Warning signs should flash on digital currencies in contracts

NM-Law-Blog-Warning signs should flash on digital currencies in contracts

In every slowdown, the nature of disputes arising signal in some sense the underlying building blocks of businesses from sector to sector. Commercial stakeholders in the UAE have long since been used to the concept of “back-to-back contracts”, but for the most part these have been relegated to the construction industry.

Historically, these arrangements have always been problematic, especially when it comes to payments and many of these have been litigated. Generally, the courts in Dubai have ruled in favour of the subcontractor receiving his full share of payment if the work subcontracted out has been completed (regardless of whether the main contractor has received his full share of payments or not).

Where payments have not been made, the court has ruled that subcontractors should receive a proportional share. However, the concept of back-to-back contracts has mutated to include payments being received in the form of cryptocurrencies. Sophisticated offer documents have even included the concept of “bonus payments”.

In particular, these contracts have not only had a locus stands between developer and contractor, but have widened the scope to include investors as well. In other words, the investor agrees into a collective investment scheme in concert with the developer, who then enters a back-to-back agreement with the contractor to build the project using the same methodology of payment using digital currencies.

In a bizarre twist of logic, often, the crypto currency used is itself “created” by one of the sister concerns of the developer, which then uses that form of payment to “reimburse” both the investor as well as the contractor. More sophisticated stratagems include paying out dividends and rental payments in the same form of currency, whereas at the back end, these currency unit offerings are then exchanged with other digital currencies and then ultimately converted to cash.

There are a number of red flags that arise with these forms of pyramid schemes. As explained earlier, these are currently not endorsed by any regulator in the UAE.

Consequently, any regulatory paperwork reveals that the underlying structure is in offshore jurisdictions, and in many instances, have not even been cleared by those authorities. A recent “Wall Street Journal” investigation, conducted showed that of the 1,180 ICOs (initial coin offerings) scrutinised, more than 70 per cent were found to be fraudulent.

This indicates that as far as even sophisticated regulatory jurisdictions go, the world of digital currencies remains for the most part the wild wild west.

There also arises the issue of conflict of interest, when the developer is part of the framework creating the digital currency or the means of exchange. This is not a legal tender, and in the process if the ultimate exchange is then monetised by the developer and not the other stakeholders, then it is safe to say the scheme resembles a Ponzi scheme in every sense of the word.

Despite ample warnings, these schemes have continued to proliferate. It is not my place to comment on the future potential of digital currencies. It may well be that as many argue, the future of money and legal tender is in the form of digital currencies.

What is clear is that currently, these offering are not cleared by the law, neither in the UAE nor in most legal jurisdictions. What is worrying is that recent offerings have become increasingly sophisticated, yet retain the same building blocks of classic pyramid schemes.

The sophistry involved – including the documentation – should serve as a warning to investors that if the concept itself is not easily explainable, then any number of purported “white papers” only serve as red flags.

In recent months, the prices of most of these digital currencies have fallen precipitously, causing ruinous losses to retail investors. That unfortunately is part of the market mechanism.

However, the framework of the law serves as a guarantee to all participants that fraudulent activity be not allowed. In the final analysis, these so called contracts, including the back-to-back contracts are simply void ab initio.

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