Although the cryptoasset marketplace is a hot target for frauds, victims still face uncertainty in the courts over whether their item is "property", if a third party could be deemed liable and how cryptoassets should be valued. Sarah Murray, Head of Commercial Litigation, discusses some of the legal issues in play.
Over the past few years, the landscape in relation to digital assets has changed beyond recognition. They are traded freely, often for incomprehensible sums of money. Typical examples of such assets in the public consciousness are cryptocurrencies or non-fungible token (NFT) artworks. The term "cryptoasset" is used to encompass a wide range of digital assets, from the weird and wonderful (such as cyber perfume, otherwise known as a "digital reflection of a physical scent", and digital collectibles such as art and tweets) to blockchain economies, methods of payment and decentralised financial (DeFi) services. The sheer versatility of digital assets presents the legal systems of the world with a wide range of possibilities and conundrums to grapple with. This is important because clients looking to bring or defend litigation look for some degree of certainty concerning their prospects of success. When you are dealing with brand new types of assets and trying to shoehorn them into long-established legal principles this certainty is hard to come by. Some of the areas raising questions are set out below.
What is a digital asset?
Even this seemingly simple question is difficult to answer. The Law Commission, in its 2023 report says, “it captures a huge variety of things including digital files, digital records, email accounts, domain names, in-game digital assets, digital carbon credits, crypt-tokens and NFTs”. It goes on to say that the “law of England and Wales is sufficiently resilient and flexible to recognise some digital assets as capable of being things to which personal property rights can relate”.
There has been a lot of debate as to whether cryptoassets are capable of constituting "property". This is important because it determines the applicability of existing property laws to such assets, thereby conferring rights and remedies on the owners. Put simply, if cryptoassets are not property, you cannot sue someone to prevent misuse or get them back if they are taken from you.
There have been a string of interim court decisions holding that cryptocurrencies and NFTs are capable of being treated as property. While these decisions are not yet supported by a final decision in a piece of litigation, they attract the support of the Law Commission which, to ensure that the matter is placed beyond doubt, recommends the creation of a specific type of asset class to cover digital assets, which it calls ‘digital objects’. The Law Commission is at pains not to constrain the limits of what might fit in this class, saying that is a job for the courts when they are presented with new types of digital asset. This position is entirely understandable because of the speed at which technology is developing to create entirely new forms of digital object, not all of which could or should attract property rights. However, it leads to uncertainty every time someone wants to bring a claim in relation to a new type of digital object and it may be some time before we have anything approaching a settled framework for what belongs in the digital object class and what does not.
This uncertainty is coupled with the fact that central to the makeup of all these assets is the core idea of independence from any third- party control (whether that is by a bank, financial institution, government, or even the courts). This makes litigation of disputes involving these assets, and the determination and enforcement of applicable remedies, particularly challenging in a fast-moving and continually evolving digital environment. It is therefore no surprise that the cryptoasset marketplace is a hot target for frauds.
Digital assets and fraud
Typical scenarios for cryptoasset fraud include:
- Individuals who have been persuaded to invest large amounts of money in cryptocurrencies with the promise of guaranteed large returns. They are sent updates showing how well their investments are doing and they are convinced that they have made an amazing investment decision, until they try to access their funds. At that stage they are asked for further sums of money to release the funds and eventually they discover that there never was any investment – the fraudsters have taken the original funds and dissipated them.
- Individuals who hold cryptocurrencies or NFTs in a digital wallet that is then hacked, or someone else gains the key – with the assets transferred elsewhere.
In many ways these scenarios are no different to traditional financial fraud. The English courts are known for being very claimant- friendly and are usually willing to flex remedies to give the claimant the best possible chance of recovering their money. This inherent flexibility in the system means that the relief available to claimants in the English courts on an interim basis translates very well to digital assets. For example, the courts are willing to grant relief against persons unknown and allow novel and highly pragmatic methods of service of proceedings to ensure that they are brought to the attention of the fraudsters.
Liability for loss
The more interesting legal questions arise after the interim remedies have been put into place and the parties settle into the long hard slog of litigation. What happens, for example, if, despite the claimant’s best efforts, the assets are unrecoverable? With traditional financial fraud a claimant might well look to a professional adviser or financial institution to make good its loss in place of the fraudster. For example, if an independent financial adviser (IFA) has not advised with reasonable care and skill, or a bank has not identified an obviously fraudulent transaction, they might be on the receiving end of a claim.
When dealing with digital assets, identifying a potentially liable third party is much more difficult because of the decentralised nature of the technology. This makes the case of Tulip Trading Ltd v Bitcoin Association for BSV particularly interesting. The claimant, Tulip (owned by Craig Wright), alleges that it owns a large amount of bitcoin that has been stolen from it in a hack, rendering the bitcoin inaccessible. It is suing the developers that controlled and ran the relevant bitcoin networks, alleging that they owe it a fiduciary duty to introduce code to allow it to secure its bitcoin against fraudsters. The court considered this argument in the context of an application to serve the defendants out of the jurisdiction. This required the claimant to satisfy the court that its case was arguable on the merits. The judge at first instance held it had failed to do so but the Court of Appeal disagreed, holding that the claimant’s arguments raised a serious issue to be tried. Until this issue is resolved by the courts, the possibility of developers being liable to the victims of fraud for their losses remains live.
Valuation point
Another interesting question arises in relation to how cryptoassets should be valued. Consider a case where Party A has delivered goods or services to Party B and Party B has agreed to pay Party A in cryptocurrency. If Party B fails to do so, Party A will have to sue Party B. Can Party A ask the court to order transfer of cryptocurrency to meet the contractual obligation? This would be an order for specific performance and there must be some doubt as to whether it would be available in this scenario – such orders are usually only available where damages would not be an adequate remedy. If specific performance is not available, Party A will be claiming damages equivalent to the value of the cryptocurrency it was promised. But how much should the damages be? Should they be equivalent to the value when the contract was made, the time at which the breach occurred or the date of judgment? Given how volatile cryptocurrency can be this could make a tremendous difference.
Value becomes even more interesting when it comes to NFTs which are, by their nature, unique. When you buy an NFT you are in essence buying a sequence of computer code. This computer code can serve several purposes but most commonly it serves as a certificate of authenticity and/or membership card. The most well-known NFTs authenticate digital artwork and collectors have paid significant sums to acquire them. If they were to be lost or stolen and become irretrievable, there would be a legal question to answer as to how they should be valued for the purpose of assessing damages. At one extreme they can be seen as a unique and highly prestigious artwork and at the other they are no more than a couple of lines of computer code. A court faced with the challenge of
valuing an NFT will have to steer a course between these two extremes and come up with a commercially sensible conclusion.
The examples set out above only scratch the surface of the challenges facing the English courts (and indeed other courts all around the world) when it comes to defining digital assets and how they fit into a well-established legal framework. There is no question that the difficulties with applying existing, widely-accepted legal principles to digital assets will lead to uncertainty. Clients looking to litigate over digital assets cannot make any assumptions as to how the legal framework will apply and should prepare themselves for a long and hard-fought road to recovery of what they have lost. While the current landscape raises all sorts of fascinating questions (if you are a lawyer), for clients they run the risk of being expensive problems.
Note
1. [2023] 4 WLR 16: www.judiciary.uk/wp-content/uploads/2023/02/Tulip-v-Van-Der-Laan-judgment-030223.pdf
This article was first published in Fraud Intelligence and can be accessed via www.counter-fraud.com and www.i-law.com.
Sarah Murray