How Kraken is refusing to accept financial and legal responsibilities of its flash crash!

Kraken, one of the most liquid exchanges in the crypto world, suffered a huge ‘flash crash’ on 22^nd February 2021 at 2:20 p.m GMT. The reference spot price for ether (ETH) absolutely collapsed, causing all other trading pairs with ETH to follow suit and head south. Security mechanisms kicked in automatically, leading to a cascade of massive liquidations. All in all, Kraken users lost millions in less than 15 minutes, so now, the question on everyone’s lips is, “who is responsible for all this?”    

Users seek compensation for losses

In this case, users didn’t lose money because they were taking on excess risk, misinterpreting data or following questionable trading strategies.

The losses came as the consequences of a failure or a flaw in the Kraken platform, which left in its wake huge liquidations, even though traders had placed their orders with full knowledge of the market conditions.

While Kraken acknowledges that its exchange platform suffered a flash crash, it refuses to take responsibility for this structural flaw – and especially the financial repercussions it has caused. I’ll say that again: it refuses to reimburse users who have been robbed of their assets deposited on its platform, which has just proved that it has a serious flaw.

Furious customers – some of whom ruined – have opened a class action lawsuit (for our UK readers, this is a case where several people with the same legal problem band together), only to discover that Kraken made them agree to disproportionate T&Cs forbidding them from calling on higher legal powers to save them! 

From a flash crash to a refusal to accept its legal responsibilities and to repay the losses of its clients, we will discover Kraken’s abusive terms of service/sale and its highly controversial use of arbitration, a private court of law for the mega rich that delivers very fast and very secretive rulings.

The facts of the case

On 22^nd February 2021 at 2:20 p.m. GMT, Kraken experienced an ETH flash crash. The platform went from displaying ETH at a value of $1,600 to $700, a instantaneous 64% drop in its value.

Because of this new value, automatic security mechanisms were triggered in a chain reaction. Stop-losses (an order that automatically executes to limit losses or take profit) were triggered and there was a massive liquidation of leveraged traders’ collateral. On top of this, the platform was made inaccessible and accounts were blocked.

Kraken CEO Jesse Powell argued that the sudden drop in the price of ether on the exchange was caused by a wider problem, and not one specific to Kraken.

The very next day, Jesse Powell gave this explanation in an interview with Bloomberg: “We’re in the process of investigating but there doesn’t seem to be any evidence of a trading-engine malfunction. It seems like trades processed accurately. It could be that a single whale just decided to dump his life savings.”

In plain English, he attributes the crash to a single seller holding a lot of ETH who simply decided to click the sell button for all of his bags. This whale’s huge transaction was simply too much for Kraken to handle, destabilising the price and exchange pairs’ prices.

So, that’s it, case closed. Kraken CEO Jesse Powell blamed the crash on a whale, makes sense, right?

Except…

Exchanges are regulated to ensure market security. Regulations require them to take technical and operational measures to avoid these kinds of events (which, let’s not forget, amount to market manipulation). This is why conventional markets – stock exchange operators such as LSE, Nasdaq, EuroNext, etc – are not obliged to accept massive buy or sell orders.

When a trader has too much of a stock to trade normally, transactions must be carried out in the anonymity of dark pools, which were created to facilitate the trading of blocks of securities in large volumes. These official bodies are comparable to private stock exchanges and are registered with their national supervisory bodies, such as the FCA in the UK or the SEC in the USA.

This opaque system limits negative market impacts as well as price volatility. It also helps to maintain trading prices that benefit both parties, reduce conflicts of interest between high-frequency buyers/sellers/traders and maintain investor confidence in the regulated market.

In short, everything is done to ensure that these transaction volumes do not interfere with the usual prices, which would normally take a beating from large orders. This unusual volume would be cause regular market participants to start acting erratically, over-buying or over-selling, which would promote price hypervolatility that destabilises markets for investors and companies themselves.

Now, the important thing to note is that the dark pool principle has not just been put in place for traditional stock exchange operators in the USA, Europe, UK, etc. It also exists for crypto exchanges and it works perfectly! This was a long explanation, but it shows that there is something amiss with Kraken’s version of events.

Over and over again…

Unfortunately, this is not the first time that Kraken has experienced this type of technical glitch: flash crashes are actually nothing new for the platform.

NEXO, which used Kraken’s prices exclusively as a benchmark for its interest rate calculations and collateral calculations to liquidate loans, reassured its customers impacted by this price crash. They are taking full responsibility for these automatic liquidations and are compensating the customers impacted.

Refunds: yes – but only for those who can negotiate them…

Surprisingly, Kraken did start compensating some users with amounts ranging from 5–60% of their total losses.

This is an odd move, because it only applies to certain accounts, and the amounts compensated are not the same as the users lost!

What’s behind all these inconsistencies?

On closer inspection, we can see that some users tried to resolve their dispute with Kraken’s ChatBot, while other people went direct to a human to recover more funds.

