Tracing Freezing Recovering the Intangible Products of Cryptocurrency Fraud Before It Is Too Late
TRACING FREEZING RECOVERING THE INTANGIBLE PRODUCTS OF CRYPTOCURRENCY FRAUD BEFORE IT IS TOO LATE
While it may seem that the law is playing catch up with technology, there are in fact existing remedies available for the tracing, freezing and recovery of stolen cryptocurrencies…
It is hard to believe that a mere decade ago most of the world still transacted using notes and coins as the main form of currency. Fast forward to today, many have grown comfortable with pointing to numbers on the screen as proof of their wealth, and exchanging goods and services for virtual currencies.
Cryptocurrency is the latest player in this evolution of money. Tesla CEO and Silicon Valley billionaire has publicly touted cryptocurrency as a "far better way to transfer value than pieces of paper"1, and cryptocurrencies like Bitcoin and Ethereum have increasingly been adopted by investors and traders as a form of value transfer. The relatively light-touch regulation on the cryptocurrency industry and the prevalence of its use has however led to an inevitable rise in cryptocurrency related fraud and scams. In the United States alone, more than 80,000 crimes involving cryptocurrencies were reported in 202023.
In light of these worrying trends, it is clear that laws and regulations must evolve alongside technology to guard against the increasingly sophisticated nature of cryptocurrency fraud. It has become necessary to have legal solutions to trace, freeze and recover stolen crypto-assets, even after they have been mixed and dissipated across thousands of crypto-wallets worldwide. We discuss below some of the available legal mechanisms in major financial centers such as the United Kingdom (UK), Hong Kong (HK) and Singapore.
Is cryptocurrency considered as property?
This is a threshold question to determine whether the legal principles invoked to trace and recover traditional "property" may likewise apply to cryptocurrencies. Across all three jurisdictions, it is encouraging that there is support for the proposition that cryptocurrency could be recognized as property in the context of asset recovery.
• Following a slew of cases where specific relief was granted to preserve cryptocurrencies, the UK Jurisdiction Taskforce published a paper in November 2019 which stated that cryptoassets are "to be treated in principle as property"4.
• The Singapore Court of Appeal, in considering whether it was appropriate to create a trust over cryptocurrencies, opined that there may be "much to commend the view that cryptocurrencies should be capable of assimilation into the general concepts of property"5.
• In 2019, a Mareva injunction was granted by the HK Court of First Instance to freeze assets including Bitcoins. The willingness to grant such remedy suggests that cryptocurrencies are regarded as having some proprietary character.
The two most common tools to track down the proceeds of fraud are (1) a Norwich Pharmacal disclosure order, and (2) a Bankers Trust disclosure order.
• A Norwich Pharmacal disclosure order compels an individual or entity to provide information to enable a plaintiff to ascertain the identity of a potential defendant before commencement of proceedings. Such orders are commonly made against banks, to compel disclosure of customer information including KYC documents, transaction statements, and payment instructions.
• A Bankers Trust disclosure order may be sought to compel financial entities to disclose information regarding the proceeds of stolen funds, allowing victims to follow its current whereabouts.
These tracing tools are especially useful in the context of cryptocurrency fraud. Although blockchain has greatly facilitated the transparency and accessibility of crypto-assets, tracing efforts are often hampered by the use of pseudonymization to obscure the account holders' identities.
Orders have been successfully obtained against cryptocurrency exchanges to obtain information on customer identities and the movement of crypto-assets between accounts. Orders have also been obtained against Internet service providers to obtain information regarding the fraudster's IP addresses.
With stricter regulation of crypto-exchanges (for example, in Singapore, where crypto-exchanges must be licensed and collect customer information as part of due diligence), disclosure orders may make it easier for victims to trace down perpetrators through legal mechanisms. A case in point – AI company Fetch.ai had recently succeeded in obtaining disclosure orders from the UK High Court against crypto-exchange Binance, to locate more than US $2.6 million6 lost through fraudulent cryptocurrency transactions executed at an undervalue6. Binance has confirmed that they "are helping Fetch.ai in the recovery of assets", and that "it routinely freezes accounts that are identified as having suspicious activity in line with [their] security policies"7.
Once the stolen crypto-assets are located, a freezing order or Mareva injunction may be obtained to ensure that the monies can no longer be "tumbled" into mixed funds and be dissipated worldwide.
This remedy is relatively less contentious. The UK and HK courts have previously granted freezing orders in respect of cryptocurrencies. This is likely to be the position in Singapore as well given the implicit recognition that cryptocurrency should be regarded as property in Singapore.
The recovery of crypto-assets could be somewhat more challenging.
Conventionally, once default judgment is obtained against a fraudster, victims may apply for a garnishee order against the party holding the funds (e.g. banks) to gain access to the fraudster's assets. However, unlike banks which have physical headquarters in multiple jurisdictions, the location of crypto-exchanges are often shrouded in secrecy.
This could give rise to complications in determining where the garnishee order should be sought.
Moreover, not all cryptocurrencies are held on exchange-hosted wallets. If the stolen funds are traced to a cold, offline wallet, there may be difficulties in compelling individuals to disclose their private keys (to which they retain total and exclusive control of the cryptocurrency) in order that the victims may access the funds.
While it may seem that the law is playing catch up with technology, there are in fact existing remedies available for the tracing, freezing and recovery of stolen cryptocurrencies. The challenge now would be to successfully adapt and use these tools for this new asset class.
Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.