Stablecoin TerraUSD’s $45 billion implosion last week triggered hysteria in the crypto space. TerraUSD, which is a so-called algorithmic stablecoin that is meant to maintain a 1:1 peg with the U.S. dollar, collapsed on May 12 and at its lowest point last week, was valued at just $0.02.
Singapore-based Terraform Labs Pte. Ltd., which operates price-stable cryptocurrency, froze and then restarted its Terra blockchain in the wake of the collapse of TerraUSD and its affiliated Luna token. The market has since stabilized somewhat, but the crash last week has exposed the myriad of risks in algorithmic stablecoins and what the world saw as a new form of finance.
Lawyers in Asia say whether Terra and its South Korean founder, Kwon Do-hyung, will face legal consequences will largely depend on the fact-finding process. “At this stage, the facts are still far too fluid to tell,” said Joseph Chu, a partner at Hong Kong law firm ONC Lawyers.
The most appropriate party from whom to recover damages is the one that orchestrated the series of transactions that led to sudden devaluation, said Chu, who acted on one of Hong Kong’s first crypto litigation against a locally-based crypto exchange back in 2015.
But lawyers involved will first have to investigate and identify the parties that hold the ultimate culpability, lawyers say. And accountability and culpability have always been problematic for disputes and investigations related to digital assets.
Singapore-based Danny Ong, a Rajah & Tann partner, recently acted on a landmark fraud case that succeeded in recovering about $7 million in cryptocurrencies that were stolen from an American entrepreneur last year. But the culprit was never identified.
The lack of robust legal frameworks in different Asian jurisdictions also means that investors in the region face more risk when investing in digital assets, including cryptocurrencies such as stablecoins.
China took a hard line and banned cryptocurrency trading in 2019. In Japan, one of the world’s most technologically advanced countries, there is still no collective regulation governing blockchain-based tokens. South Korea has a strict regulatory framework governing crypto exchanges but cryptocurrencies are not regarded as legal money in the country. None of the Southeast Asian cities has established strong foundations for governing crypto deals except Singapore, which has shown a desire to embrace the digital asset sector. The city-state recently passed a law that will tighten rules for cryptocurrency service providers, but lawyers argue that the guidelines just aren’t vigorous enough.
Even in the U.S., current laws don’t provide comprehensive standards for stablecoin issuers. The Biden administration has pressed Congress to pass legislation that would regulate issuers of digital assets as stringently as traditional financial institutions.
Lawyers say while the lack of regulation may have contributed to the risk faced by holders of stablecoins, regulatory frameworks can only support investors in part.
According to Timothy Loh, a founding lawyer of Hong Kong law firm Timothy Loh LLP, crypto products, unlike traditional financial products, are typically structured with a focus on technological innovation rather than on legal structures. This focus sometimes means that lawyers and other professionals with experience in managing those risks do not play a role in the product structure, leading to an increased possibility that those risks are not addressed or are inadequately addressed.
“In our experience, a lot of times on the legal side, there are no legal terms and conditions to the crypto products. There’s only code.” said Loh.
They also fail to consider some of the risk that more institutionalized investors would look to, particularly through professional advisers, he added.
“There might be a YouTube video or a webpage that explains how it works but with so much emphasis on the technology, it’s easy for investors to lose sight of the fact that financial product structuring is built on decades of experience,” Loh said.
With no mention of legal terms and conditions, it’s not obvious to investors that they should turn to lawyers with experience in financial products to evaluate the product and identify risks. “Investors shouldn’t assume that the latest technology addresses structural risks. They should assess whether the structure works or not,” he said.
If the structure of the stablecoin is not being misrepresented as to how it works, investors are more willingly taking on the risks. But they will have little to fall back on legally.
Chia Ling Koh, a director at Osborne Clarke’s Singapore office—known there as OC Queen Street—said that typically, there is little recourse.
“The terms and conditions of the sale of a coin or use of a chain would have protected creators and founders,” he said. “A possibility is misrepresentation, fraud or deceit, but all that will depend on what creators and founders say or do to induce investments.”
Lawyers who are experienced in financial product structuring will be able to help investors point out the potential risks, said Loh.
But the well of highly experienced crypto lawyers—particularly in Asia where the acceptance of regulation of digital assets varies greatly—just isn’t deep enough.
The practice of law in Hong Kong is still largely a paper-based occupation, Chu said. Lawyers there are eager to make money from the tech sector, but “there are very few believers and implementers,” he added.
“This is more important than ever, as advising clients on how to obtain compensation in a situation like Luna requires a significant understanding of how the underlying technology works,” Chu explained, adding that this is essential to figuring out what happened, who was involved and who should be held liable.
In the case of TerraUSD, however, there are still traditional legal avenues that Luna holders can pursue to recover their losses, Chu noted. The company is governed by Singapore law and the group can also be traced to Singapore, so in this case, there will be a level of governance and regulatory accountability.
Kwon had already been involved in lawsuits with the U.S. Securities and Exchange Commission. Last year, he hired Dentons’ New York partner Douglas Henkins when the SEC accused him of violating its own rules and the Due Process Clause of the U.S. Constitution. Henkins also represented Kwon when the SEC served him with a subpoena on a separate investigation involving another of Terra’s products, Mirror Protocol.
Henkins did not respond to a request for comment for this story.