The relative infancy of cryptocurrency in the financial ecosystem, and lack of legal precedent in disputes related to it, mean that each crypto-related judgment will have broad significance for the future.
In D’Aloia v Persons Unknown [2024] EWHC 2342 (Ch), the English High Court has clarified, in a judgment following a rare full trial, various issues relating to claims by the victims of fraud against cryptocurrency exchanges. In this instance, the claim failed on the basis of its expert evidence. The court was however open more broadly to the viability of the various claims brought. Ed Holmes and Aleks Valkov examine the decision.
Background
To date, most of the published judgments relating to crypto fraud have been made at interim hearings (for example, to grant freezing injunctions or disclosure orders) and have thus only been established to the “good arguable case” standard. In D’Aloia, the court handed down a detailed and technical judgment following a full trial, which provides significant clarity on various legal issues facing victims of crypto fraud when seeking redress against exchanges through which stolen crypto is transferred.
The facts of D’Aloia follow a familiar pattern. Mr D’Aloia alleged that unknown persons fraudulently induced him to hand over Tether (“USDT”), a stablecoin tied to the US dollar, and another type of crypto not relevant to this trial, worth, in total, around £2.5m. The USDT was then passed through a number of wallets before ultimately being withdrawn as fiat currency by another set of unknown persons. This trial concerned the claim against one of the exchanges, Bitkub, which operated a wallet for a Ms Hlangpan. Following 14 alleged transfers or “hops”, USDT 400,000 was transferred to Ms Hlangpan’s wallet, 46,921 of which was said to have been Mr D’Aloia’s (or its traceable proceeds).
Crucially, the court did not accept that the claimant’s expert evidence had established that his identifiable USDT had reached the wallet operated by Bitkub. As we will see below, that was fatal to his claims.
Property
Until now, the question of whether cryptoassets constitute property does not appear to have been decided at a full trial, although the Law Commission’s “Digital Assets: Final report”, published on 27 June 2023, recommended that it be recognised as falling into a third category of property. On 11 September 2024, the UK government introduced the Property (Digital Assets, etc) Bill, which seeks to give effect to that. The question is important because if cryptoassets are property, then depending on the nature of the property rights associated with them, the assets can be followed and traced (more on which below).
The court found that USDT specifically is property because there is an expectation, beyond mere hope, that transactions involving it will be honoured, based on cryptographic security designed to make it happen. As to the precise nature of the property, the court found that USDT was neither a “chose in possession” nor a “chose in action” but a different class of asset, not premised on an underlying legal right to which property rights attach. Therefore, it can be the subject of tracing and constitute trust property in the same way as other property.
The difference between following and tracing
The court noted, as held by the House of Lords (as it then was) in Foskett v McKeown [2001] 1 AC that the processes of following and tracing are legally distinct. Following, as the name suggests, involves following the same asset as it moves from hand to hand. Tracing is the process of identifying a new asset as the substitute for the old.
Mr D’Aloia had brought a claim on the basis of tracing and following. The court held that per Byers v Saudi National Bank [2023] UKSC 51 and Shalson v Russo [2003] EWHC 1637 (Ch), English law still recognises separate regimes for tracing in equity and common law, despite the Supreme Court’s obiter comments to the contrary in Foskett v McKeown. As a result, tracing through a mixed fund is not possible at common law. Nor can a chose in action be followed at common law.
Can USDT be “followed”?
As USDT was held to be a different class of property (ie not a chose in action), it was, in principle, possible to follow the USDT into Ms Hlangpan’s wallet with Bitkub, even when mixed in wallets with other USDT. That is because the court found that USDT was better characterised as a “persistent” thing in that it maintains a distinct identity, even in a mixture, such that, in theory, it could be tracked as it passes through the system.
The court noted there was thin evidence on this issue before it, but it took into account Tether’s own white paper, which states that Tether is the only party that can create or destroy Tether.
However, unfortunately for Mr D’Aloia, his expert had not been able to show how much, if any, of the USDT in Ms Hlangpan’s wallet was originally his. There was a suggestion that Tether itself has the ability to track each individual USDT, but there was no such evidence before the court. So, the following claim failed.
The tracing claim
As for the tracing exercise, the court held that the “first in, first out” (“FIFO”) method for tracing was not the only approach available to claimants. Other methods, if sound and properly evidenced, are available in the context of claims arising from fraud.
However, the tracing methodology adopted by Mr D’Aloia’s expert was unclear, so the court couldn’t accept that his evidence reliably demonstrated any flow of Mr D’Aloia’s assets to Ms Hlangpan’s wallet with Bitkub.The tracing claim therefore failed too.
Unjust enrichment
Mr D’Aloia also brought a claim for unjust enrichment. The court found that Bitkub had been enriched as a result of the transfer into Ms Hlangpan’s wallet of a large sum of USDT. That enrichment was unjust on the basis that (i) the transfer by the unknown persons through the various hops (ultimately to Ms Hlangpan’s Bitkub wallet) was unauthorised, and (ii) Mr D’Aloia had paid the money under a mistake, namely, he made the transfers because he had been misled and was a victim of fraud.
