Background: crypto-assets as legal property
For businesses issuing, transacting in, or custodying digital tokens, the question of whether a crypto-asset is property is of vital importance. It determines whether courts or tribunals will treat as legal, valid and enforceable, transfers of assets, or security granted over them. It will also govern what happens to the asset in the event of fraud, theft or breach of trust.
Therefore, industry players seeking legal certainty over the effectiveness of transfers or loans of digital assets, or the legal right to recover them from hacking or exploitation, will aim to do business under laws which recognise such rights.
Jurisdictions seeking to encourage digital innovation have likewise sought early clarity on this issue. In November 2019, the UK Jurisdiction Taskforce issued a Legal Statement on Cryptoassets and Smart Contracts (the "Legal Statement") confirming that crypto-assets could be property. The authors found that a crypto-asset was capable of satisfying the four-part test for property in the English case of National Provincial Bank v. Ainsworth,2 namely that it: (1) be definable, (2) be identifiable by third parties, (3) be capable in its nature of assumption by third parties, and (4) have some degree of permanence and stability.
Later decisions of courts of common law jurisdictions have further pointed to an emerging consensus that digital assets can be treated as a type of intangible property. This includes decisions in England and Wales,3 Singapore,4 the BVI,5 Australia,6 New Zealand,7 Canada8 and the United States.9
The Hong Kong court has previously granted proprietary relief over crypto-assets,10 suggesting that it takes the same view. Nonetheless, there has until now been no judicial discussion or express finding by the Hong Kong courts that crypto-assets are property.
Background: segregation, ownership and trust in common law jurisdictions
Where an exchange holding crypto-assets is wound up, customers retaining beneficial ownership of their assets, are in an advantageous position. The assets are held by the exchange operator on trust, and do not form part of the estate. This compares to the position for users who have ceded ownership to the exchange. These customers will be mere unsecured creditors, enjoying a lesser priority.
Generally, the creation of an express trust is only valid if the classical “three certainties” test is met, namely there is certainty of the subject matter of the trust, certainty of the object, or class of beneficiaries, and certainty of intention to create a trust.11
Importantly, with respect to crypto-assets, the concepts of segregation and trust are distinct ones. Segregation of assets is neither necessary nor sufficient to create a trust relationship. In Ruscoe v. Cryptopia, the New Zealand courts found a trust to exist over co-mingled assets. On the other hand, in Quoine, the Singaporean court determined that the mere fact that assets are segregated does not lead to the conclusion that there was a trust.
Following the high-profile collapse of various crypto-exchanges in 2022, regulators have focused increasingly on consumer protection issues, including measures related to the custody of crypto-assets. For example, under Hong Kong regulations due to take effect in June this year, licensed virtual asset trading platforms are required by law to hold client assets on trust for clients through a separate Hong Kong-incorporated “associated entity”.12
Facts
Gatecoin Limited ("Gatecoin") was one of Hong Kong’s first centralised crypto-asset exchanges. It operated a platform which provided cryptocurrency trading services to customers who deposited crypto-assets or fiat currencies. It also traded crypto-assets in its own right.
Gatecoin did not segregate customer assets. Instead, when a customer deposited crypto-assets into the platform, these would be transferred into one of 18 “Mother” wallets and mixed with other assets. In-house transactions within the platform would be recorded on a private “Exchange Ledger” but would not involve any transfer between crypto-wallets, and so would not be recorded on the relevant blockchain.
In 2016, Gatecoin was subject to a high-profile hack of customer assets that were intended to be kept in cold storage. In following years, it suffered difficulties with banking support and payment provision. In 2019, the Hong Kong court ordered the platform to be wound up.
Gatecoin had regularly updated its Terms and Conditions (“T&C”) with the most recent T&C coming into force on 6 March 2018 (“the 2018 T&C”). Importantly, while the previous T&C included provisions stating that the user “will have beneficial ownership interest in” related crypto-assets; that Gatecoin acts as a “custodian” holding the crypto-assets “on trust” for the user; and repeatedly making reference to “your digital assets”, the 2018 T&C removed all trust language and expressly disclaimed any fiduciary obligations.
Consequently, the liquidators’ position was that assets belonging to customers under the immediately prior version of the T&C were held on trust by Gatecoin for those customers, whereas customers under the 2018 T&C enjoyed no such ownership and had only contractual claims against Gatecoin. This, in turn, had consequences for the question of whether Gatecoin had any assets which could be deployed by the liquidators to pay Gatecoin’s expenses and make distribution to the unsecured creditors.
Section 200(3) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) provides for liquidators to seek court directions in certain circumstances. In this case, the liquidators sought directions from the Court of First Instance (“Court”) as to how to characterise the cryptocurrencies and fiat currencies (the “Currencies”), and accordingly, the method of allocating the Currencies to customers
Decision: property
The Court considered at length the question of whether crypto-assets comprised property capable of being held on trust. Madam Justice Linda Chan referred to and considered the legal positions in various common law jurisdictions, including, in particular, the reasoning in the New Zealand case of Ruscoe v. Cryptopia,13 in which the court had given a detailed analysis of the crypto-assets by reference to the Ainsworth test.
