Cryptocurrency fraud and asset recovery
Cryptocurrency and the use of blockchain has become increasingly popular in the commercial world in recent years, as more investors have come to view crypto as an asset of genuine value. We have seen organisations, corporate entities and even governments investing in crypto assets. They do this as a means of diversifying their portfolios or treasuries, using cryptocurrency as a serious alternative to traditional fiat (meaning government-issued) currency.
While cryptocurrency has been attractive to many in terms of potential investment, from a legal perspective (particularly in England and Wales) it is still a developing area. At the time of writing, the value of a Bitcoin is currently around US $46,736. This means that Bitcoin’s market capitalisation – the total value of all Bitcoin – is somewhere in the region of US $915 billion. This is lower than its highest-ever market capitalisation of US $1 trillion – and there has certainly been volatility in the crypto markets in the past 12 months. Nonetheless, cryptocurrency has still become an established asset. The law, however, has proved sluggish in its attempts to keep up with the use of cryptocurrency and the markets for it that have emerged.
Unfortunately, there is one aspect of cryptocurrency that is not attractive: its use is often associated with wrongdoing and fraud. Part of its appeal is the anonymity that many believe it offers. But it needs to be emphasised that with the right tools and correct legal applications, crypto assets can be tracked, traced, identified and then safely recovered from those who have gained them through wrongdoing. But doing this requires careful planning, the right strategy and taking the right action at the most appropriate time.
Pre-seizure planning
Taking the right steps to regain your crypto assets
The most important factor in any pre-seizure planning is to remember at all times that the primary objective is to recover the assets. This may involve going beyond tracing the cryptocurrencies. In many situations, following the crypto assets into the right exchange will often not be enough. There can be scenarios where the proceeds for the fraud go into an exchange and are then subsequently transferred out to a bank account and then into physical property that is registered in another party’s name, such as a partner or relative.
When this does happen, you will need to find and produce the evidence that proves that such physical property is also the proceeds of fraud. Finding the money can be difficult – and identifying any assets it has been used to buy takes time and resources. There is nothing that ensures success when it comes to recovering assets more than pre-seizure planning. Attempting to freeze crypto assets takes considerable time and preparation. This is not an action that can wait until the last minute. Preparation is required at each and every stage of any attempt to recover crypto assets.
Cryptocurrencies are truly global. The bad actors that use them to perpetrate fraud or gain them as a result of fraud may be located in various jurisdictions around the globe. This has to be taken into account when plans to recover assets are being devised. Not all countries have the framework to deal with freezing crypto assets, which can mean that it often seems like the Wild West when dealing with crypto in some jurisdictions. This is one more reason why preparation is key. That preparation requires having the right crypto recovery specialists on board and considering whether there is a need to co-ordinate with foreign counterparts.
Attempts to regain crypto assets can differ from efforts to locate and regain more traditional assets. Planning and executing an asset tracing and recovery plan for them can, therefore, require a different mind-set.
Intelligence collection
The key to successful tracing of cryptocurrency is assessing the information available to you, giving due consideration to the assets in question and taking all necessary steps to ensure that the investigations are carried out in a comprehensive manner.
It is important to dispel the myth that cryptocurrencies are anonymous. While they do give users some degree of privacy not available when acquiring more conventional assets, they are not entirely anonymous. It is well known that all transactions relating to cryptocurrencies are publicly available on the blockchain. By using the correct investigation support and technology, you can obtain the right information relating to the bad actors involved.
Cryptocurrencies must be tracked and traced through the blockchain for any meaningful recovery to take place. During the course of your initial investigation, the right software and algorithms for tracing the assets must be used so that you then have an accurate blockchain analysis. Such an analysis will prove essential to your enquiries.
Hosted v un-hosted wallets
A hosted wallet is a digital account hosted by a third party, like an exchange. It allows the account holder to store, send and receive cryptocurrency. An unhosted wallet, however, is not hosted by a third-party financial system.
The chances of recovering crypto assets increase if you can identify them as being in a wallet that is hosted to an exchange. This means that recovery of them can use the traditional process employed for tracing assets, such as, for example, the proceeds of fraud when they are deposited in a bank account. You can apply to freeze the assets in question and serve the freezing order on the exchange.
Un-hosted wallets make anonymity possible, leading to difficulties in identifying who is accessing or controlling the cryptocurrencies in that wallet. In this scenario, it is much harder to serve a freezing injunction on a person whose identity you do not know. It is likely that the defendant or their co-conspirators may have private keys to gain access to the un-hosted wallet in question. This then changes the dynamic of the investigation: a proactive approach will be needed to identify who has the crypto asset in question, and whether it is in a private wallet or in cold storage (i.e. stored in a wallet offline/not connected to the internet).
