Crypto Fraud: English Court Clarifies Pathways and Pitfalls in Stolen Crypto Recovery
December 02, 2024
Key Takeaways
- USDT as Legal Property: This decision has major consequences for investors, as it means that Tether (USDT) can be traced and treated as trust property, with property rights attaching to it.
- Challenges in Tracing Cryptoassets: The case highlighted significant evidential difficulties in tracing cryptoassets, especially when they are co-mingled with other assets. The fact that the blockchain records transactions is not sufficient to persuade a Court that the stolen crypto has been received by a defendant.
- Constructive Trusts: There must be identifiable trust property for a constructive trust to exist. Whilst fraudsters are likely to hold the assets on constructive trust, this will not automatically apply to exchanges on whose platforms the fraudsters operate.
- Defences for Exchanges: Exchanges dealing with cryptoassets might rely on defences such as change of position and bona fide purchaser for value without notice, provided they act in good faith. Having effective and readily enforceable AML policies in place is a key factor for exchanges seeking to avail themselves of these defences in cases of crypto fraud.
In a rare judgment on crypto fraud following a fully contested trial, the English Court has recently provided valuable guidance for investors and exchanges. From confirming that Tether (USDT) is a form of property, to analysing the application of trust and tracing principles and the potential liability of exchanges in crypto disputes, we set out below the key takeaways from the judgment.
The Facts
Mr. D’Aloia alleged that he was the victim of a cryptocurrency scam after transferring a total cryptocurrency (USDT) equivalent of GBP 2.5 million into a trading account via the website tda-finan.com. Mr. D’Aloia understood the website to be associated with a regulated US brokerage but the website was in fact a scam operated by alleged unknown fraudsters. Mr. D’Aloia’s USDT was then transferred through several wallets before it was eventually withdrawn as fiat currency by another set of unknown persons.
Mr. D’Aloia issued proceedings against the alleged unknown fraudsters as well as five cryptocurrency exchanges with which they held accounts. However, the trial concerned only one of the exchanges: Bitkub Online Co Ltd, a Thai company which operated a wallet for a Ms. Hlangpan. Through a series of 14 transfers, USDT 400,000 arrived in Ms. Hlangpan’s Bitkub wallet, (the “Bitkub Wallet”), USDT 46,291 of which was said to have belonged to Mr. D’Aloia (or represented the traceable proceeds of his USDT).
Bitkub had AML policies in place to police suspicious account activity. However, in contravention of those policies, Ms. Hlangpan successfully submitted several withdrawal requests, in amounts vastly exceeding her daily withdrawal limit. This resulted in a near total withdrawal of the USDT 400,000 just three days after it had arrived in the Bitkub Wallet.
Mr. D’Aloia argued that Bitkub was liable to him for the USDT 46,291 on the basis that it held the USDT on constructive trust,2 or had been unjustly enriched by having received the USDT.
The Decision
The Court dismissed the claim and made the following key findings:
1. USDT is legal property. This was not a contested issue, but the Court nonetheless made a finding that USDT (as opposed to cryptoassets generally) constitutes property. As for the specific type of property, it is neither a “thing in action” nor a “thing in possession”.3 Rather, it is a third distinct category of property that is capable of being traced and can constitute trust property.
2. The evidential difficulties of tracing cryptoassets. Critical to Mr. D’Aloia’s claim was proving that the USDT he paid to the alleged fraudsters ultimately ended up in the Bitkub Wallet. The Court emphasised the need for precise and reliable evidence in tracing claims (whilst recognising the difficulty of the exercise where cryptoassets are co-mingled in accounts with other assets), which was not provided in this case. As a result, he could not prove that Bitkub had been unjustly enriched at his expense.
3. Constructive trusts require the existence of trust property. Whilst the contract with td-finan was nothing more than a fraud, such that the alleged fraudsters held the USDT on constructive trust, the same did not automatically apply to Bitkub. Mr. D’Aloia failed to show that Bitkub received any of his assets and, in any event, the USDT received had been paid away, such that there was nothing against which a proprietary claim could be asserted.4
4. Possible defences for exchanges. The Court confirmed that those dealing with cryptoassets (at least in respect of USDT) may rely on the defences of change of position and bona fide purchaser for value without notice,5 provided that they were acting in good faith. Bitkub’s awareness that Ms. Hlangpan had breached her withdrawal limit (and therefore Bitkub’s AML policies) when extracting the USDT from the Bitkub Wallet would have potentially prevented the exchange from relying on these defences.
Conclusions
The Court's recognition that USDT attracts property rights is welcome news to investors of that cryptocurrency, enabling them to bring equitable claims to trace or follow those assets should they ever be stolen.
However, Mr. D’Aloia’s failure to evidence the flow of his cryptocurrency between accounts was fatal to his claim, which serves as a stark reminder to investors that following and tracing stolen cryptocurrency is not always a straightforward task, notwithstanding the immutable nature of the blockchain. Tracing methodologies have been hotly contested in recent Court decisions and this trend is set to continue. This case highlights the importance of having strong expert evidence to support tracing claims.
From the perspective of exchanges, this case highlights the importance of ensuring not only the existence but also the practical implementation of adequate AML systems and controls. Exchanges would be well advised to ensure that their account monitoring systems and other compliance policies are effective, to avoid liability for fraudsters operating on their platforms.
Contributors
The authors would like to thank Holly Alderton, Trainee Solicitor in London, for her valuable contributions to this OnPoint.
Footnotes
1. Most recent judgments of the English Courts on issues relating to crypto fraud have been interlocutory, meaning that issues might not be fully argued and/or contested, and at which there is a lower standard of proof to meet as opposed to at a full trial. Dechert wrote about this case at an earlier stage of the proceedings, before it proceeded to a full trial: see here.
2. In summary, when property is obtained by fraud, a constructive trust is imposed on the recipient so that they hold legal title to the assets on trust for the victim.
3. This is in line with the recent Property (Digital Assets etc) Bill. In summary, a “thing in action” represents personal rights over property which can only be claimed or enforced by action, and not by taking physical possession (e.g. the right to sue), whereas a “thing in possession” represents personal rights over property which can be physically possessed (e.g. bank notes).
4. Even if Mr. D’Aloia had been able to prove that Bitkub had held his USDT, he had not pleaded a claim of constructive trust on the basis of knowing receipt, which would have covered the eventuality of the funds having been paid away by Bitkub.
5. In summary, “change of position” is a defence to unjust enrichment, whereby a defendant’s circumstances have changed so detrimentally that it would be unjust to make them repay the money or return the assets that they received. As for the “bona fide purchaser for value”, this defence means that an innocent purchaser of property who acquires it for value without notice of any other party’s claim against it, will take good title to the property.
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