Cryptocurrency projects can attract substantial investment in a remarkably short period of time. New tokens, NFT collections, decentralized finance projects, and other digital assets are often promoted through social media, online communities, influencers, and promises about future development.
Unfortunately, some projects are created or promoted with very different intentions. A so-called “rug pull” can leave purchasers holding virtually worthless digital assets while the individuals behind the project disappear or transfer investors’ funds elsewhere.
The following FAQ explains what crypto rug pulls are, how they may give rise to civil fraud claims in Ontario, and some of the legal tools that may be available to identify defendants, trace cryptocurrency, and preserve assets.
What Is a Crypto Rug Pull?
A crypto rug pull generally occurs when the founders, developers, or promoters of a cryptocurrency or digital asset project attract purchasers and then withdraw money or liquidity, sell their own holdings, abandon the project, or otherwise leave investors with assets that have little or no value.
Rug pulls can involve cryptocurrency tokens, decentralized finance projects, NFTs, liquidity pools, and other blockchain-based assets. The precise mechanics vary considerably from one project to another.
How Does a Crypto Rug Pull Work?
There is no single formula. In one common version, developers create a new cryptocurrency token and encourage people to purchase it. As demand increases, the value of the token may appear to rise. The developers then remove cryptocurrency or other assets from the project’s liquidity pool, potentially making the new token difficult or impossible to sell.
Another version involves insiders holding a large portion of a token’s supply. Promotional activity may increase interest and prices before insiders rapidly sell their holdings, causing the token’s value to collapse.
Rug pulls can also involve projects that raise cryptocurrency by promising future products, services, rewards, NFT benefits, technological development, or other features. Once funds are collected, the promised project may never materialize.
Is Every Failed Crypto Project a Rug Pull?
No. Cryptocurrency and other digital assets can be highly volatile, and a project may fail for reasons that have nothing to do with fraud. A token losing most of its value does not, by itself, establish that its creators committed wrongdoing. Startups can fail, development plans can change, market demand can disappear, and promoters may make predictions that ultimately prove incorrect.
In civil fraud litigation, the circumstances surrounding what was represented, what the people behind the project knew or intended, how investors responded to those representations, and what happened to the funds can be important. The distinction between a failed project and an allegedly fraudulent project is therefore highly fact-specific.
What Is a “Slow Rug Pull”?
Not every alleged rug pull happens overnight. A “slow rug pull” generally describes allegations that project insiders gradually extract value or fail to deliver what was promised while continuing to reassure purchasers that development remains underway.
Can Someone Who Loses Money in a Rug Pull Start a Civil Lawsuit?
Potentially. Whether a civil claim exists depends on what occurred and the evidence available.
Depending on the circumstances, claims arising from an alleged crypto rug pull could potentially involve fraudulent misrepresentation, conspiracy, breach of contract, unjust enrichment, knowing receipt, knowing assistance, conversion, or other causes of action. Not every remedy or cause of action will apply to every dispute.
Identifying the proper defendants can also be complicated. Crypto projects may involve anonymous founders, pseudonymous developers, corporations in multiple jurisdictions, online promoters, cryptocurrency exchanges, wallet addresses, and intermediaries.
Can Cryptocurrency Transactions Be Traced?
Blockchain transactions can provide information that is uncommon in many traditional fraud cases. Transactions on many public blockchains are recorded on a distributed ledger, allowing transfers between wallet addresses to be viewed and analyzed.
That does not necessarily reveal who owns a particular wallet. A blockchain address may be pseudonymous, and cryptocurrency can be moved through numerous wallets, exchanges, bridges, tokens, or jurisdictions.
Blockchain analysis may nevertheless help establish where assets moved after an alleged fraud. Information obtained from cryptocurrency exchanges or other intermediaries may sometimes assist in connecting wallet addresses to identifiable individuals or entities.
What Is a Norwich Order?
A Norwich order is a form of court-ordered disclosure that can require a third party connected to alleged wrongdoing to provide information. In fraud litigation, these orders can sometimes be used to identify unknown wrongdoers, locate evidence, or assist with tracing assets.
Cryptocurrency exchanges can hold information that is not visible on the blockchain, including account registration records and other identifying information.
Ontario courts have recognized that Norwich orders can apply in cryptocurrency disputes. However, they are exceptional remedies rather than an automatic method of obtaining exchange records.
Can a Court Freeze Cryptocurrency Before Trial?
In appropriate circumstances, a litigant may seek a Mareva injunction, commonly referred to as a freezing order. A Mareva injunction can restrain a defendant from dealing with or dissipating assets while litigation proceeds. Because it can significantly restrict a defendant’s ability to use their property before the merits of the lawsuit have been finally decided, it is considered an extraordinary remedy and involves a demanding legal test.
Ontario courts have considered Mareva, preservation, and Norwich orders together in other cryptocurrency-related fraud proceedings.
Why Can Timing Matter After a Suspected Rug Pull?
Cryptocurrency can be transferred between wallets extremely quickly and may move through exchanges or other services across multiple jurisdictions. For that reason, delay can complicate asset-tracing and preservation efforts.
Preserving available records can also be important. Relevant material may include wallet addresses, transaction hashes, screenshots, emails, project websites, white papers, smart contracts, Discord or Telegram messages, social media posts, promotional materials, records of cryptocurrency purchases, and communications with founders or promoters.
Should a Suspected Rug Pull Be Reported to Authorities?
Civil litigation and regulatory or criminal investigations are separate processes, although the same conduct can potentially result in more than one type of proceeding.
The Canadian Anti-Fraud Centre accepts reports concerning fraud and cybercrime, including cryptocurrency investment fraud. The Ontario Securities Commission also publishes investor alerts and information concerning potentially harmful investment activity and crypto asset trading platforms.
Whether particular conduct engages securities regulation, criminal law, civil liability, or some combination will depend on the circumstances.
What Makes Crypto Fraud Litigation Different From Other Fraud Claims?
Crypto fraud litigation combines traditional civil fraud principles with technology that can make both investigation and recovery unusually complex. A claimant may know exactly which blockchain address received funds without knowing the person controlling it. Assets may be visible on-chain but located on an exchange in another country. Tokens can be swapped for other assets, distributed across wallets, or moved rapidly after a dispute arises.
At the same time, the blockchain can create a permanent transaction trail that may assist investigators and litigants. As Ontario’s developing cryptocurrency jurisprudence demonstrates, traditional fraud-litigation remedies such as disclosure, tracing, preservation orders, and freezing injunctions can intersect with this new form of property and financial activity.
Milosevic & Associates: Toronto Civil Fraud Lawyers for Cryptocurrency and Rug Pull Claims
Suspected crypto fraud can involve anonymous participants, blockchain tracing, rapidly moving assets, international exchanges, and complex questions about the representations made to investors.
Milosevic & Associates assists individuals and businesses in Toronto and throughout Ontario with civil fraud litigation, cryptocurrency fraud claims, crypto asset tracing, investment fraud disputes, Mareva injunctions, Norwich orders, and asset recovery litigation. Where a dispute involves an alleged crypto rug pull, our fraud litigation lawyers can assess the circumstances, available evidence, potential defendants, and procedural options that may apply. To schedule a consultation, please contact us online or call (416) 916-1387.