Before takedown
Making legal applications
Crypto assets move in milliseconds. If you find them at a particular place it is imperative that you ensure legal action is taken as swiftly as possible. Once the crypto assets are identified, you need to utilise the right legal applications immediately. The English civil courts have a significant range of tools available to judges to act quickly. Some of these interim remedies (i.e. those before trial) include:
- Urgent ex parte applications.
- Proprietary injunctions.
- Freezing orders/injunctions.
- Third-party disclosure orders (Norwich Pharmacal and Bankers Trust), made to a third party compelling it to disclose certain information to the applicant to assist in the identification of the perpetrators.
- “I am Spartacus” orders.
- Other ancillary orders.
When it is an issue that crosses borders and includes other jurisdictions, it is important to have the proper legal approaches in place to effectively freeze and recover the assets. In the first instance, there is a very good chance that the person you will go after is “persons unknown”. It is well established in England and Wales that freezing injunctions can be granted against persons unknown. However, you will eventually need to find the bad actor that you can enforce the judgment against.
When you are assessing who you are going after, it is essential to also include the exchanges. Exchanges often carry out “Know Your Client” (KYC) and anti-money laundering checks. Information from these can prove valuable in your attempts to locate and identify who has your assets.
The next important issue to consider is the need to clearly define crypto assets before the court. This is important because this will determine the type of relief that judges are willing to grant, particularly in an urgent (without notice) application. There are various issues surrounding tracing, and a judge will have to be persuaded that there is a tracing remedy available to resolve your problem.
Finally, you will have to consider exactly where the respondent or defendant is in these proceedings. This could involve you needing to convince a judge to grant the order out of the jurisdiction in which the court sits. The majority of crypto exchanges are not likely to be located in England and Wales, and the bad actors’ location is not likely to be known. For these reasons, innovative legal arguments will need to be mounted to persuade the court to grant orders out of the jurisdiction. For example, you may need to use the Bankers Trust jurisdiction to obtain a disclosure order against an exchange for service outside of the jurisdiction. Here you must show that the case meets the jurisdictional “gateways” as set out in CPR Practice Direction 6B – an issue which was significant in the case of LMN v Bitflyer and others, which I refer to later in this piece.
The gateways allow English courts to exercise jurisdiction over foreign defendants, where the dispute has a sufficient connection to England. Some examples of the gateways that may be appropriate include:
- A remedy is sought against a person domiciled within the jurisdiction.
- The claim relates wholly or principally to property within the jurisdiction.
- The contract was made in the jurisdiction.
- The contract is governed by English law.
- The contract contains a term giving the English courts jurisdiction.
- The damage was/will be sustained within the jurisdiction.
The question of service will also need to be considered. If an order is made to be served outside of the jurisdiction, personal service is not likely to be possible. You will, therefore, need to convince a judge why service by an alternative means, for example, via email, is appropriate in the circ*mstances.
The tools for interim relief at a judge’s disposal are certainly powerful. However, the criteria that must be satisfied to secure the interim reliefs are of a high standard. For example, in order to obtain a freezing order, the applicant must satisfy the court that:
- it has a substantive cause of action against the respondent;
- it has a “good arguable case”;
- there is a “real risk of dissipation of assets”; and
- it is “just and convenient” to grant the order (here, the court must consider: (a) the conduct of the applicant (coming to court with “clean hands”); (b) the rights of, and any impact upon, any third parties who may be affected by the order; and (c) whether the order would cause legitimate and disproportionate hardship for the respondent).
As such, careful consideration must be given when making such applications.
Seizure
During takedown – actions after the
legal applications
Ongoing risk management is key once the relevant applications have been made to the court. Once crypto assets are frozen, you need to ensure that they do not fall into the hands of any bad actors. When you freeze cryptocurrency, it is important to ensure that there is no dissipation of assets. You need to plan what will happen as soon as the relevant orders are served on the parties involved.
The most important information will come from the exchanges following a disclosure order and/or Bankers Trust order served outside of the jurisdiction. It may be that you will need to remind the relevant exchanges of the severe consequences for not complying with such orders. It is well established that such orders contain within them a penal notice, which states that it is a contempt of court to breach the order. The result of any such breach can be the company and its directors being liable to have their assets seized and individuals facing the prospect of up to two years’ imprisonment.
After takedown – holding those responsible to account
The aim is to bring the perpetrator to book as soon as possible. Anyone seeking to do this has to know how to proceed. In our experience, the exchanges hold crucial information so that a claim can be made, and enforcement action can commence. This is where the use of a disclosure order is so important.
