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The Unique Quandaries Faced in Recovering International Cryptocurrency Frauds

Cryptocurrency itself is a string of computer-generated code.  This line of code is accessed by an owner's unique passcode secret private key.  Each owner's cryptocurrency is kept in their "Virtual Wallet". Virtual wallets are similarly anonymous as are the virtual currency balances. The transfer of cryptocurrency is based upon the block chain protocol, a public decentralized ledger that identifies transactions by a digital code with no link to a person or place.

Practically, there is no public record of virtual currency transfers.  Other than the debtor's own testimony, a creditor would not know where to begin searching for evidence of virtual currency purchases or transactions. There is no way for a creditor to identify either the owner or location of a transferee's cryptocurrency address. In some cases, the debtor could honestly state that he does not know the identity of the individual who received his cryptocurrency transfers.

For asset protection purposes, a cryptocurrency account currently functions similarly to offshore banking prior to the IRS's crackdown of anonymous personal foreign accounts.  Today, it is almost impossible for U.S. citizens to establish an anonymous bank account, or any type of bank account, outside of the U.S. With the advent of Bitcoin, a U.S. citizen can open and maintain a financial account that has creditor protection features similar to an offshore bank account in that the Bitcoin account is anonymous and can be maintained outside the geographical jurisdiction of domestic courts. Since block chains are decentralized, they are not subject to any central authority (such as a bank or other financial institution) that might be legally compelled to provide a court with access or control over assets in its possession. Without the complete private key, no court or legal authority can manipulate ownership of a block chain asset.

At the moment, creditors face obstacles of identifying potential defendants and the international nature of the transaction.  Properly selected offshore fiduciaries holding accounts are unlikely to become subject to the jurisdiction of a court where a defendant may be sued.  Absent jurisdictional authority, a court is powerless to compel the fiduciary to turn over assets. Similarly, a US court could try to compel the party to turn over the account or information about the transaction. The court's contempt powers could be used to coerce compliance. Arrest and incarceration can be utilized. See In Re Lawrence, 279 F.3d 1294,1300 (11th Cir. 2002); FTC v. Affordable Media Inc., 129 F.3d 1228, 1229 (9thCir. 1999). But, on cruel and unusual punishment grounds, incarceration cannot be imposed forever. If the asset is more important than personal freedom, a court's power of compliance is limited.  

There are two equitable remedies that exist under English common law which could be flexibly applied to these evolving transactions. One existing remedy is the equitable pre-trial discovery device known as a Norwich Pharmacal order requiring third parties to disclose information to potentially identify the wrongdoer, to trace funds and to assist prospective plaintiffs in determining whether a cause of action exists.  (There are five states in the U.S. that also allow for pretrial discovery to identify the wrongdoing.)  Norwich orders, being a flexible tool of equity, could assist in claims involving cryptocurrency transactions.  It may be possible that identification information might come from "know your customer" information given a bitcoin exchange.  Proceedings could be constituted as "the bitcoin holder with the public key number…"  However, the hurdle still exists to identify the wrongdoer.

The second equitable remedy is injunctive relief.  Courts have granted world-wide injunctions, particularly when the impugned conduct is occurring online and globally, such as the internet.  InGoogle Inc. v. Equustete, 2017 SC 34, the Supreme Court of Canada recently held that injunctive relief can be ordered against somebody who is not a party to the underling lawsuit, even if that third party is not guilty of wrongdoing.  Google was ordered to stop displaying search results globally for any Data Link websites.  "The problem in this case, is occurring online and globally.  The internet has no borders; its natural habitat is global.  The only way to ensure interlocutory injunction (order) attain its objection was to have it apply where Google operates - globally."  Thus, if the third party to the block chain transaction can be identified, there may be a remedy to discover information and wrongdoing.

Therefore, courts will need to apply not only new remedies, but expand existing ones.  While the identities of the buyer and seller are encrypted, a transaction record is maintained on the public ledger. In the future, anti-money laundering laws and cryptocurrency exchanges may require the collection of personal data of customers. Until then, the challenge of recovery will require creativity and experience. 

© Horwood Marcus & Berk Chartered 2020. All Rights Reserved.National Law Review, Volume VIII, Number 32



About this Author

Rick Rein, Creditor's Rights Attorney, Horwood Marcus & Berk Law Firm

RICK REIN is chair of Horwood Marcus & Berk's Litigation Group and focuses his practice on creditor's rights, loan enforcement and creditor bankruptcy representation. He regularly advises secured creditors in workout and restructuring transactions, including forbearance agreements. He also assists secured creditors in recovering pledged collateral through Uniform Commercial Code sales and commercial mortgage foreclosures, in prosecuting claims based on fraud, non-performing loans, intercreditor disputes and loan commitment litigation and in defending creditors...