However, crucially, Mr D’Aloia had not established that Bitkub had been enriched at his expense because he had not shown that his USDT could be traced to Ms Hlangpan’s wallet. Mr D’Aloia was also unsuccessful in arguing unjust enrichment on the basis that each of the hops had been a sham (analogous to that in Relfo v Varsani [2014] EWCA Civ 360). That argument failed because he hadn’t been able to establish that it was his USDT (or the proceeds thereof) that had ultimately reached Ms Hlangpan’s wallet with Bitkub. The sham transactions could have contained another victim’s funds.
Although the unjust enrichment claim had failed, the court provided helpful guidance on the defences to claims for unjust enrichment involving crypto:
- It confirmed that a good faith change of position by the defendant is, in principle, a defence available in the context of crypto assets. However, Bitkub had failed to show good faith as Ms Hlangpan’s withdrawals had repeatedly breached her account limits, which should have caused Bitkub to block her account pending further inquiry.
- It also confirmed that the defence of ministerial receipt is available in the context of crypto assets. That defence arises where an agent receives a benefit on behalf of its principal and pays over to the principal the value of the benefit in accordance with the principal’s instructions, provided it acted in good faith and without notice of the claim. However, this defence would have failed as Bitkub had only credited Ms Hlangpan’s account rather than actually paid sums to her, such that the credits were reversible. Further, Bitkub had not acted in good faith for the reasons noted above.
The equitable proprietary claims
Mr D’Aloia’s equitable proprietary claims also failed, but again for evidential rather than legal reasons.
The court accepted that the whole arrangement leading to the initial payment by Mr D’Aloia had been a scam such that a constructive trust arose against the unknown persons behind it, who were holding legal title on trust. Mr D’Aloia, as the beneficiary, had a proprietary interest in the trust property, which was enforceable in equity against any subsequent holder of the property (whether the original property or substituted property into which it could be traced). However, once again, Mr D’Aloia had failed to provide evidence, by tracing or otherwise, that his funds had flowed to Bitkub, so the claim failed.
There was also a legal question as to how the breach by the trustees in paying away the USDT would give rise to a claim against Bitkub itself. In accordance with the Supreme Court’s decision in Byers v Saudi National Bank [2023] UKSC 51, the court indicated that if Bitkub had still held the USDT, Mr D’Aloia would have had an equitable proprietary claim to the asset (subject to the evidential issue described above). But where a defendant such as Bitkub no longer retains the asset, the claimant has a personal claim against it for knowing receipt, provided it has a continuing equitable proprietary interest and the defendant had the requisite knowledge at the time of its receipt. However, Mr D’Aloia was scuppered once again because he had not pursued a claim in knowing receipt.
Mr D’Aloia also pursued a claim on the separate ground that Bitkub itself was the constructive trustee. This was on the basis that Bitkub had failed to act in a commercially reasonable manner, including by failing to freeze the account in light of the suspicious account usage. However, this failed on the basis that no such claim had been pleaded, and there is a strict requirement under Civil Procedure Rule Practice Direction 16 paragraph 8.2 that details of all breaches of trust must be specifically pleaded. Furthermore, yet again, Mr D’Aloia had failed to show that Bitkub had received any of his funds.
The court nonetheless went on to confirm that, in respect of the equitable claims, Bitkub could not rely on the defence that it was a good faith purchaser for value without notice. The flow of funds should have caused a block to be placed on Ms Hlangpan’s account and raised alarms, but Bitkub allowed her to pay those funds away. Therefore, Bitkub had actual notice of the risk that the account was being used for money laundering.
Conclusion
The court noted that it had given a lengthy judgment because the legal points were novel, contentious or both. In doing so, we now have more clarity over various issues highly relevant to claims by victims of crypto fraud. Broadly, the decision confirms the availability, in principle, of various legal remedies in the context of crypto fraud.
That said, such claims will always depend on their facts. For example, it would be unwise to assume all cryptocurrencies will be capable of being followed. That will depend on their individual characteristics. USDT was held to be a persistent thing so it could be followed. However, if a crypto asset is destroyed on transfer and a new token is created in its place, it will be traceable, but it will not be possible to follow it. Even as regards USDT, the court noted that the evidence before it was difficult to reconcile with the evidence as to the nature of USDT before the court in Piroozzadeh v Persons Unknown [2023] EWHC 1024 (Ch).
Furthermore, the evidential difficulties in following and tracing the cryptocurrency in this case are not to be underestimated. Many victims of fraud will face similar difficulties.
Nonetheless, the decision in D’Aloia has potentially improved the prospects of claims by victims of fraud. In recent years, there have been a series of decisions in favour of defendant banks and institutions, in particular in the context of Quincecare duty claims but also trust propery and unjust enrichment claims (see for example Tecnimont Arabia Ltd v National Westminster Bank Plc [2022] EWHC 1172 (Comm)). The decision in D’Aloia potentially redresses that balance.
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