In a typical disclosure order, you would expect the exchange to provide the lawyers with:
- Information regarding any customer accounts which the crypto assets in question were allocated to and/or received on behalf of.
- The names of the account holders for the accounts in which the crypto assets in question are held.
- Any other information about the account holders, such as residential addresses, bank account details, email addresses and contact numbers.
- Any documents supplied when the wrongdoer opened an account with the exchange.
- An explanation of what has become of the crypto assets in question.
Potential pitfalls and defence considerations
As emphasised earlier, careful consideration must be given to any application for interim relief.
Rahman Ravelli acted for the defendant – an international private client and investor – in the leading case of AA v Persons Unknown. This was a landmark judgment in England and Wales as it was the first case where Bitcoin was defined as property and, as a result, a proprietary injunction was granted over crypto assets.
The defence in this 2019 case argued the defendant was a bona fide, good faith purchaser of the Bitcoin in question. The claimant, AA, said it had a claim for restitution and/or under constructive trust against persons unknown and the exchange. The Honourable Mr Justice Bryan had to assess whether it was possible to have a proprietary claim over Bitcoin (and, by implication, any other crypto asset). The claimant’s case relied on the fact that this was a claim for an interim remedy pursuant to S25 of the Civil Jurisdiction and Judgments Act 1982 (the Act). The claimant also stated this was a claim in tort where the damage sustained was in England.
S25 of the Act is in relation to interim relief in support of foreign proceedings. The initial application in AA v Persons Unknown made no reference to foreign proceedings being issued. This was a mistake by the claimants as they were attempting to serve overseas. Furthermore, the claim that was brought in this case was for restitution and a claim under a constructive trust. The test that was applied before the court related to a claim for tort. This again was a blunder by the claimants as the wrong test was applied. Mistakes like the above can sometimes be made in uncontested ex parte hearings such as these.
Upon identifying the above pitfalls, the matter led to negotiations and was concluded by way of a settlement.
The approach taken so far by courts
As crypto-asset litigation is still developing in England and Wales, it is currently unclear to what extent the courts will be asked to grant innovative legal arguments in order to secure such assets. That is something that will have to be closely monitored on a case-by-case basis.
This was highlighted in the 2020 case of Ion Science Ltd and Duncan Johns v Persons Unknown, Binance Holdings Limited and Payward Limited, in which the applicants were represented by Rahman Ravelli.
The case is an indicator of both the courts’ evolving response to cryptocurrency and the flexibility that courts are willing to extend to assist victims of fraud involving cryptocurrency.
It is a landmark case because it is:
- Believed to be the first case of fraud involving an initial coin offering – where a company looks to raise money to create a new currency – to go before the Commercial Court.
- One of the only cases where the court has granted permission to serve a free-standing Bankers Trust order out of the jurisdiction against cryptocurrency exchanges.
- The first time that a court has considered the lex situs (location) of Bitcoin.
The case of Fetch AI Limited, Fetch AI Foundation PTE v Persons Unknown, Binance Holdings and Binance Markets (2021) – which Rahman Ravelli also featured heavily in – was also notable. It was the first case to come before the courts where hackers had gained access to cryptocurrency accounts, traded the assets cheaply to a third party known to them and then sold them on at their proper value and taken the gains.
The case was also significant as London’s High Court ordered the crypto exchange Binance to both identify those who carried out the hack and freeze their accounts. It is a case that debunks the idea that all crypto-assets activity can be conducted anonymously – and will assist many in the future who are attempting to regain what they lost to crypto-related crime.
Another recent development is the aforementioned High Court case of LMN v Bitflyer and others (2022), which may prove to be of benefit to many who lose crypto assets to hackers. This is the first case to successfully use the new disclosure gateway which expanded the English courts’ jurisdiction in order to make it easier to secure information orders against non-parties based overseas.
The case involved Rahman Ravelli applying to the High Court for Bankers Trust orders to be made against six exchanges based overseas, requiring them to disclose information that could help trace hackers who misappropriated crypto assets worth US $10.7 million. On 1 October 2022, the Civil Procedure Rules extended the jurisdictional gateways, which enabled English courts to give permission for claims and applications to be served outside of the jurisdiction of England and Wales – making it possible for Rahman Ravelli to serve the application on the overseas exchanges.
As a result, the High Court ordered the exchanges to provide the names of the account holders and a wide range of information about them, including bank account and payment card details, email and residential addresses and phone numbers – information that can be an immense help in tracking down those who have taken crypto assets and the assets themselves. The case sets an important precedent regarding the types of information that can be sought via a court order against those outside of the UK. Furthermore, when applying for this type of order, Mr Justice Butcher also made it clear what was necessary to bring such an application. It was essential for the applicant, LMN, to have a “good arguable case” in order to establish that there was a serious issue to be tried in proceedings against the wrongdoers.
