A federal jury in New York has found South Korean crypto magnate Do Kwon—and his company Terraform Labs—liable for defrauding investors who collectively sank billions of dollars into cryptoassets whose value later fell to near zero.

Filed in February 2023 by the Securities and Exchange Commission, a regulatory body responsible for protecting US investors, the civil complaint alleged that Kwon and Terraform had “perpetrated a fraudulent scheme that led to the loss of $40 billion of market value,” whereby they lied to investors about the prospects and stability of the cryptotokens they issued.

Kwon, who went into hiding after the tokens crashed in 2022, is facing criminal charges in the United States and South Korea. He was recently released on bail from a prison in Montenegro, where he was arrested last year and awaits extradition.

In Kwon’s absence, the jury in the US civil trial in the Southern District of New York heard evidence from investors who bought into Terraform tokens, whistleblowers from companies with which Terraform partnered, and other witnesses. After a deliberation lasting less than two hours, the jury found Kwon and Terraform liable on civil fraud charges related to making false claims and misleading investors in Terraform’s cryptotoken.

“We are pleased with today’s jury verdict holding Terraform Labs and Do Kwon liable for a massive crypto fraud,” said SEC Division of Enforcement Director Gurbir S. Grewal in a statement. “For all of crypto’s promises, the lack of registration and compliance have very real consequences for real people.”

The resolution of Kwon’s civil trial—along with the recent sentencing of Sam Bankman-Fried, founder of fallen crypto exchange FTX—will help to draw a line under a traumatic period for the crypto industry, says market analyst Noelle Acheson, formerly of crypto brokerage Genesis Trading. “Many feel hurt by what Do Kwon did. Those that invested feel betrayed,” she says. “Hopefully, people will be reminded to do more homework and ask better questions, to avoid getting drawn into rather flimsy claims again.”

Kwon started Terraform in 2018, alongside cofounder Daniel Shin. By 2020, the company announced plans to launch a stablecoin called TerraUSD (UST), whose value would remain pegged to the US dollar, ostensibly providing holders with a refuge from the volatility of other crypto assets.

Stablecoins are typically held to a specific value by an underlying basket of assets—including cash and short-term government bonds—for which they can be redeemed at any time. But UST, claimed Terraform, would be pegged to its dollar value by way of a complex algorithm, tying it to a second coin issued by the firm known as LUNA. If the value of UST were ever to diverge from $1, traders would theoretically be incentivized to either buy or sell the stablecoin until the target value was restored.

At the height of its popularity, in early 2022, LUNA was among the 10 largest cryptocurrencies in the world by the combined value of coins in circulation—and UST wasn’t far behind. “It was an intriguing and very novel mechanism,” says Acheson. “Many smart people believed it would work.”

In May 2022, it all went wrong. When holders of large amounts of UST sold the token in bulk, it slipped from its dollar peg, leading to panic and a broader sell-off that drove the price practically to zero. LUNA and Terraform’s other coins were decimated along with it. “The mechanism was based on the faulty assumption that people would want it to self-correct and therefore it would,” says Acheson. “[Kwon] made marketing claims about the stability of stablecoins that weren’t true.”

The incident sent crypto markets into a downward spiral and catalyzed a chain reaction that brought a string of crypto companies to their knees. The failure of Terraform’s tokens contributed to the collapse of hedge fund Three Arrows Capital in June, followed by crypto lenders Voyager Digital, then BlockFi, then Genesis—and, in a roundabout way, FTX too.

After the incident, Kwon fled Singapore, where Terraform was headquartered, for Dubai and then Serbia. He was later apprehended by authorities in Montenegro, where he was sentenced to four months in prison for attempting to leave the country on a fake Costa Rican passport. The kind of “hubris” displayed by Kwon, says Acheson, “has been part of the crypto ecosystem for some time.”

The SEC’s case was built around two core allegations: First, that Kwon and Terraform had misled investors about the capacity for UST to restore itself to a dollar valuation—to self-heal—without intervention; and second, that they had lied about Chai, a large Korean payments firm founded by Shin, utilizing Terraform technology to conduct its operations, leaving investors with an unmerited confidence in the prospect of widespread adoption.

In May 2021, after UST had fallen from its peg for the first time, the SEC alleged, Kwon struck a secret deal with trading firm Jump Trading, which agreed to purchase the token in large volumes until its value was restored to the target level. At trial, a whistleblower who had worked as a software developer at Jump Trading testified to that effect. (During the SEC investigation, the president of Jump’s crypto trading division declined to comment in a deposition, invoking his Fifth Amendment rights against self-incrimination. Jump has not been charged by the SEC.)

