Crypto fraud: pursuing crypto exchanges

The recent judgment in D'Aloia v Persons Unknown [2024] EWHC 2342 has important implications for disputes involving crypto assets, particularly where the claimant is seeking to recover assets following a fraud.

The Claimant, Mr D'Aloia, was the victim of a fraud. The fraudsters convinced Mr D'Aloia to transfer cryptocurrency in the form of Circle and Tether (USDT) worth around £2.5 million. The fraudsters transferred the cryptocurrency through multiple wallets held on multiple exchanges, including Bitkub (the Sixth Defendant in the claim) before withdrawing the value of the cryptocurrency in fiat.

The key issue for this aspect of the claim was whether Mr D'Aloia could recover from Bitkub the Tether he lost pursuant to the fraud. Mr D'Aloia argued that Bitkub held the misappropriated Tether on constructive trust. Alternatively, that Bitkub had been unjustly enriched at his expense.

While the Judge accepted that the First Defendants (being persons unknown) who received the funds from Mr D’Aloia did so as part of a fraud, which gave rise to a constructive trust, Mr D'Aloia's claims against Bitkub failed. While the constructive trust against the fraudsters could found a claim against parties that received trust property and were not bona fide purchasers for value without notice, Mr D'Aloia was unable to show that the fraud involved his funds and that those funds had flowed to Bitkub, or that Bitkhub still held assets over which a proprietary claim could be asserted.

The Judge also held that there was a significant gap in Mr D'Aloia's claim resulting from the fact that he did not plead a claim of knowing receipt against Bitkub. When a person receives property in breach of trust, and that person, who is not a bona fide purchaser for value without notice, no longer has the property, (e.g. because they have transferred, dissipated or destroyed the property in question) they can still be liable to account to the claimant for the value of the assets – which is a personal, rather than a proprietary claim. That may assist claimants in circumstances where they are unable to assert a proprietary claim. However, in this case Mr D’Aloia would still have faced the challenge of proving that his funds actually flowed to Bitkhub. 

Were the Judge to have held that Mr D'Aloia could establish that Bitkub held the Tether on trust for him, Bitkub would not have been able to rely on good faith defences. The Judge held that Bitkub had actual knowledge of suspicious activity in the accounts that were used to perpetrate the fraud and failed to investigate. The suspicious activity included that the account holder exceeded the daily withdrawal limits for her account, which was supposed to trigger other steps to be taken by Bitkub but did not, and the value of the deposits and withdrawals made to the relevant accounts far exceeded the annual income declared by the account holder as part of Bitkub's account processes. 

This judgment serves as a warning to claimants to take extra care when pleading a case against an exchange which has received funds as a part of a fraud, and to ensure that the expert evidence in support of a tracing and/or following claim is based on an appropriate methodology and does in fact demonstrate how the claimant's assets have been used.

The key points to be aware of for claims involving crypto assets are as follows:

• Tether, which is a form of cryptocurrency, can attract property rights under English law. The Judge held that it is neither a chose in action nor a chose in possession, but rather a distinct form of property not premised on an underlying legal right. 

• The Property (Digital Assets etc) Bill has now been introduced into Parliament which seeks to introduce into law a new category of personal property rights which clarifies that a thing is not prevented from being the object or personal property rights merely because it is neither a thing in possession nor a thing in action. You can track the progress of the Bill here.

• As Tether can attract property rights under English law, it can be the subject of a constructive trust. This means that where there has been a fraud involving cryptocurrency, the victim can assert a proprietary claim over the misappropriated assets held by the fraudster. If the misappropriated assets have been transferred or substituted, the victim may be able to assert a claim over the value of those assets instead. 

• Claimants should consider carefully at the outset the basis on which their claim is pleaded and whether knowing receipt should be plead alongside a proprietary claim.

• The processes for identifying the misappropriated assets are referred to as tracing or following. As a matter of law, tracing and following are different things. Following is the process of 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. 

• Tracing and following are available in principle for crypto assets. However, it is important to note that tracing is not possible at common law in respect of mixed funds (ie, where it is not possible to identify the claimant's asset) but is possible in respect of equitable tracing. 

• Tracing/following methods are not limited to FIFO (first-in, first-out), pari passu and rolling charge methods. Other methods, if methodologically sound and properly evidenced, are available to a party seeking to trace assets, at least in the context of claims arising out of fraud.

• The Judge held that it is was possible for a trust to arise in respect of a third party, such as Bitkub in this case, where for example a voidable transaction has been rescinded on the grounds of fraudulent misrepresentation and the third party received the trust property. However, the claimant in this case was not able to show that the third party received the trust property. 

• Where a third party has received trust property, it will usually have a defence to the claim if it can show that it acquired the asset for value and did not have notice of the claimant's proprietary interest. The defences of bona fide purchaser for valuer without notice, good faith change of position, and ministerial receipt can be applied in claims involving crypto assets.