. § 5330 requires entities engaged in money transmission, or money transmitting businesses (“MTB”), as defined by FinCen, to register with the U.S. Department of Treasury. Failure to so register violates 18 U.S.C. § 1960, which criminally prohibits the operation of an unlicensed MTBs. MtGox became concerned when Coinlab claimed it “was registered as a ‘prepaid access’ provider and such was sufficient.” Countercl. ¶  21. According to MtGox, “[b]y the expiration of the Transition Period on March 22, 2013 CoinLab was not FinCEN registered as a money transmitter and was not licensed by any state to be a money transmitter.” Countercl. ¶ 33. Ergo, Coinlab breached the contract, and MtGox was no longer required to perform its obligations. From the Answer:

Between approximately March 19, 2013 and April 20, 2013 MtGox personnel and CoinLab personnel had several oral and email communications in which MtGox sought to determine if CoinLab was properly registered with FinCEN as a money transmitter and properly licensed as a money transmitter in those states in which MtGox customers were located. In such communications CoinLab personnel admitted that CoinLab was not registered with FinCEN as a MTB and that CoinLab had not been licensed as a MTB by any state. By the expiration of the Transition Period on March 22, 2013 CoinLab was not FinCEN registered as a money transmitter and was not licensed by any state to be a money transmitter.

Countercl. ¶ 33. The end of the Answer section contains fifteen affirmative defenses that MtGox argues excused their performance under the contract. They’re mostly variations of the same theme, viz., the contract was void from its inception and is unenforceable or was valid but rescinded, but in the terms of different legal theories.

The Counterclaims

The remainder of the document, pages 19–49, contains MtGox’s counterclaims, which are its claims against Coinlab. In other words, MtGox argues not only that CoinLab’s complaint is without merit, but also that Coinlab has injured MtGox by its (non-)performance of the contract. Specifically, Section 4(A) of the Agreement provided for revenue sharing between MtGox and Coinlab (Coinlab entitled to 40% of revenue generated by current Coinlab customers). While MtGox interpreted the provision to begin after the 120-day Transition period, Coinlab asserted it was operative during that period. “as a result, MtGox made a net transfer to CoinLab of USD $62,258.70, CAD $ 40.00 and 1428.81263537 Bitcoins.” Countercl. ¶ 27. So MtGox’s argument goes, because Coinlab breached the contract by failing to register as an MTB, Coinlab needs to return the monies & bitcoins it received under the contract.

MtGox also requests the court erect a constructive trust in the amount of $5 million, presumably to cover the balance of Coinlab customer deposits. While MtGox credited Coinlab customer deposits to the tune of almost $12.8 million on its site, Coinlab never transferred the actual funds to MtGox. After the presumptive end of the Transition period, MtGox Demanded and Coinlab transferred a portion of those amounts: around $7.5 million. That leaves a Coinlab with an outstanding balance of $5.3 million due to MtGox. [Good catch Sturles!]

The rest of the counterclaim goes on to say as much according to different legal theories.

Concluding Remarks

It doesn’t look good for Coinlab. As MtGox noted in its counterclaim, “in April 2013 CoinLab applied for an MTB license in the State of Washington. CoinLab still has not obtained a MTB license in any other state.” Countercl. ¶ 35. It’s also noteworthy that Coinlab wanted payments during the Transition period, but lacked “a schedule, a deadline or a plan to finance the application process” to become compliant. Countercl. ¶ 33. If we follow Occam’s Razor, one simple explanation is that Coinlab ran out of its venture capital, persuaded MtGox to (unknowingly) float its operating expenses, and then failed to understand or ignored Anti-Money Laundering regulatory compliance. A joint status report is due on September 20 to the federal court hearing the case, and some of the unanswered questions should be resolved.


UPDATE: the parties requested additional time, which the court granted, for Coinlab’s responsive pleading and both Coinlab’s and MtGox’s joint status report. [Link]

20 AUG—End of Summer 2013 BTC Summary

Signs of life! After a two month hiatus, this post synopsizes some BTC news highlights and sketches some contours of where the bitcoin community may want to go from here. Without further ado,

News roundup:

An obvious and pervasive theme is US state and federal regulatory hostility towards BTC as a payment mechanism. A subsequent article will examine price movement relative to news of regulatory activity.

Where to from here?

If it is a goal of the Bitcoin community that Bitcoin becomes a legitimate form of global currency, then the legitimization of Bitcoin within the U.S. is both a means towards that goal, and an end unto itself. One of the greatest problems frustrating greater capital investment in bitcoin financial infrastructure is the staggering uncertainty that arises from something that the courts haven’t ruled on yet. It is possible, if not likely, that many lawyers and courts of general jurisdiction are ill equipped to understand the technical nature of peer-to-peer cryptocurrency transactions sufficiently well enough to properly apply facts made unfamiliar by technical jargon, e.g., public key cryptography against more settled legal principles, such as electronic transactions under the Uniform Commercial Code. Taking the analogy one-step further, bitcoins are roughly analogous to electronic bearer negotiable instruments, see UCC Article 3, but bifurcated along the lines of public and private keys: the public key is the face value of an electronic instrument, while the private key can be used to redeem the value of the instrument to the claimant’s wallet. Thereafter, the value of such instrument, or fraction therof, can be similarly transferred.

Notably, at no point is a computer required for the negotiation of the instrument: it can be traded physically in the real world. By isolating the transaction and casting it in a light that courts are more familiar with, especially that of contract, the likelihood of reaching the “right” decision, whatever it may be, is increased. So the argument goes, Bitcoin transactions are bilateral contracts in which one party’s performance is satisfied by tendering a private key or keys equal in value to an agreed upon sum denominated in Bitcoins.

Here the argument comes full circle—there’s no way of knowing whether a court may find that argument persuasive until it is presented with a factually developed controversy. And while the argument may be legally sound, the facts may be hard enough such that disposition promulgates in “bad law.” In other words, this is just one possible pro-Bitcoin construction among many legitimate constructions. Which side a court might agree with is precisely what the legal proceedings are fighting over. Ultimately, a national campaign promoting favorable legal constructions is relatively narrow in scope, but still no small undertaking. In a Catch-22 the uncertainty surrounding Bitcoin frustrates investment that might otherwise support a Bitcoin Legal Defense Fund.

DISCLAIMER: this does not constitute legal advice – Summer 2013 BTC Summary. 

FinCen BitCoin Mining Ruling Requested

Atlantic City Bitcoin (“ACB”) has requested an administrative ruling from FinCen regarding whether bitcoin mining, in and of itself and without more, requires registration as a Money Services Business (“MSB”). ACB correctly identifies a problem presented for BitCoin miners as a consequence of FinCen’s March Guidance. Specifically, FinCen’s guidance states:

A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter.

So far so good; guidance continues:

By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter.

Uh oh. That seems to mean that miners who sell their mined BitCoins would have to register as an MSB. Further complicating matters is FinCen’s definition of Money Transmission Services:

The term “money transmission services” means the acceptance of currency, funds, or other value that substitutes for currency from one person and the transmission of currency, funds, or other value that substitutes for currency to another location or person by any means.

31 C.F.R. § 1010.100(ff)(D)(5)(i)(A). Arguably, the transfer of BitCoins falls within this definition. Unfortunately, in the aftermath of the Liberty Reserve debacle, it seems unlikely that FinCen would issue a permissive ruling. Moreover, it would provide the U.S. government an opportunity to clearly signal an attempt to increase regulatory control over crypto-currencies. Stay tuned…