US Department of Justice will revise the process for assessing compensation for victims of crypto fraud

What’s new? The US Department of Justice has taken an interest in the mechanism of compensation payments to affected customers of the bankrupt crypto companies. According to a new memorandum, the officials intend to review the valuation of confiscated assets intended for recovery and find out whether crypto fraud victims should receive payments based on the current exchange rates of digital assets. The agency is interested in high-profile cases from 2022: the bankruptcies of the FTX exchange, as well as the lending platforms Voyager, Celsius, BlockFi, and Genesis.

DOJ memorandum

What else is known? While the DOJ is not a regulator of digital assets and not all of the bankruptcy cases cited involved criminal charges, officials have noticed that some cases involved the loss of digital assets due to fraud and theft, and the value of those assets increased dramatically in the years that followed.

For example, Sam Bankman-Fried’s FTX filed for bankruptcy on November 11, 2022, when bitcoin was trading at $17 500. In January this year, the asset hit an all-time high above $108 000, and while it has now fallen to $84 000, that’s still a significant return that is, however, out of reach for those affected. Thus, by court order, they will be compensated in fiat at the exchange rate at the time of bankruptcy.

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Legal experts interviewed by Unchained Crypto note that under current bankruptcy rules, assets seized by the DOJ must be returned to victims at their dollar value at the time of the fraud.

While this may seem unfair, the rule is quite difficult to change: it can be difficult to determine the exchange rate for settlement, especially in a market as volatile as the cryptocurrency market.

The DOJ, on the other hand, in its memorandum refers to the provision of 28 C.F.R. § 9.8(c), which requires that victim compensation be valued at the fair market dollar exchange rate on the date of loss, exclusive of interest and incidental expenses incurred. It also states that victims shall receive equal shares of the total amount forfeited instead of the portion of assets personally lost.

In the case of a crypto exchange collapse, this may seem unfair, as this way users who made wise investments will receive the same compensation as those who made bad investments. For example, an investor whose losses amounted to 50% of the total amount would only be due 1% of the payout if there were 100 people affected in total.

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However, this standard has been set by decades of litigation against traditional assets, where such policies appear, on average, to be fairer. This ensures that “the last victims who invested in any particular fraud, for example, do not benefit from the recovery more than victims who invested earlier,” Kobre and Kim explained.

However, judges have the discretion to adjust the amount paid to each victim on a case-by-case basis based on various factors and evidence. For example, in the FTX case, the vast majority of victims received compensation that was nearly 20% more than the value of their assets at the time of bankruptcy, adjusted for the amounts they held on the exchange.

Some FTX victims insisted on compensation in kind, that is, in tokens they bought on the exchange. One victim said, “I did not gamble with leverage trading or random meme/scam coins, I researched quality projects and made long term investments to try and change my life.”

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However, returns in kind also carry a huge risk for victims, as many tokens depreciate greatly over time. With bankruptcy cases dragging on for years, investors in small altcoins may not receive any compensation at all, as the exchange rate could drop to zero by then.

If the DOJ receives congressional approval, it could issue updated rules and regulations for the crypto industry, but the memo does not specify a timeline for when officials will propose improvements to compensation valuation policies.