In Ruscoe, the court had found that crypto-assets met all four limbs of that test:
- They were “definable” since a wallet’s public key is “readily identifiable, sufficiently distinct and capable of being allocated uniquely to an individual account-holder”;
- They were “identifiable by third parties” since only the private key-holder would be able to access and transfer the cryptocurrency from one wallet to another;
- They were “capable of assumption by third parties” because they could be the subject of active trading markets; and
- There was “some degree of permanence of stability” in that the entire life history of a cryptocurrency is recorded and available in the blockchain.
Justice Chan concluded that, “[a]lthough the definition of “property” [under Hong Kong statute] is different from those adopted in the other jurisdictions considered above, I note that like other common law jurisdictions, our definition of “property” is an inclusive one and intended to have a wide meaning”. Noting also the Hong Kong judicial support for the Ainsworth test, the Court confirmed that “it seems to me that in considering the question whether cryptocurrency is “property”, it is appropriate to apply and follow the reasonings in the Legal Statement and Ruscoe v Cryptopia, and their conclusion that cryptocurrency is “property”, which is capable of forming the subject matter of a trust.”
Decision: ownership and trust
Despite the Court’s finding that the Currencies comprised property capable of being held on trust, it determined that the majority of customers no longer had a proprietary interest in the Currencies, and there was no trust in place.
This was not simply a function of the co-mingling of these assets in the Mother wallets. The Court, following the New Zealand case of Ruscoe v. Cryptopia, found that, despite their pooling in common wallets, these classes of crypto-assets were identical and claims could be made to a proportionate share by reference to the Exchange Ledger. This was in turn sufficient to meet the subject matter and object components of the “three certainties” test for establishing a trust.
However, the Court found that, for most customers, there was no certainty of intention, and consequently no trust. On the contrary, the 2018 T&C, which superseded the prior T&C, were “clear” that “there was no intention to create any trust for the [c]ustomers”, meaning assets held under those ToS were held by Gatecoin in its own right.
It followed that the only customers who benefitted from the trust language in the earlier T&C would be pre-existing customers who never used or accessed the platform after those T&C came into force (since in doing so they did not agree to the amendments contained in the 2018 T&C). This class of customer retained ownership of their crypto-assets, which were held on trust by Gatecoin.
Commentary
This decision leaves no doubt that Hong Kong law aligns with the emerging common-law consensus that crypto-assets comprise property. This should instil greater confidence for market participants operating or looking to establish in Hong Kong.
The court’s discussion on segregation and ownership also raises questions for industry participants. Exchanges and customers alike will be increasingly attentive to questions of ownership, custody and segregation in the wake of high-profile insolvencies, which have brought these issues into sharp relief. Of course, these issues may have less significance in Hong Kong, which will soon mandate exchanges to hold customer funds segregated and on trust for users.
Readers may be interested in our notes on Hong Kong’s introduction of comprehensive licensing regime for Virtual Asset Trading Platforms (VATPs), and forthcoming rules regarding stablecoins.
- Re Gatecoin Limited [2023] HKCFI 91
- [1965] AC 1175.
- AA v. Persons Unknown [2019] EWHC 4556 (Comm).
- CLM v. CLN [2022] SGHC 46.
- Joint Liquidators of Torque Group Holdings Ltd (In liq) v. Torque Group Holdings Ltd (In liq) (BVIHC (Com) 0031of 2021, 2 July 2021.
- Australian Federal Police v. Bigatton [2020] NSWSC 245.
- Ruscoe v. Cryptopia [2020] NZHC 728.
- Copytrack Pte Ltd v. Wall [2018] BCJ 3325; Shair.Com Global Digital Services Ltd v. Arnold [2018] BCJ 3114.
- United States v. 50.44 Bitcoins, Civil Action No. ELH-15-3692 (D Md, 31 May 2016); Lagemann v. Spence, 2020 U.S. Dist. LEXIS 88066 (SDNY, 18 May 2020); Meta-Tech Consultants, LLC v. Niu, 2021 U.S. Dist. LEXIS 209207 (D Nev, 29 October 2021); BDI Capital v. Bulbul Investments LLC 446 F.Supp.3d 1127 (2020).
- Nico Constantijn Antonius Samara v. Stive Jean-Paul Dan [2021] HKCFI 1078; Yan Yu Ying v. Leung Wing Hei [2021] HKCFI 3160; Huobi Asia Limited & Anor v. Chen Boliang & Anor [2020] HKCFI 2750.
- Snell’s Equity, 34th ed., §22-012.
- See Part X of the proposed “Guidelines for Virtual Asset Trading Platform Operators, June 2023”.
- [2020] NZHC 728.
In-depth 2023-102
