Source: Wired

Compiled by: BitpushNews Yanan

A New York federal jury recently announced an important verdict that South Korean cryptocurrency tycoon Do Kwon and his company Terraform Labs were found guilty of fraud. This ruling brings a ray of hope for investors who have invested billions of dollars in crypto assets, only to see their value almost disappear.

The origin of this civil lawsuit can be traced back to February 2023, when the U.S. Securities and Exchange Commission (SEC), the regulatory agency responsible for protecting the rights and interests of investors, resolutely stood up and filed a civil lawsuit against Kwon and Terraform. The indictment detailed how the defendants carefully planned a fraud drama, causing the market to lose up to $40 billion in wealth. They wove a beautiful lie to investors, exaggerating the prospects and stability of the crypto tokens they issued, and luring countless people into this financial vortex.

Kwon went on the run after the market crash of 2022. Not only does he face criminal charges in the United States, he is also being sought by South Korean police. The former crypto tycoon was recently released on bail from a prison in Montenegro, where he was arrested last year and is now awaiting extradition.

In Kwon's absence, the jury in the Southern District of New York listened carefully to the testimony of investors who purchased Terraform tokens, whistleblowers within companies that had worked with Terraform, and other key witnesses. After less than two hours of in-depth deliberations, the jury unanimously found Kwon and Terraform liable for civil fraud by making false statements and misleading investors.

Gurbir S. Grewal, director of the U.S. SEC’s enforcement division, said in a subsequent statement: “We are satisfied with today’s jury verdict, which clearly found Terraform Labs and Do Kwon responsible for a large-scale crypto fraud. Although crypto investments seem to be attractive and full of beautiful promises, the lack of necessary compliance measures has brought extremely serious consequences to real-world investors. We will continue to unwaveringly maintain the fairness, transparency and order of the market and protect the legitimate rights and interests of investors.”

Market analyst Noelle Acheson, formerly of crypto brokerage Genesis Trading, said the outcome of Kwon’s civil trial, as well as the recent verdict against Sam Bankman-Fried, founder of crypto exchange FTX, marked the end of a painful period for the crypto industry. “Many people are deeply hurt by Do Kwon’s actions. Those investors feel betrayed,” Acheson commented. “Hopefully, these events will serve as a reminder to do your homework before investing and ask more targeted questions to avoid being fooled by empty and unrealistic promises again,” she further noted.

Kwon founded Terraform in 2018 with co-founder Daniel Shin. In 2020, the company ambitiously announced the launch of a stablecoin called TerraUSD (UST), claiming that its value would be pegged to the U.S. dollar, providing investors with a safe haven from volatility in other crypto asset markets.

Stablecoins usually maintain their specific value through a basket of underlying assets (such as cash and short-term government bonds) and allow investors to redeem them at any time. However, Terraform claims that UST will use a unique mechanism to maintain its value link with the US dollar through a complex algorithm by pegging it to another token issued by the company called LUNA. If the value of UST deviates from $1, traders will theoretically be incentivized to buy or sell stablecoins to restore the value to the target level.

In early 2022, UST and LUNA were very popular, with LUNA once becoming one of the top 10 cryptocurrencies in the world in terms of currency value, and UST also followed closely behind. Acheson said: "This mechanism is both interesting and novel, and many smart people believed it could work successfully at the time."

In May 2022, a sudden storm hit the cryptocurrency market. When a large number of UST holders began to sell the token in bulk, UST quickly broke away from the peg to the US dollar, the market fell into panic, and triggered a wider sell-off, and the price of UST fell to almost zero. At the same time, other tokens related to LUNA and Terraform also suffered heavy losses, with their market capitalizations shrinking significantly. Acheson said: "UST's claimed clever mechanism is based on a false assumption that people expect it to self-correct, so it can self-correct." She further pointed out: "[Kwon] made unrealistic marketing claims about the stability of stablecoins and misled many investors."

This incident not only put the crypto market into a downward spiral, but also triggered a series of chain reactions. A series of crypto companies fell into trouble as a result, with the hedge fund Three Arrows Capital bearing the brunt, which went bankrupt in June. Subsequently, crypto lending companies Voyager Digital, BlockFi, and Genesis also fell into trouble one after another, and even indirectly affected the stability of other large crypto companies such as FTX. This storm made the entire crypto industry feel an unprecedented chill.

After this series of events, Terraform founder Kwon fled from Singapore to Dubai and then to Serbia. However, he was eventually arrested in Montenegro. At the same time, Kwon was sentenced to four months in prison for trying to flee the country using a forged Costa Rican passport. Market analyst Acheson pointed out that the "arrogant" attitude shown by Kwon actually reflects some of the long-standing problems in the crypto ecosystem.

The SEC's lawsuit against Kwon and Terraform focuses on two core allegations. First, they are accused of misleading investors by claiming that UST has the ability to self-recover to its U.S. dollar valuation without external intervention. Second, they are accused of falsely claiming that Chai, a large Korean payment company, uses Terraform technology for its business operations, a false claim that gave investors excessive expectations about the broad application prospects of UST.

In addition, the SEC alleges that Kwon entered into a secret agreement with trading firm Jump Trading in May 2021, after UST first deviated from its peg. Under the agreement, Jump Trading agreed to purchase a large number of UST tokens to assist in its return to its target value. During the trial, an insider who worked as a software developer at Jump Trading testified as a whistleblower and confirmed the existence of this agreement. However, during the SEC's investigation, Jump Trading's president declined to comment on the matter, citing his Fifth Amendment rights involving self-incrimination. It is worth noting that Jump Trading has not been sued by the SEC.

