Out-Law / Your Daily Need-To-Know

Out-Law Analysis 6 min. read

Cryptoasset fraud recovery hinges on questions of property

People who are defrauded of their cryptoassets, have them stolen by hackers, or are the victim of more 'traditional' fraud the proceeds of which are then laundered through cryptocurrency exchanges, are less likely to be able to recover their losses if cryptoassets are not considered to be 'property'.

It is one of the reasons why legal certainty is needed on the fundamental question of whether cryptoassets constitute property, money or something else.

New case law

In order for businesses to develop effective new uses for blockchain technology and evolve existing ones, it is vital that they have as much clarity as possible as to the legal framework in which these will operate. We are seeing more disputes in this area, particularly fraud cases involving cryptoassets. Greater clarity as to parties’ rights in these situations is therefore much needed.

Some clarity was provided by the High Court in London recently when it considered claims that the cryptocurrency 'Bitcoin' could be deemed a person's property.

While the court did not rule definitively on the issue, it held that there was a serious issue to be tried as to whether Bitcoin can be classed as property. On that basis, the court issued an asset preservation order to prevent Bitcoin allegedly defrauded from a cryptocurrency trader from being dissipated.

The case was brought by Liam Robertson who claimed that an investment he made in Bitcoin worth £1.2 million was misdirected to fraudsters after he fell victim to hackers. Some of the Bitcoin was traced to a cryptocurrency wallet in the UK, but the identity of the alleged fraudster had not been determined.

Barristers at Brick Court Chambers said they believe the case was the first time a UK court has considered in any detail whether Bitcoin can be regarded as property. It is understood that the case has now settled, so that no further clarification will come from the courts in that particular piece of litigation.

It is to be hoped that this topic will be explored further by the LawTech Delivery Panel's UK Jurisdiction Taskforce (UKJT), a team of industry experts and leading figures from government and the judiciary. Its remit is to clarify issues of legal uncertainty regarding cryptoassets, distributed ledger technology and smart contracts. The UKJT earlier this year carried out a consultation to gather feedback and shape its future work on the topics.

Meeting the definition of property

The concept of property is typically derived from common law. Property is something considered to have inherent value, to be transferable, and to be capable of being touched, held or recognised as intangible property, such as intellectual property or, perhaps more analogous to cryptoassets, debt or shares.

It is thought that until the Robertson case, the specific question of whether cryptoassets constitute property had not been considered in any detail by a UK court. The Singapore International Commercial Court, to which the High Court reportedly referred in the Robertson judgment, recently held that cryptoassets could be the subject of a trust relationship between a custodian and a client. This conclusion was based on the presumption that cryptoassets could be property for the purposes of trusts law.

There are, however, a number of conceptual hurdles to recognising cryptoassets as property.

For example, previously, the Court of Appeal in England and Wales has ruled that information stored electronically does not constitute property over which someone can exercise possession. The court considered that while information held on an electronic database can qualify for protection under copyright or database rights laws, and therefore qualify as intellectual property, in cases where such rights do not subsist in the information, then the data in its own right is not property. In contrast it said that the physical medium on which the information is held constitutes property.

In the context of cryptoassets, that ruling is potentially relevant. This is because it could be argued that consideration of cryptoassets cannot be separated from the underlying blockchain on which they are held. In the case of cryptoassets, there is not even any relevant physical medium which would be regarded as property.

Cryptoassets are also different from money held in a bank account, where the account holder has a form of property known as a 'chose in action' because they can compel the bank to pay them legal tender corresponding to the amount in their account.

In contrast, a blockchain platform is, at its most fundamental, simply a record of transactions. The "currency" of the system is just the other side of the coin, in that a unit of cryptocurrency is a measure of the ability to instruct the system to increase another party’s account balance, in return for reducing one’s own.  Some commentators argue that the reason why cryptocurrencies could never be choses in action is that, in a blockchain platform, there is no one to sue to enforce any rights which might attach to the asset.

It is true that there will not necessarily be a counterparty to a blockchain-based asset. In every transaction on a blockchain, however, there is a hypothetical person who would be sued if their identity were known to the claimant: the person who previously held the asset, or the person who now holds the asset. Litigation is likely to arise if, for example, the previous holder of an asset defrauds the transferee by duplicating the asset using ‘double-spend’ tricks. This might be where someone transfers a cryptoasset to one user and then, before the miners have executed the transaction, purports to transfer the same asset to another person but has not actually done so, or if a fraudulent transferee procured the transfer of the asset by hacking the transferor’s account.

These observations indicate that a blockchain asset does confer a right, which entitles the owner to the non-interference of others.

Indeed, it might be said that blockchain platforms are similar to deeds systems, such as that still used in Northern Ireland to document land ownership. With each land sale, the bundle of ‘deeds’ is added to with the record of the latest transaction. In this system, ownership of land is simply the superior title of the latest person in the line, to be disposed of by adding to the bundle in order to make someone else’s superior title to yours. In practical terms, this can be considered to be similar to the system which operates on a blockchain, and so cryptoassets can be regarded as legally similar to dematerialised property deeds.

The role of the UKJT

The Robertson case marked the true awakening of the English courts to the potential disputes concerning cryptocurrencies and transfers of cryptoassets. It highlighted the fact that fraudsters are adapting to the modern world and are shifting their tactics to holders of cryptocurrencies and the blockchain trade. This makes it even more pressing to obtain clarity on the question of cryptoassets as property, and the work of the UKJT is therefore to be welcomed.

It will be valuable for the UKJT to explore the rights which market participants believe come with, or ought to come with, ownership of cryptoassets, and how these rights are given practical effect. The UKJT should then seek to answer definitively whether a cryptoasset should be recognised as property.

In our view, there are clear public policy arguments why cryptoassets should be classified as such under the English legal system. For example, in some of the cases of fraud involving cryptoassets which we are seeing, a hack on an exchange or a more 'traditional' fraud is followed by the laundering of the proceeds through cryptocurrency transactions. The recourse available to victims in such cases often depends in part on whether they have a proprietary claim to the assets.

At present, victims may in practice have to think more creatively about how to pursue their claims, for example by pursuing third parties such as agents.

In Japan, the question of the legal status of cryptoassets has also arisen in the context of insolvency law, in a case concerning the Mt. Gox cryptocurrency exchange.

The Mt. Gox exchange was hacked in 2014 resulting in billions of dollars-worth of Bitcoin being stolen. The exchange subsequently went bankrupt, but the value of the Bitcoin that remained held by the exchange then rocketed and was enough that all victims of the hack who had lost money could be reimbursed. The Japanese courts held, though, that the Bitcoin held were not the property of the company in its insolvent state, thus presenting a barrier to the exchange's operators' bid to facilitate reimbursement. It was only through a special rehabilitation claim process that those who held funds with the exchange were given scope to recover their funds.

No doubt the UKJT will consider these and other arguments for considering cryptoassets as property. This will help inform their views on the circumstances in which, as a matter of English common law, a cryptoasset would be recognised as property. It will also be interesting to see whether there are circumstances in which they conclude a cryptoasset should be recognised as property but where new legislation would be needed to arrive at that position

Jennifer Craven is a civil fraud and asset recovery specialist at Pinsent Masons, the law firm behind Out-Law. Pinsent Masons submitted a response to the UKJT's consultation, which closed on 21 June.

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