Cryptoasset recovery: current issues and UK developments

There have been a number of developments in cryptoassets in recent months, both globally and in the UK:

• The UK government has set out its plan to make the UK a global cryptoasset technology hub, and on the regulation front, confirmed its intention to extend financial promotion restrictions to include qualifying cryptoassets, and the Advertising Standards Authority (the ASA) has updated its guidance and issued Enforcement Notices in respect of advertisements and promotions that are for or involve cryptocurrencies or exchanges.
• Various claims have been brought following ICO fraud, ransomware attacks, NFT auctions and theft against developers, online platforms and persons unknown. They have resulted in the courts considering whether cryptoassets such as Bitcoin can be posted as security for costs, and issuing freezing injunctions and Bankers Trust and Norwich Pharmacal orders. You can read our discussions and thoughts:
  • On the High Court’s decision to reject a claim that Bitcoin developers owed a duty of care or a fiduciary duty to an alleged owner of Bitcoin in our blog post here.
  • Regarding the types of claims investors may have in a LUNA/TerraUSD type stable coin collapse here.
  • In relation to the risks involved in litigating a dispute arising from a transaction on a blockchain in March 2022’s volume of the International Journal of Blockchain Law (see page 16).
  • About the cases that led both the UK High Court and the Singapore High Court to recognise NFTs as “property” in our blog post here, which also touches on the decisions in which cryptocurrencies like Bitcoin have also been recognised as “property”.

Even if the courts recognise them as a type of property, how recoverable are cryptocurrencies and NFTs? Although we already know from existing UK judgments that they are capable of being the subject of worldwide freezing orders and proprietary injunctions, and are theoretically traceable and recoverable, there remain many challenges. Here we look at some of the practical challenges from a UK perspective.

Traceability

Cryptoasset records are stored on immutable ledgers which cannot be altered (except in certain theoretical circumstances such as a so-called 51% attack which we do not consider here). If cryptoassets are stolen, their movement should be able to be traced on any given blockchain via the data stored in chain itself.

However, recovery is not that simple. Blockchains operate globally, cryptoassets can be quickly mixed, dissipated, traded or converted into non-blockchain assets, and there is a level of anonymity associated with CeFi, DeFi and unhosted accounts/wallets/addresses.

Centralised exchanges and the identity of unknown persons and account locations

Centralised exchanges (CEXs) play a key role in the world of cryptoassets. On opening an account with a CEX, such as Binance or Coinbase, users can:

• Buy cryptocurrencies and NFTs using fiat currency and access a range of financial services, such as trading, lending, staking, and borrowing services.
• Send and receive digital assets to/from other crypto wallets/accounts/addresses, and as such, use their CEX account as a gateway to the world of DeFi, or as a means through which to get currencies to an unhosted wallet.

While Know Your Customer (KYC) information does not need to be provided for a user to open an unhosted wallet or a DeFi account/address/wallet, the range and nature of the services offered by CEXs mean that they are required to have proper and effective KYC measures in place, not least for AML purposes. It follows that (and despite HM Treasury having just released a statement confirming that it will not be implementing measures that require CEXs to obtain information about a recipient when assets are being sent to an unhosted wallet):

• CEXs are a suitable target for Norwich Pharmacal/Bankers Trust applications (which, broadly speaking, are types of third-party disclosure applications that can require the disclosure of documents or information pertaining to the identify of wrongdoers or the location of assets).
• Geolocation identifiers aside, the pseudoanonymity of blockchain transactions may be limited by identifying information held by CEXs.

While any person who dishonestly accesses, removes or receives cryptoassets from an account/wallet/address is therefore identifiable to some extent, there are still a few hurdles that a claimant may need to jump over in order to have the court assist them in their recovery. We outline some of these next.

Hurdles to overcome

Jurisdiction

A claimant will have to show that the Courts in which they want to bring the claim have jurisdiction over it. Many CEXs are not registered in England and Wales, and the location of unknown persons cannot be assumed. As such, to bring a claim in the English courts the claimant will have to seek permission to serve out of the jurisdiction on the basis that they have an arguable case that England is the appropriate forum to hear it, and that there is a basis for the English court to take jurisdiction.

Claims

In terms of the claims available, if cryptoassets (such as NFTs and cryptocurrencies) are dishonestly removed from a wallet/account/address without licence or consent, the owner of that wallet/account/address might attempt to:

• Establish a claim based on unjust enrichment and an equitable proprietary claim against those who removed the assets and/or knowingly received the assets.
• Prove to the requisite standard that, if the owner’s private key has also been misappropriated in the process, the owner has an action for breach of confidence against the person who misappropriated that information.

Relief - freezing orders and proprietary injunctions

If a claimant has a claim that is available and maintainable, and the claimant has the means to identify who may have dishonestly taken and/or knowingly received cryptoassets from the owner’s wallet/address/account, and/or where those assets may be located, the English courts might be willing to grant worldwide freezing orders and/or proprietary injunctions against those persons.

However, although applications for these types of relief are generally heard in private in the English courts, cryptoassets can be dissipated, traded and converted quickly, and we are really yet to see how effective any of the injunctions/freezing orders issued by an English court will be in the cryptoasset space.

Law Commission

In parallel to the proceedings that are being brought before the English courts, the Law Commission for England and Wales is continuing to progress its digital asset project, through which it will be making a number of recommendations around the treatment and classification of digital assets, which includes cryptoassets.

Once published, the Law Commission’s recommendations should provide some necessary clarity around where proceedings relating to cryptoassets should be commenced, and how, irrespective of traceability and enforcement issues, cryptoassets are to be treated and transferred in the eyes of the law.

The Law Commission expects to publish its consultation paper shortly, and it will be accessible from the Law Commission’s website.