The Realities of Cryptocurrency Asset Recovery

In recent years digital assets, including cryptocurrencies and blockchain-powered assets, have rapidly gained popularity and prominence worldwide. The significant rise in the value of and the seamless ability to transfer digital assets make them great targets for fraud, misappropriation and other illicit activities. According to TRM Labs, a block chain analysis company, volumes of illicit transactions[1] in 2024 amounted to $45 billion[2]. The decentralised nature of cryptocurrencies and the lack of coherent regulatory frameworks requires the legal approach to tackling cryptocurrency related fraud and the recovery of cryptocurrencies and digital assets (collectively crypto assets) to be multidisciplinary, expeditious and pragmatic, combining technical knowledge with legal and investigative skills.

A developing body of case law in several jurisdictions (including England, Singapore, and the British Virgin Islands) demonstrates that the traditional legal framework can be used in asset recovery efforts and disputes involving crypto assets. Yet many challenges remain which often require novel approaches. Some of those challenges are discussed below, and more specific issues going to the practical side of recovery and realisation will be addressed in Part II of this digital asset recovery series for INSOL.

Costs of litigation as a barrier or deterrent

For many victims of crypto asset fraud, the cost of litigation can be too high and often far outweighs their financial losses, arguably preventing access to justice. In these circumstances, collective proceedings such as liquidation can be an appropriate avenue to redress. For example, following the well-publicised collapse of FTX, Atom Asset Exchange (AAX) ceased operations. The principals of AAX were alleged to have misappropriated the keys to crypto wallets holding AAX users’ assets totalling the equivalent of USD 30 million. The holding company of AAX –  Atom Holdings – was incorporated and registered in the Cayman Islands, and a winding up petition was presented by Baker & Partners on behalf of retail investors[3] who held the equivalent of approximately USD 20,000 in aggregate of crypto assets on AAX.

As a precautionary measure and because the misappropriation in Re Atom Holdings was ongoing, the applicants sought the ex parte appointment of joint provisional liquidators to take control of Atom Holdings and its subsidiaries. This permitted the provisional liquidators to gain access to the exchange’s property and documents and begin the recovery process of the misappropriated crypto assets. In the Cayman Islands, applicants are typically required to give undertakings in damages when seeking to appoint provisional liquidators. However, the circumstances of the case warranted the Court’s dispensation of the undertaking requirement so that the Cayman legislation and insolvency rules would not operate as a barrier to the investors’ access to justice.

Legal status of crypto assets

The legal status and classification of crypto assets can impact the rights and remedies available to fraud victims and other stakeholders.

Traditionally, property is either a chose in action or a chose in possession. Crypto assets are considered to be neither by the English High Court, but rather a distinct form of property not premised on an underlying legal right[4].

However, English common law recognises crypto assets as capable of being personal property[5] because it is definable, identifiable by third parties, and capable in its nature of assumption by third parties and has some degree of permanence or stability. Despite the growing body of English cases to that effect (albeit on interim or otherwise uncontested applications)[6], there is still controversy about the question of how digital assets can be regarded as ‘property’ under English law.

To help clarify this, the Law Commission of England and Wales (Commission) engaged in a public consultation process which resulted in two reports and a draft bill which, inter alia, classifies crypto assets as a third form of property which is not a chose in action or chose in possession[7]. The Commission concluded that any law reform should be through the common law development where possible due to its flexibility to accommodate the rapid technological advancements being made in this sector.

Notably, Dubai’s DIFC Court of Appeal recently held in Gate Mena DMCC & Huobi Mena FZE v Tabarak Investment Capital Limited & Christian Thurner[8] that crypto assets constitute a distinct third category of property, finding that crypto assets were capable of being factually controlled (akin to possession) and transferred.

There are several jurisdictions, including the Cayman Islands, where courts have yet to consider whether crypto assets can be treated as property. Given the highly persuasive nature of English authorities in the Cayman Islands it is likely that the Cayman Court will follow suit, although due to the evolving nature of the crypto asset market and technology this may not be a foregone conclusion.

Identifying the correct party to the claim

The recognition of crypto assets as a form of property means victims whose crypto assets have been misappropriated  can rely on legal remedies such as urgent disclosure applications and proprietary injunctions to freeze assets or to cease certain activities and provide recourse for asset recovery. These applications are routinely brought against known parties as well as “persons unknown.” However, a problem arises due to the anonymous nature of crypto assets which makes it difficult to identify the person against whom a claim can be brought.

Norwich Pharmacal orders and Bankers Trust orders are effective in compelling third parties, including regulated centralised cryptocurrency exchanges, to disclose information that could help identify the wallet holders and determine any onwards movement, where traceable misappropriated assets were credited. The Cayman and other Commonwealth courts have jurisdiction to grant Norwich Pharmacal relief in support of contemplated proceedings (including proceeding before a foreign court). In such circumstances, applicants are typically required to provide undertakings covering expenses and damages.

