A Practical Guide To Tracing And Recovering Crypto Assets – Fin Tech – United States


17 October 2022

Brown Rudnick LLP

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On Wednesday, 28 September 2022 I was a panelist alongside my Brown Rudnick colleagues Jane Colston and Jessica Lee (London) and Stephen D. Palley (Washington DC) discussing recent developments in crypto fraud. The session was recorded and is available  here, but some of the key points of the discussion and areas of comparison between the US and the UK included:

Is the “crypto winter” and falling price of cryptocurrencies resulting in less fraud in the area? 

  • Unfortunately, we don’t think it does – there is still significant activity in the crypto market and while consumers are more aware of crypto scams, bad actors continue to innovate.
  • We have seen a significant move to fraudsters and hackers targeting DeFi platforms and cross-chain bridges – which is exactly what happened to Binance last week when a hacker targeted a cross-chain bridge and made off with c.$100m of crypto.

Victims of crypto fraud do have a chance of recovery as transactions can be traced even where the perpetrators of the fraud are unknown

  • The blockchain is pseudonymous and not anonymous. All transactions are recorded on the blockchain including wallet addresses making it possible to trace the movement of crypto and identify wallets which have received stolen crypto assets.  
  • Following the Legal Statement on Cryptoassets and Smart Contracts of 2019, the English courts have been willing to treat crypto assets as property and grant injunctions (including worldwide freezing orders) to recover stolen crypto. Non-fungible tokens (NFTs) have also been held to fall within this category. Note – the Law Commission is currently considering establishing a new third category of personal property called “data objects” that would cover digital assets including cryptocurrencies which would firmly establish crypto as capable of constituting property.
  • If the identify of potential defendant is not known, the persons unknown jurisdiction in the UK and many other common law jurisdictions (the equivalent in the US being the John/Jane Doe jurisdiction) enables claimants to seek interim relief against a defined categories of persons unknown such as owners of the wallets that received the stolen funds.
  • In both the US and the UK, service of court orders and proceedings has been effected by using the blockchain and airdropping an NFT into a known wallet address despite the wallet holder being unknown. In a recent US crypto case, service was also made via a help chat box on a website.

Orders can be obtained to enable the discovery of the identity of the fraudster, though there can be some difficulties here

  • The English courts have stepped in by granting Norwich Pharmacal Orders (NPOs) and Bankers Trust Orders (BTOs) against third parties (e.g. crypto exchanges) to obtain disclosure of information to identify unknown wallet holders who have received stolen funds.
  • However, the level of information held by exchanges varies hugely and so disclosure orders may not always be effective in practice but incoming international regulation in this area will likely make a difference.
  • In particular,  a new civil procedure gateway was introduced in CPR PD 6B Para 3.1(25) on 1 October 2022 which will facilitate a more cost efficient process to enable information orders to be obtained against parties outside of the jurisdiction seeking disclosure of (a) the identity of a defendant; and (b) what has become of the claimant’s property, without having to first issue costly court proceedings.

Incoming regulation will hopefully improve the prospects of recovery in crypto fraud cases

  • There is also a provisional agreement on the EU level to extend anti-money laundering regulations to the transfer of crypto assets and bring crypto assets and related entities under a regulatory framework aimed at enhancing consumer and investor protection known as the Regulation on Markets in Crypto Assets (MiCA).
  • The FCA held CryptoSprint events in 2022 to discuss areas for reform including on-going disclosure of information regarding crypto assets to buyers, identifying when regulation should apply and the need for custody regulatory framework, with a view to protecting consumers. This is in addition to Money Laundering Regulations that crypto asset businesses have to comply with (and which will enhance the KYC information available in instances of crypto fraud) and the financial promotion of crypto assets to the UK consumers.

Other interesting developments to watch in this space include:

  • Questions over whether there can be other technological routes to recovery. Panelists discussed whether developers on a network could be subject to fiduciary or other duties of care to users to reroute stolen crypto back to users. This is currently the subject of an ongoing dispute in the Tulip Trading case which is pending before the English Court of Appeal.
  • Liability of decentralised autonomous organisations (DAOs). Recently, the US Commodity Futures Trading Commission (CFTC) has charged the individual members of a DAO, treating the DAO as an unincorporated association. How DAOs will be treated more generally in the UK and the US is yet to be determined and gives rise to a number of potential issues including their legal status and who is liable for a DAO’s actions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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