Gary Jones v Persons Unknown and others (2022) is also worthy of note. In this case, Mr Jones obtained an order for delivery up of Bitcoin. Mr Jones fell victim to a large-scale cyber fraud, commonly referred to as a “pig butchering” scam. Here, wrongdoers convinced him to transfer 89.616 Bitcoin to a fraudulent investment platform promising significant returns. The High Court granted him a worldwide freezing injunction against defendants and claims were brought when the defendants had not filed a defence before the deadline. Mr Jones applied for summary judgment and sought to extend the injunctions that had been granted, in order to prevent further dissipation of his funds.
The court held that Mr Jones was entitled to both summary judgment against the defendants and an order for his assets (which were in Bitcoin) to be returned to him. In a ruling that may have relevance for many others in similar situations, the court granted permission for the order to be served by way of email and non-fungible token (NFT) airdrop.
Tulip Trading Ltd v Bitcoin Association for BSV and others (2022) was a case that saw Tulip, a Seychelles company, bring a claim for US $4.5 billion against the developers of four Bitcoin networks, alleging that they were obliged to help it recover the digital assets it had lost to hackers. However, the High Court determined that there was no good or arguable case that the developers, whose code is widely adopted and used, owed either fiduciary duties or a common law duty of care to those who use that code to trade or store their crypto assets.
Due to this, the court set aside both an order from a lower court that had granted Tulip permission to serve a claim form out of the jurisdiction and the service of the claim form itself. However, Tulip then took the case to the Court of Appeal. The Court of Appeal overturned the High Court’s decision, finding for the first time that developers of Bitcoin networks might owe fiduciary duties to Bitcoin owners. Tulip Trading’s claim, and the key question of whether such duties exist, will now need to be determined at trial once the relevant facts have been established.
Conclusion
The world of cryptocurrency is constantly changing, which poses various challenges to those who are involved in it. The law is catching up with the developments surrounding cryptocurrency, even if it is doing so rather slowly.
The United States is an example of this progress. In October 2021, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) published guidance emphasising the need for everyone involved with virtual currency to ensure they are complying with sanctions obligations. The same month saw the creation of the US’s National Cryptocurrency Enforcement Team (NCET) to investigate and prosecute the use of cryptocurrency for criminal gain. Its remit includes ransomware use, money laundering, illegal or unregistered money services businesses, trading on “dark markets” and the tracing and recovery of assets lost through crypto-related criminal activity. Late 2022 saw two US senators introduce the Digital Asset Anti-Money Laundering Act of 2022, which, by late 2023, was gaining bipartisan support. If it became law, it would extend anti-money laundering and countering of terrorism financing requirements to cryptocurrency and digital assets. This move came after warnings from, among others, the US Treasury Department and Department of Justice that digital assets are increasingly popular with those involved in fraud, theft, money laundering and terrorist financing.
Efforts to regulate crypto assets have arguably become more relevant in the wake of the collapse of the FTX cryptocurrency exchange in November 2022. In the UK, HM Treasury and the Financial Conduct Authority (FCA) have made it clear that they believe that increased retail investors’ ownership of crypto has come at a time when misleading advertising about such products has been on the rise and, crucially, when people’s understanding of such products has been decreasing. This is perhaps best illustrated by FCA statistics, which show that 6,372 crypto-related scams were reported to it in 2021, compared to none in 2017. The FCA opened 759 cases about potential unregistered or scam crypto-asset businesses in the 2022–23 financial year – a 17% increase on the previous year.
It is a situation that has prompted action. The Financial Services and Markets Act 2023 introduced into the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 a definition of crypto assets (similar to the definition adopted by the EU in its Markets in Cryptoassets Regulation), and placed new obligations on crypto-asset providers to comply with the UK financial promotions regime.
Cryptocurrency is, therefore, attracting increasing attention from the authorities around the world. And, in our experience, judges in English courts are willing to show that they are prepared to adopt formidable tools to accommodate cryptocurrency fraud applications. Recent years have seen the courts applying trust law in cases involving cryptocurrency, and confirming that cryptocurrency can be considered property when the authorities are seeking to issue a property freezing order against individuals.
But while the law is now addressing some of the main issues surrounding cryptocurrency-related crime, those seeking to regain assets lost to it still face a battle. Much will depend on the strength of the application you make in such cases. This, ultimately, is determined by the effort and intelligence involved in your preparation.