As noted above, courts may grant relief in respect of a victim’s proprietary claim against a person or entity that falls into the category of “persons unknown” where the person controlling the wallet holding the misappropriated crypto assets cannot be readily identified[9]. But limitations arise with non-custodial wallets (i.e., cold / hardware wallets) and international jurisdictional issues.

A Bankers Trust disclosure order[10] may be obtained against regulated centralised cryptocurrency exchanges requiring them to provide KYC and AML information that could identify the wallet holders (who could be the individuals behind the fraudulent transactions) where the traceable or followable misappropriated proceeds have been credited.

Challenges with Tracing Crypto Assets

The doctrines of following (following an asset as it moves from hand to hand) and tracing (identifying a new asset as the substitute for the old asset) may be used to locate and identify misappropriated assets, their proceeds, and the persons who have handled or received them to establish the evidential basis for a claim.  There are separate regimes for tracing in equity (where the proprietary interest in the property is equitable) and at common law (where legal title can be established). Tracing through a mixed fund is impossible at common law but is possible in equity. Litigants are required to substantiate their tracing claims and requests for disclosure or injunctive relief by filing evidence including blockchain forensic tracing reports. Since many of the freezing and disclosure relief applications have been against “persons unknown” or have otherwise gone uncontested, there has been little judicial commentary on such reports.

However, in D’Aloia v Persons Unknown Category A and Others[11], the applicant’s tracing reports were challenged, and the English High Court analysed the common law approach of following and tracing (both at common law and in equity) – and ultimately found the applicant’s expert’s tracing methodology to be unreliable. An important lesson learned from this case is that when tracing through mixed funds, blockchain tracing reports should clearly set out and follow the appropriate methodologies which must be clearly identified, applied coherently and consistently, and treat all innocent claimants comparably[12]. The authors discuss the implications of D’Aloia in Part II of this series.

Forum, jurisdiction and lex situs

The decentralised nature of crypto assets poses challenges in pinpointing the appropriate jurisdiction in which to commence proceedings. The English Court’s approach to jurisdiction alternates between residency and domicile[13]. When considering the proper place in which to bring a crypto asset related claim, the English Courts have considered whether the applicant is resident or domiciled in England; whether there were good grounds for considering the lex situs (the applicable law) of the crypto asset to be in England; whether the relevant documents were in England; and that the law of England and Wales at least arguably governed the proprietary claim.  For example, the English Commercial Court in Ion Science decided England was the appropriate jurisdiction based on several factors like the location of the company’s bank account and the lex situs of the crypto asset.

As stated in Dicey, Morris, & Collins, “something with no physical existence can hardly have a location in space; nevertheless, the courts have evolved rules under which a situs is ascribed to choses in action of different kinds in order to apply legal rules originally developed for tangible property” (e.g., judgment debts, letters of credits, and shares in companies). The lex situs of a crypto asset remains a complex and evolving issue for courts to grapple with, and such an analysis is beyond the scope of this article.

Service of process

Where a respondent (including persons unknown) is located outside of the jurisdiction the permission of the court is required to serve proceedings on them. Each jurisdiction will have its own requirements or gateways for service out. From a Cayman Islands perspective,  the Court must be satisfied that there is a serious issue to be tried between the applicant and the respondent/persons unknown; there is a good arguable case that the claim falls within one of the jurisdictional gateways in the Grand Court Rules Order 11; and the Cayman Islands is the appropriate forum to bring the claim (e.g., the applicant is located in the Cayman Islands and the crypto assets are to be treated as having been removed from the applicant in the Cayman Islands).

If “persons unknown” are in Hague Convention jurisdictions (where service would be too slow), a departure from the methods of service permitted by the Convention may be justified.

Service may, in exceptional circumstances, be effected by email, WhatsApp, or by NFT (non-fungible token) airdrop[14] (giving notice to the holder of the wallet’s private keys) where it may be the means most likely to bring the proceedings and the order to a respondent’s attention. However, not all methods of service as mentioned above have been approved by the Cayman Court, which has a high threshold for granting substitute service. These thresholds may need to be reconsidered in light of the properties and unique characteristics of crypto assets.

[14] D’Aloia v (1) Persons Unknown (2) Binance Holdings Limited and others, 24 June 2022, [2022] EWHC 1723 (Ch). See also: Jones v Persons Unknown 2022] EWHC 2543 (Comm) where the Court held that service by non-fungible token on persons unknown was appropriate because it was the means most likely to bring the proceedings to the attention of the respondents quickly.

Enforceability of court orders

Another major challenge litigants face involves the policing and enforcement of court orders, including freezing and seizure orders.

The issuance of a freezing order will not necessarily prevent the further transmission or misappropriation of crypto assets. Crypto thieves are unlikely to respect freezing orders (including those which have penal sanctions attached) and the stolen crypto assets can continue to be transferred under relative anonymity. However, it is possible to obtain tokenised freezing orders and serve those orders by airdrop. In an unreported 2023 decision from the High Court of Singapore[15], the Court granted a tokenised worldwide freezing order (in this case a soulbound token or SBT) which once airdropped on a fraudster’s wallet (including cold wallets), act as notice to the world that the wallet was tainted with stolen crypto assets. The SBT’s are designed to be non-transferable and remain on the served wallet more as a police caution tape to warn others against transacting with that wallet, on the basis that the wallet is subject to a court order and that they may be in breach of its terms by interacting with it. They do not freeze the crypto assets stored at that wallet address.

