Crypto yield faces a securities test as court revives DCG fraud claim

A federal judge in Connecticut has reinstated a fraud lawsuit against Digital Currency Group (DCG), its founder Barry Silbert, and other defendants regarding the failed Genesis Yield project, while also allowing a federal appeals court to ponder a monumental question that can impact the way crypto lending is done.

The question is: “Are crypto yield products securities?”

This particular ruling can have potentially more serious implications if the Second Circuit Court of Appeal accepts the appeal, as it could determine how crypto products that earn interest would be treated in American jurisdictions.

The news about how the courts have approached the regulations of securities was shared by Judge Stefan Underhill, who recalled that the judges have arrived at different conclusions in dealing with the existing regulations regarding the application of long-standing securities laws to crypto products.

Court revives fraud claim while narrowing state-law case

The recent ruling, by the U.S. District Court for the District of Connecticut, readdressed the issue following the invocation of the Class Action Fairness Act by investors to preserve their claims under state law. Underhill reinstated the fraud claim under New York common law against Silbert, DCG and defendants, while maintaining his earlier decision of the dismissal of various other state law claims.

Consumer protection claims under California, Florida and New York law are still in suspension, with the claims made in relation to the laws of Illinois, Kansas, Nevada and Texas being dismissed. Following the recent ruling, those federal securities claims that are still alive have also been allowed to proceed.

The revived fraud claim provides the plaintiffs another means of seeking for damages. Common law fraud differs from the federal securities claim in that it focuses on the aspect of whether the company executives knowingly made the misleading and untrue statements, whether the investors relied on those statements and what losses were suffered.

Appeal could define how crypto yield products are treated

However, the most notable development was when Underhill gave his approval for an interlocutory appeal enabling DCG, together with Silbert and DCG President Mark Murphy, to ask the Second Circuit whether Genesis Yield is classified as a security.

According to Underhill’s ruling done in February, it was found that Genesis Yield is indeed classified as a security.

The ruling by Underhill relied on the application of two landmark cases decided by the U.S. Supreme Court, namely the Howey Test, which determines if an investment contract exists or not, and the Reves Test, which decides if notes and borrowing instruments constitute a security or not.

This is important to note because crypto yield products have created a blurred line between loans and investments. Under the Howey test, courts examine whether investors put money into a common enterprise to expect profits from the investment efforts of other individuals. On the other hand, the Reves test starts from the viewpoint that a note should be treated as a security unless it has very similar features to an ordinary commercial loan.

Genesis Yield included aspects of both. Investors put in their cryptocurrencies and expected to receive interest. Genesis merged these funds and lent them to institutional customers. Interpretation of these two tests by the Second Circuit could present one of the first authoritative appellate cases regarding crypto-lending products.

Genesis’ collapse triggered years of litigation

Genesis Yield provided customers with the possibility of getting interest through deposited digital assets with its help. Investors claim that both DCG and Silbert kept marking Genesis as financially healthy, even when the company’s balance sheet had already deteriorated.

According to the lawsuit, Genesis’ troubles accelerated after hedge fund Three Arrows Capital defaulted on roughly $1.1 billion in obligations in June 2022. Three Arrows reportedly accounted for about 30% of Genesis’ loan book. Plaintiffs allege DCG attempted to conceal the resulting losses by replacing the bad debt with a 10-year promissory note issued by DCG.

Genesis suspended withdrawals in November 2022 following the collapse of FTX before filing for Chapter 11 bankruptcy protection two months later. DCG has repeatedly denied wrongdoing, calling the allegations “baseless” and saying it intends to vigorously defend itself.

One collapse, three major legal fronts

The lawsuit filed in Connecticut is part of a series of regulatory moves prompted by the crisis at Genesis, but regulators and the private plaintiffs are utilizing different approaches to pursue similar claims based on the same events.

In January 2025, the U.S. Securities and Exchange Commission (SEC) announced that DCG and former Genesis chief executive Soichiro “Michael” Moro have agreed to pay $38.5 million in connection with the allegations of deception that were made against them due to Genesis’ financial condition after Three Arrows Capital filed for bankruptcy. DCG agreed to pay $38 million while Moro has made a separate contribution of $500,000, without confirming or denying the SEC’s findings.

At the time, Sanjay Wadhwa, then Acting Director of the SEC’s Division of Enforcement, said, “It is vital that companies and their officers speak truthfully to the investing public, especially in times of financial instability or turmoil.”

In addition, New York Attorney General Letitia James has broadened her civil fraud litigation filed against Genesis, DCG, and Gemini in February 2024, by raising investor losses to more than $3 billion instead of $1 billion as initially claimed.

According to the firm, more than 230,000 investors were affected by the fraud, and Genesis later agreed to settle the case for $2 billion, while claims against the remaining defendants continue.

Thus, the three cases reflect different approaches regarding the same organization’s collapse. The SEC was focused on the alleged violations of disclosure provisions of federal securities laws. New York, on the contrary, was engaged in civil fraud proceedings. The case in Connecticut can be responsible for determining the broader question of whether cryptocurrency yield products should be considered as securities.

What’s next?

The revived fraud claim and federal securities claims will be handled in Connecticut, while the Second Circuit considers the possibility of hearing the appeal from DCG. If it is allowed, the appeal could result in one of the most significant appellate decisions in crypto lending to date.

For an industry still trying to understand the implications of the regulatory issues of the lending boom of 2021 and the disasters that followed in 2022, a definitive determination on how the Howey and Reves tests affect yield products will bring much-needed clarity for lenders, exchanges, investors and regulators.

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