When this became known to the general public and the traders concerned, it was deemed (quite rightly) as totally unfair! But the scandal doesn’t end there.

To get straight to the point: Kraken is hiding behind its terms and conditions to prevent its users from seeking compensation.

How can users be stopped from going to court?

The kraken.com website is accessible to all, with general terms of service written in English, based on American law (and more specifically Californian law). They feature a so-called “compromise” clause, where the user agrees to follow an arbitration procedure in the event of dispute. To users, this commitment does not seem all to extreme, but that’s only because they don’t know the meaning or scope of it.

In reality, the T&Cs stipulate that:

• customers may not band together to sue the company in a class action lawsuit
• customers may not open a trial with their national court of justice

This means, in other words, that clients will only be able to sue the company individually and that if they want to take legal action, they will be forced into an arbitration tribunal.

Arbitration tribunals are relatively unknown to the general public, but they are extremely effective in all respects, meaning that they are very expensive, very fast and completely secret.

The court of arbitration is not open to the general public, it’s a closed and secretive world

Any legal contract may state in its clauses that disputes will be settled through arbitration.

By accepting this clause, the parties waive their right to launch a public trial before a national court, instead agreeing to convene before a tribunal, consisting of a panel of experts meeting behind closed doors (no public audience allowed!) who will verify the matter themselves.

It’s a kind of court that is completely opposite to that of a national, independent and impartial one, which is established by the state where the headquarters of the company or the person complaining are based. However, arbitration tribunals are quite common in the UK, so it is very unlikely that a judge will consider Kraken’s compromise clause illegal.

The devil hides in the detail: what laws are we talking about?

These kind of T&Cs usually stipulate the jurisdiction that the court of arbitration will hear this case and bring some kind of resolution to the conflict. Even if there is no justification, these clauses will indicate their choice of legislation, whether it is U.S. law, Bahamas law, Chinese law or European law.

The complexity of national legislation and the expertise required lead to exorbitant costs if this were to go to a court of arbitration.

Originally created to lighten the load of courts, shorten trial times, keep experts available and pass sentences in international or confidential cases involving Big Finance, the Arbitration Tribunal has since become the weapon of choice for the financial powers that be. It’s a classic David and Goliath story, where this time, David has effectively been robbed and remains penniless. Whatever the tribunal rules, the conclusions of the conflict will remain secret and never damage the reputation of the parties involved.

In Kraken’s case, by imposing arbitration, its terms and conditions require clients waive their right to access non-private justice. This clause violates the European Convention on Human Rights, which states in its Article 6 that “Everyone has the right to a fair and public trial.”

On the attack, on behalf of Kraken’s customers

The French lawyer by the name of Pascaline Melinon has taken it upon herself to represent the Kraken users who have had their funds liquidated, by presenting a case before both the court of arbitration and the national courts.

She has picked through through every promise, argument and allegation put forward by Kraken to go after the exchange on the following counts:

• Deceptive practices: Kraken calls itself the best and safest cryptocurrency exchange, yet has shown that it is neither of these by forcing its customers bear the worst of its technical flaws. Moreover, it would appear that Kraken is dodging liability under its T&Cs, which is simply unacceptable. It must compensate its customers.
• Violation of consumer law: Kraken does not comply with European Commission Directive 93/13/EEC, which considers in Article 6(1) that “unfair terms used in a contract concluded with a consumer by a seller or supplier shall, as provided for under their national law, not be binding on the consumer”, in order to open a European class action lawsuit.
• False advertising: accounts were blocked during the flash crash, while Kraken promises “a world-class security team,” “optimal site security,” “the best security in the sector,” “24/7 assistance in the event of a problem,” and “guarantees the protection of our customers’ assets.” Kraken must, therefore, compensate its clients.

Melinon’s firm may also use the testimony of some of its clients, who have been robbed of all of their assets following a set of strange practices:

• Kraken threatened to delete their account if they dared to challenge the interpretation of the contract.
• Kraken blackmailed them over time to accept the final offer of 20% compensation for the loss.

The lawyer will also highlight that the Terms of Service violate the rights of Europeans to refer the matter to their national courts and their country’s legislation.

Furthermore, when (not if) the European Court declares the nullity of this illegal clause – because it prohibits the use of the national and public judge – then European customers will be able to bring (in addition to their individual cases) a new collective case – a European class action lawsuit.

Between the court of arbitration, French legislation and the regulatory research of the European financial authorities, we may be able to find out what happened to the loss of several hundred million pounds in less than 15 minutes, and then demand a refund!

The case of Kraken and its failures, flaws or otherwise has brought the question of terms and condition set by exchanges and crypto companies back to the fore. How can states tax these companies and their users, while guaranteeing a minimum amount of appropriate regulation and security? Whether centralised or decentralised, how can they handle the money of domestic users while resorting to international arbitration procedures that open the door for them to sidestep national law?