To seize (rather than freeze) a target wallet (including a cold wallet), litigants will have to locate or obtain the private keys. Private keys can be obtained through disclosure and seizure orders (including Anton Piller orders) and can be found in the most obscure places including embedded in JPEG images or on cloud storage devices. In some circumstances where the private keys cannot be located or where the identity of the wallet holder is unknown, it may be possible to “burn” and “re-issue” certain crypto assets (which is described further in Part II of this series). That said, this will very much depend on a case by case basis.

These are just some of the creative and ever evolving techniques used by litigants to combat crypto fraud and recover their misappropriated crypto assets.

Conclusion

The speed at which digital assets can be transacted anonymously within minutes allows crypto criminals to mask their trails. This necessitates approaches that are quick and effective to combat crypto enabled crime and freeze, seize, and ringfence crypto assets related to criminal conduct, preventing them from being transferred, exchanged, on-ramped / off-ramped, or dissipated while investigations take place.

Despite the inherent challenges surrounding digital asset recovery, the combination of efforts through the use of traditional legal remedies and innovative technologies makes it increasingly possible to track down, identify and recover misappropriated crypto assets. Collaboration between law enforcement, private practitioners and the judiciary – including information sharing and court-to-court communication – may be necessary to combat the speed at which crypto assets are stolen, moved around the blockchain and ultimately off-ramped  into fiat currencies.

As a follow-up to this article, Part II of this series will focus on issues not already covered and will expand on some of the complex issues addressed herein.

Footnotes

[1] Recorded on certain blockchains monitored by TRM Labs.

[2] At the time of drafting this article, the world’s largest crypto theft from the Bybit exchange (nearly USD 1.5 billion worth of USDT) had just taken place.

[3] See https://www.bakerandpartners.com/insights/cayman-islands-court-confirms-importance-of-access-to-justice-in-case-involving-collapse-of-the-aax-cryptocurrency-exchange/. Baker & Partners acted for the investors who petitioned the Cayman Court to wind up Atom Holdings.

[4] D’Aloia v Persons Unknown Category A and Others [2024] EWHC 2342 (Ch) at [5].

[5] AA v Persons Unknown [2019] EWHC 3556 (Comm), the test for property in National Provincial Bank Ltd v Ainsworth [1965] A.C. 1175, [1965] 5 WLUK 32 applied. See also Tulip Trading Ltd v Bitcoin Association for BSV [2023] EWCA Civ 83.

[6] Beginning with the judgment in AA v Persons Unknown and culminating in the English Court of Appeal decision in Tulip Trading Ltd v Bitcoin Association for BSV.

[7] See https://lawcom.gov.uk/digital-assets-as-personal-property-supplemental-report-and-draft-legislation/.

[8] (1) Gate Mena DMCC (Formerly Known as Huobi OTC DMCC) (2) Huobi Mena FZE v Tabarak Investment Capital Limited (2) Christian Thurner [2023] DIFC CA 002, which endorsed AA v Persons Unknown.

[9] AA v Persons Unknown. See also D’Aloia v (1) Persons Unknown (2) Binance Holdings Limited and others, 24 June 2022, [2022] EWHC 1723 (Ch), the first English cases in which a court ordered service on “persons unknown” by transfer of non-fungible tokens; and Mooij v Persons Unknown [2024] EWHC 814 (Comm) in which the English Commercial Court granted summary judgment against persons unknown who had perpetrated a cryptocurrency fraud.

[10] In Ion Science Limited v Persons Unknown (unreported) 21 December 2020 (Commercial Court) (Ion Science), the English Commercial Court permitted service of a free-standing Bankers Trust order out of the jurisdiction against foreign cryptocurrency exchanges holding information relevant to a cryptocurrency fraud perpetrated by persons unknown.

[11] D’Aloia v Persons Unknown Category A and Others [2024] EWHC 2342 (Ch).

[12] D’Aloia v Persons Unknown Category A and Others [2024] EWHC 2342 (Ch), see [221].

[13] Ion Science at paragraph 13: “The lex situs of a crypto asset is determined by the place where the person who owns it is domiciled in the present case”.

[14] D’Aloia v (1) Persons Unknown (2) Binance Holdings Limited and others, 24 June 2022, [2022] EWHC 1723 (Ch). See also: Jones v Persons Unknown 2022] EWHC 2543 (Comm) where the Court held that service by non-fungible token on persons unknown was appropriate because it was the means most likely to bring the proceedings to the attention of the respondents quickly.

[15] M31 Capital Partners, LP and another v Various Defendants HC/OC 371/2023.