Cryptocurrency

Information orders against exchanges to aid the recovery of misappropriated cryptocurrency | Walkers

As part of our series looking at the potential impact of recent cases on the future decisions of the Cayman Islands, BVI and Bermuda Courts relating to crypto assets, we consider the English decision of LMN v Bitflyer Holdings Inc and others [2022] EWHC 2954 (Comm), and specifically whether victims of cryptocurrency fraud are able to obtain Bankers Trust orders compelling cryptocurrency exchanges to disclose confidential information to help recover misappropriated cryptocurrency.

The applicant in LMN v Bitflyer and others was a cryptocurrency exchange (the “Applicant“) which fell victim to a hack where millions of dollars-worth of cryptocurrency was stolen. In preparing to commence proceedings to recover the cryptocurrency, the Applicant instructed an expert to trace the stolen cryptocurrency. The expert was able to track the initial dissipation from the Applicant as such transactions stemmed from ‘Hot Wallets’ (i.e. wallets connected to the internet) and transfers were therefore recorded on the relevant cryptocurrency’s blockchains. However, when the cryptocurrency was transferred to an address / wallet maintained by a cryptocurrency exchange, this complicated the tracing exercise since the crediting of cryptocurrency to the customer’s account maintained by the exchange takes place “off-chain” (i.e. via an internal accounting exercise where such cryptocurrency is commingled in an ‘omnibus wallet’ used to service many customers). The misappropriated cryptocurrency processed by exchanges was therefore rendered untraceable making it necessary for the Applicant to seek information from the relevant exchanges in order to continue the tracing exercise and determine who was behind the relevant transactions.

In this instance, the Court considered that the test to obtain a Bankers Trust order was satisfied, namely that:

  • the misappropriated cryptocurrency about which information was sought belonged to the Applicant, as the Court found that there was a good arguable case that whoever held the cryptocurrency or traceable substitutes did so as a constructive trustee for the Applicant;
  • there was a real prospect that the information sought would lead to the location or preservation of assets, as the information sought concerned the identity of the account holders associated with the transfer of the misappropriated cryptocurrency and the destination of the transfers; and
  • the interest of the Applicant in obtaining the order outweighed any possible detriment to the exchanges in complying with the order, as the Applicant provided undertakings as to expenses and damages and restrictions were put in place on collateral use of any information disclosed.

The Courts in the Cayman Islands, BVI and Bermuda have followed the English Courts in making Bankers Trust orders and we think it likely that they will be similarly willing to assist victims of theft and fraud in a crypto context where victims seek information to aid recovery of misappropriated crypto assets. Further, this decision affirms previous decisions which classify cryptocurrency as property and therefore subject to proprietary remedies and, crucially, serves as a timely reminder to cryptocurrency exchanges to ensure they comply with applicable KYC requirements given they may be compelled to produce such information where doing so assists the recovery of misappropriated crypto assets. If they are unable to comply with such orders, there would need to be a very good reason to avoid being in contempt of Court

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