Almost as soon as Jump intervened to manually restore UST to its dollar valuation, the SEC claimed, Kwon and Terraform began to make misleading public statements, telling people the token “automatically self-heals” by design.

A second SEC whistleblower, a former Chai executive, testified that the payments company did not process or settle transactions using Terraform technology, as Kwon had claimed. Instead, the SEC alleged, Terraform had artificially mirrored Chai transactions on its network to create the impression of legitimate traffic. It presented to the court messages between the two Terraform cofounders in which Kwon suggested they create “fake transactions that look real,” and promised to “try my best to make it indiscernible.”

Both strands of the SEC’s case were “extremely strong,” says Daniel Silva, a former US prosecutor and attorney at law firm Buchalter. “It’s easy when you have people lying. ‘Fraud’ is a fancy word, but really it’s just lying to gain property. And everyone understands lying is wrong—or at least that it can get you in trouble.”

The defense attempted to draw a distinction between the failure of Terraform’s crypto assets, whose risk profile it implied was well understood by investors, and the acts of fraud alleged by the SEC. “Failure doesn’t equal fraud,” David Patton, attorney to Kwon, reportedly told the courtroom in his opening statement.

The defense also sought to undermine the credibility of the SEC whistleblowers, whom it reportedly suggested were in it only for the financial reward. The defense dismissed the account of the former Jump employee as hearsay and cast the Chai whistleblower as a disgruntled former staffer.

The defense also contended that Chai had utilized the Terraform blockchain, and argued that the SEC could not prove otherwise without access to the Chai source code. The messages between Shin and Kwon about “fake transactions,” Kwon’s lawyers claimed, related to a different project entirely.

The jury was ultimately unconvinced.

Having been found liable, Kwon and Terraform will be dealt a financial penalty, the size of which will be confirmed by the judge at a later stage. They’ll likely be prevented from participating in the US securities market in the future. But the implications of the case spill further afield.

Before the trial, the defense had called for dismissal on the grounds that the SEC had misclassified UST, LUNA, and other Terraform tokens as securities—a specific class of financial instrument from which investors expect to profit—and, therefore, lacked jurisdiction. The debate over the appropriate classification of crypto is central to multiple ongoing legal disputes in the US, between the SEC and Ripple, Coinbase, and other firms. The crypto industry has repeatedly accused the SEC of “regulation by enforcement”—of wielding legal action instead of articulating clear rules for the road—and making a jurisdictional land grab.

However, in an opinion issued before the trial, Judge Jed Rakoff, who presided over the Kwon case in New York, rejected the arguments for dismissal. The SEC should be allowed to “resolve new and difficult questions posed by emerging technologies where the technologies impact markets that on their face appear to resemble securities markets,” he ruled.

The opinion does not establish a rule that other US judges are duty bound to follow, but in combination with the verdict in favor of the SEC, sets a precedent of sorts for a crypto organization having violated US securities laws. “This case is before a well-respected judge who is thorough and careful. He’s influential,” says Lisa Bragança, attorney at Bragança Law and former branch chief at the SEC. “A decision from him will be cited over and over again by fellow judges.”

Terraform had already signaled prior to the trial its intention to appeal an unfavorable verdict, citing the ambiguity over the proper classification of its tokens. The absence of Kwon from the courtroom, which denied him the ability to “sit at the counsel table, hear the testimony of witnesses, and respond,” says Bragança, could support the appeal bid.

“We are very disappointed with the verdict, which we do not believe is supported by the evidence,” a Terraform spokesperson said in a statement. “We continue to maintain that the SEC does not have the legal authority to bring this case at all, and we are carefully weighing our options and next steps.”

In the absence of legislative direction from the US Congress, says Silva, the classification question will be settled only when a crypto case moves through the appellate courts, perhaps arriving eventually at the US Supreme Court. “It’s an evolving area of the law,” he says. “It’s crystallizing with each case that comes down. It just hasn’t crystallized yet.”

From 4,500 miles away in Montenegro, Kwon will have played his part.

Updated: 4-6-2024, 6:28 pm EST: This story has been updated to include a statement from Terraform Labs.

Updated 4-8-2024 10:42 am BST: Correction to note that it was the president of Jump’s crypto trading division, not the president of Jump Trading, that declined to comment in the SEC investigation.