According to the SEC’s allegations, at the same time that Jump Trading intervened to artificially help UST restore its dollar valuation, Kwon and Terraform began to issue misleading public statements, claiming that the token was able to “automatically self-heal” through a unique mechanism design. This contradictory behavior and statement caused investors to seriously misjudge the true situation of UST.

In addition, another SEC whistleblower, a former executive of Chai, also testified that the payment company did not use Terraform technology for transaction processing or settlement as Kwon claimed. Shockingly, Terraform was also accused of artificially replicating Chai's transaction records on its network to create the illusion of a legitimate transaction. To confirm this accusation, the SEC submitted to the court the communication records between the two Terraform co-founders. In these records, Kwon suggested that they create "fake transactions that look real" and promised to "do my best to make it difficult to distinguish."

In response to the SEC's attack, Daniel Silva, a former U.S. prosecutor and current attorney at Buchalter Law Firm, said the charges were "very powerful." He explained: "When someone intentionally lies, the situation becomes very simple. Although the word "fraud" sounds serious, it actually refers to intentional lying for the purpose of gaining benefits. Everyone knows that lying is wrong - at least it will get you in trouble."

In court, the defense vigorously defended the distinction between Terraform’s crypto asset failure and the fraud alleged by the SEC. Kwon’s attorney David Patton made it clear in his opening statement: “Failure does not mean fraud.” He emphasized that investors were fully aware of the relevant risk characteristics when investing.

The defense also sought to question the credibility of the SEC whistleblowers, suggesting they may have come forward out of financial motivation, and denounced statements by former Jump Trading employees as mere hearsay rather than hard evidence. The defense also portrayed the Chai whistleblower as a disgruntled former employee, further undermining the credibility of his testimony.

In addition, the defense insisted that Chai did use Terraform's blockchain technology. Without access to Chai's source code, the defense insisted that the SEC could not prove the authenticity of its allegations. Regarding the communication records between Shin and Kwon about "false transactions" in the evidence submitted by the SEC, the defense stated that these records were not directly related to this case, but involved other projects.

Ultimately, the jury did not accept the defense's argument.

After being found liable, Kwon and Terraform will face corresponding financial penalties, the specific amount of which will be determined by the judge at a later stage. In addition, they may also be banned from participating in future US securities market activities. However, the impact of this case goes far beyond this.

Prior to the trial, the defense had attempted to dismiss the charges on the grounds that the SEC had mistakenly classified UST, LUNA, and other Terraform tokens as securities, and insisted that the SEC had no jurisdiction over the matter. In fact, the classification of cryptocurrencies has been a core issue in many legal disputes in crypto cases in the United States. These disputes not only involve the SEC's disputes with companies such as Ripple and Coinbase, but also reflect the entire crypto industry's views on regulators. The industry has repeatedly criticized the SEC for adopting an "enforcement regulation" approach, which relies more on legal actions rather than formulating clear rules to guide industry development. They are worried that this regulatory approach will hinder innovation and attempt to expand the jurisdiction of regulators. The outcome of this case will undoubtedly have a profound impact on these disputes and will also provide an important reference for the future regulatory direction of the crypto industry.

However, before the trial, the New York judge presiding over the case, Jed Rakoff, issued an opinion explicitly rejecting the defense’s motion to dismiss the charges. The judge ruled that the SEC has the authority to “address novel issues raised by emerging technologies, particularly when those technologies have an impact on markets that are at least superficially similar to securities markets.”

Although this opinion will not force other US judges to follow it, considering the SEC's victory in this case, it actually provides a clear precedent for crypto companies to be punished for violating US securities laws, providing an important reference for similar cases in the future. In this regard, Lisa Bragança, a lawyer at Bragança Law and former SEC branch director, said: "This case was heard by a highly respected and meticulous judge whose influence cannot be ignored. It is foreseeable that his decision will be cited many times by other judges in the future."

Before the trial, Terraform had indicated that if faced with an unfavorable ruling, they would appeal on the grounds that the token classification issue remained ambiguous. “Given that Kwon was unable to appear in person, sit at the lawyer’s table to listen to witness testimony and respond in person, Terraform’s appeal request may be supported,” said Lisa Bragança.

In a public statement, Terraform's spokesperson expressed their dissatisfaction with the verdict in strong words. They insisted that the verdict lacked sufficient evidence and was more like a piece of paper. What was even more unacceptable to them was that they believed that the SEC had no right to bring this lawsuit. At present, they are carefully weighing various options and making full preparations for the next action.

At this critical moment, the U.S. Congress failed to provide clear legislative guidance, which made the entire crypto industry confused. Silva knows that this thorny classification problem can only be truly resolved when a representative cryptocurrency case is rigorously reviewed by the appellate court and even finally reaches the threshold of the U.S. Supreme Court. He lamented: "The development of the law is always accompanied by controversy and uncertainty. Each new case is like a touchstone to make the law clearer. It's just that now, we are still groping forward."

Even though he is thousands of kilometers away from New York in Montenegro, Kwon's influence has not diminished. He will still play a key role behind the scenes and influence the direction of this case. His presence makes this legal battle more complicated and confusing, and makes people more looking forward to the final outcome.