Introduction
In the recent case of Fabrizio D'Aloia v. Persons Unknown Category A & Ors [2024] EWHC 2342 (Ch), Mr D’Aloia (the claimant) was induced to transfer around US$2.5 million worth of cryptocurrency in the form of USDC (which was not relevant for the trial) and USDT into a counterfeit trading account. The fraudsters, who were persons unknown to the claimant, then proceeded to transfer the cryptocurrency through various wallets on numerous exchanges, including Bitkub, before dissipating the stolen cryptocurrency. Mr D’Aloia sought to recover his assets from the crypto exchanges which had been used to move the cryptocurrency.
Bitkub is a Thailand-based crypto exchange regulated by the Thailand Securities and Exchange Commission. It provides custodial digital wallet services for cryptocurrencies, including USDT. Unlike non-custodial digital wallets, custodial digital wallets like Bitkub manage the private keys necessary to execute transactions on the blockchain. This means that Bitkub controls access to the cryptocurrency held in the wallet and, in order to settle any transactions, the holder of the wallet would be required to ask Bitkub to settle those transactions on its behalf. In the UK, custodial digital wallet services are subject to anti-money laundering regulation.
Readers with an interest in cryptocurrency case law might recognise the name “D’Aloia” from a 2022 decision, referenced in our previous client alert, as the first instance of permission being granted for service via NFT in the context of cryptocurrency fraud claims.
In the D’Aloia case, the High Court was asked to consider, amongst other things, two particular questions of interest in the world of cryptocurrency law. First, was USDT considered “property” under English law? And second, could Mr D’Aloia establish, through tracing and following, that his USDT reached the relevant Bitkub wallet?
1. Does USDT constitute property? If so, what other considerations arise from that categorisation?
This claim was specifically about USDT – a stablecoin tied to the value of the U.S. dollar. The claimant sought to follow or trace the USDT to a specific wallet. Following and tracing are processes which allow a claimant to identify assets in the hands of either a defendant or a third party. Following involves following the asset in which the claimant has a proprietary interest as it moves from hand to hand. Tracing is the process of identifying a new asset as the substitute for the misappropriated property.
In order to determine whether these processes could be used in respect of the USDT, the Court had to first address whether USDT constituted property as following and tracing are both exercises in locating property belonging to a claimant. If USDT was found to be property, then the nature of the associated property rights also had to be defined, as the rules on following and tracing differed between the two categories of legal rights over property. For a chose in action (where rights can only be claimed or enforced by action, rather than physical possession) following would not be possible, whereas for a chose in possession (where rights are claimed or enforced by taking physical possession), following was possible in principle.
Although the status of cryptoassets as property has previously been addressed at interim hearings and by the Law Commission in its report “Digital Assets: Final Report”, Law Comm No 412, the point had not yet been decided at trial in England and Wales1. In determining whether an asset constituted property, the Court held that the “starting point” and often the “end point” was the case of National and Provincial Bank v. Ainsworth [1965] AC 1175. This held that “before a right or an interest can be admitted into a category of property, or of a right affecting property, it must be:
- definable;
- identifiable by third parties;
- capable in its nature of assumption by third parties; and
- have some degree of permanence or stability”.
It was accepted in Tulip Trading v. van der Laan & Ors [2023] EWCA Civ 83 para 24 that the Ainsworth criteria was satisfied in the case of Bitcoin. In D’Aloia, the Tether white paper was relied on as evidence that USDT operates in much the same way as Bitcoin, but with the added feature of proof of reserves. Accordingly, the Court accepted that the Ainsworth criteria was also satisfied.
Farnhill J held that USDT attracted property rights under English law (albeit this point was not contested by either party) and that there was a strong line of authority in this jurisdiction accepting that there was a good arguable case that cryptoassets are to be treated as assets to which property rights can attach. In agreement with the Digital Assets: Final Report, the Court noted that it was significant as part of this analysis that cryptoassets had a conceptual existence, and could be used and enjoyed, independently of the legal system and of the individual users.
When faced with the two categories of either a chose in possession or a chose in action, USDT could not be a chose in possession, being virtual and unable to be physically possessed. The judge focussed his analysis on whether USDT could be a chose in action and concluded it could not, as it did not confer what are described as “Hohfeldian claim-rights”, whereby a right is only capable of being enforced through legal proceedings.
USDT was neither a chose in action nor a chose in possession, but rather a distinct form of property not premised on an underlying legal right. Farnhill J referred to the fact that USDT and Bitcoin were both premised on an expectation of performance, secured by cryptography rather than recourse to a court or tribunal. An expectation not based on a legal right, power, immunity or privilege could also be something to which property rights attached, provided that the expectation was clear and well founded. Those property rights were held to attach directly to the USDT itself, rather than the right to control it, for example, the right to use a private key.
In an approach consistent with the Law Commission’s draft Property (Digital Assets Etc.) Bill, the Court commented that the potentially wide range of assets which were neither a chose in action nor a chose in possession (of which USDT was one), should not all be bracketed into a single umbrella category.
2. By using following or tracing, could the claimant establish that the USDT reached the Bitkub wallet, for which Bitkub held the private key?
The Court looked at two different questions in respect of tracing the cryptocurrency.
Firstly, whether in principle the USDT property interest was more akin to a chose in action or a chose in possession. If it was most like a chose in action, the Court held that it could not be followed, as once the USDT passed through a mixed fund it would no longer be identifiable. However, if it was most like a chose in possession, the Court recognised that, in principle, it could be followed as long as it remained identifiable. The Court held that USDT was a persistent thing, which maintained a distinct identity even in mixture. For these purposes, Farnhill J held that USDT was more like a chose in possession than a chose in action. In agreement with the Digital Assets: Final Report, the Court held that where a cryptoasset takes the form of a persistent thing, as was the case here, following should, in principle, be an option.
Secondly, the Court considered whether USDT could be followed through a mixture. Expert evidence suggested that Tether Ltd, the company that administers USDT, possessed the necessary records to carry out that exercise. There was, however, no evidence submitted to suggest that any form of following based on those records had been attempted. On the basis of the limited evidence available, the Court found that as a matter of law USDT could in theory be followed. As a matter of fact, in this case, however, the Claimant’s USDT had not been and could not be successfully followed.
In the context of claims arising out of cryptocurrency fraud, the Court held that tracing and following methods should not be limited to only the classic first-in, first-out, pari passu and rolling charge methods. The Court’s view was that other methodologically sound and properly evidenced methods should be available to a party seeking to trace assets, and the law should not seek to be limited.
- Reed Smith has previously written a client alert on the Law Commission’s draft Property (Digital Assets Etc.) Bill (Digital Assets Bill) and how it would provide that a “thing” is not prevented from being the object of personal property rights merely because it is neither a chose in action nor a chose in possession.
In-depth 2024-231
