Lucy Frew
Partner
Cayman Islands
The Law Commission’s supplemental report on digital assets as personal property (report), the Property (Digital Assets etc) Bill and the recent judgment in D’Aloia v Persons Unknown and Ors [2024] EWHC 2342 (Ch) were all published on 12 September 2024. As well as being significant for those involved in the cryptoasset sector domestically, the report, Bill and judgment will also be influential in other jurisdictions and sectors.
They deal with important legal principles and give some of the certainty that the wider financial and business sector needs in order to transact in crypto. The judgment also establishes that a crypto-exchange’s failure to comply with anti-money laundering (AML) policies and procedures deprive it of a defence to claims by victims of crypto fraud by third party fraudsters, which is an incentive if ever there was one to be compliant. This column looks at the practical implications of the report, Bill and judgment for industry and investors.
Law Commission report and Bill on digital assets as property
Digital assets do not easily fit within the two categories of personal property that have been recognised traditionally, as they are neither:
- Things in possession (broadly, tangible things that can be physically possessed).
- Things in action (property that can only be claimed or enforced through a court action, such as debts, a right to sue for breach of contract, or shares in a company).
Even if the law were to fail to recognise or prohibited them, digital assets would continue to exist and their functionality would remain unaffected.
However, the characterisation of digital assets as property is crucial because property rights are important in bankruptcy and insolvency, for victims of crypto-fraud and for numerous legal relationships including structures involving trusts, custody relationships and collateral arrangements. In particular, the question of whether a cryptoasset is capable of being given as security depends on how it is characterised from a property perspective. So, clarity on this point has the potential to increase financings secured on digital assets.
By way of background, the Law Commission had been considering how principles of property law apply to digital assets since 2021, culminating in the publication of the Bill, which followed the government issuing a written statement in response to the Law Commission’s June 2023 final report on digital assets. The Bill, which is short and technology neutral, is intended to constitute a clear statement from Parliament confirming that a thing can be property even if it does not fit easily into the two traditional categories of personal property, essentially creating a new third category.
This is a significant and positive step forward for the crypto sector. Legal uncertainty is a material disincentive to significant transactions in cryptoassets, especially for traditional financial services and business sectors, so confirmation that digital assets are property under the law of England and Wales is very helpful. Interestingly, one argument made to the Law Commission against recognising digital assets as property was that this would encourage wider take up. Indeed, increased certainty regarding the treatment of digital assets is likely to bolster confidence and increase the use of digital assets by traditional financial and business sector players.
However, the Bill only confirms that things outside the categories of things in possession and things in action are capable of being property. The exact parameters of the third category, and the legal treatment afforded to things that fall within it, are as yet unclear and it will be a matter for the courts to develop through the common law. Meanwhile, the Law Commission has shared that the government is considering recommendations, among other things, to create a panel of industry experts to provide guidance on technical and legal issues relating to digital assets which would offer some much-needed clarity.
The D’Aloia judgment
A separate but related development is the judgment in D’Aloia v. Persons Unknown and Others, in which the High Court of England and Wales dismissed a claim brought by the victim of a scam, Fabrizio D’Aloia, against the crypto exchange Bitkub.
Mr D’Aloia claimed that a fraud had been perpetrated on him by the unknown first defendant fraudsters, in which he had been induced to hand over digital assets worth approximately £2.5 million (including Tether (USDT) and Circle). He provided expert evidence that his USDT was passed through several wallets and crypto exchanges before it was withdrawn as fiat currency from a wallet at the Bitkub crypto exchange by a Mrs Hlangpen.
Under Bitkub’s AML policies and procedures, Mrs Hlangpen was subject to a daily withdrawal limit. However, she was able to convert and withdraw a sum over ten times that limit. Bitkub’s system should have prevented the withdrawal and blocked the account but failed to do so. Mr D’Aloia claimed that Bitkub was liable to him on the basis that it was unjustly enriched by obtaining his USDT, or, in the alternative, that it had taken the USDT subject to a constructive trust.
The court held that USDT “while neither a chose in possession nor a chose in action, is capable of attracting property rights for the purposes of English law”, the importance of which finding is discussed above. However, the judgment also emphasises the importance of a coherent and fair methodology for tracing assets, which Mr D’Aloia and his expert evidence had failed to achieve. The High Court therefore dismissed Mr D’Aloia’s claim, primarily because he failed to demonstrate that his USDT had in fact reached the Bitkub wallet.
Important principles relating to following and tracing are considered within the judgment. However, the aspect of the judgment most interesting from a FinTech regulatory perspective is that failure by a crypto exchange to implement and follow its own AML policies and procedures may be fatal to its ability to defend itself from claims in the context of third-party fraud.
Although not pleaded, and therefore not analysed in any detail, it appears that Mr D’Aloia could have claimed that a constructive trust had arisen against Bitkub due to its failure to implement its own procedures aimed at combatting money laundering.
Similarly, the High Court held that if Mr D’Aloia had been able to evidence that his USDT had reached a Bitkub wallet, the court would have concluded that he had made out his claim of unjust enrichment.
The judgment confirmed that the defence of bona fide purchaser for value without notice is available in the context of the transfer of digital assets in principle. However, it would not have been available to Bitkub, given that Bitkub had actual notice due to the suspicious activity on Mrs Hlangpan’s account, in breach of Bitkub’s own AML policies.
Crypto exchanges and other crypto-service providers should take note of the judgment and ensure that they have sufficient AML policies and procedures in place not only from a regulatory compliance perspective but also to ensure they can defend themselves from claims by victims of fraud. Victims of fraud are often unable to identify the original fraudsters and can only claim against the crypto-services providers to which stolen assets can be traced.
Concluding comments
The report, Bill and judgment together make significant progress towards legal certainty in a fascinating, but still developing, area. FinTech practitioners will want to bear them in mind when advising clients and watch for further developments.
This article was first published in UK Practical Law.
