In D’Aloia v. Persons Unknown & Others,[1] the High Court of England and Wales dismissed a claim brought by the victim of a crypto-scam against Bitkub, one of the exchanges with whom the fraudsters were alleged to have held their accounts.
This is the first judgment following a full contested trial on some fundamental points regarding the status and treatment of cryptocurrency and the potential liability of exchanges to victims of crypto-frauds. The lengthy judgment traverses a number of complex issues, confirming the rights attaching to tether (USDT) as a cryptoasset, as well as the application of trust and tracing principles in crypto-disputes.
Background
We first wrote about this long-running litigation in 2022, as it was the first case in the UK and Europe in which a court had innovatively ordered service on ‘persons unknown’ by transfer of non-fungible tokens.
Fabrizio D’Aloia alleged that the first defendants – Persons Unknown A – induced him to open an online trading account on a scam website and to transfer cryptocurrency totalling approximately £2.5 million to wallets associated with the account. He believed the website was connected with a legitimate US-regulated online broker, but in fact there was no connection, and the website was operated by Persons Unknown A. These fraudsters then passed the cryptocurrency through several wallets before it was withdrawn by the seventh defendants – Persons Unknown B.
D’Aloia issued proceedings against the alleged fraudsters and the five cryptocurrency exchanges with which he alleged the fraudsters held various accounts. This trial concerned D’Aloia’s claim against one of those exchanges – the sixth defendant, Bitkub. D’Aloia asserted that he transferred approximately 1 million USDT to a wallet controlled by Persons Unknown A, and that through a series of transfers through 14 wallets, 46,291 USDT arrived in a Bitkub wallet of a Ms. Hlangpan, who withdrew it as fiat currency. Hlangpan’s withdrawals were in breach of limits placed on her account by Bitkub in accordance with its anti-money laundering (AML) policies. D’Aloia claimed Bitkub was liable to him for the 46,291 USDT, on the basis that it was unjustly enriched by obtaining possession/control of his USDT – or, in the alternative, that it had taken the USDT subject to a constructive trust. Many such cases have been asserted against exchanges when claimants have been unable to identify the fraudsters
The High Court’s decision
The High Court dismissed D’Aloia’s claim, primarily because he failed to demonstrate that his funds had in fact reached the Bitkub wallet. This was both fatal to his claim in unjust enrichment and to his contention that Bitkub had taken the USDT subject to a constructive trust. Nevertheless, the court considered a number of the legal arguments raised by both parties which are very likely to apply to future crypto-related claims.
First, 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’ for the following reasons:
- Relying on the Court of Appeal’s decision in Tulip Trading v. Van Der Laan,[2] cryptoassets are rivalrous, or, in other words, ownership by one person prevents ownership by another.
- Cryptoassets are something ‘outside the minds of their users’. They exist independently of the rights and claims associated with them and are used and enjoyed independently of whether they give rise to rights enforceable by action.
- It is consistent with a line of authority in interim applications from this jurisdiction that there is a good arguable case that cryptoassets are to be treated as assets to which property rights can attach.
This is an important finding, as it permits victims of crypto-fraud involving USDT to bring equitable claims to trace or follow those assets.
Second, the court confirmed that there are a variety of methodologies that could legitimately be used to trace cryptocurrency, but the chosen methodology should be clearly identified, applied coherently and consistently, and treat all innocent claimants comparably. Here, D’Aloia’s expert asserted that he had adopted the ‘first in, first out’ model (i.e., the first crypto into a wallet is the first out), but he had not in fact done so. The choice and application of tracing methodologies has been hotly disputed in many crypto-tracing cases so far, and this is likely to continue in future disputes.
Third, the court held that Bitkub had not taken subject to a constructive trust. The fact that a constructive trust arose against the fraudsters did not mean that one also arose against Bitkub. A claim against Bitkub based on the constructive trust that had arisen against the fraudsters would need to be advanced as an equitable proprietary claim (if Bitkub still had possession of the USDT), or a claim for knowing receipt (if Bitkub had paid away the USDT). At trial, D’Aloia made an alternative submission that a constructive trust had arisen against Bitkub due to its failure to implement its own procedures aimed at combatting money laundering. However, that contention had not been pleaded. Accordingly, this important point was not analysed by the court.
Finally, if 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 receipt of the funds by Bitkub was an enrichment, as the funds were initially paid by D’Aloia to the fraudsters. While the court stated that the defence of bona fide purchaser for value without notice is available in the context of the transfer of cryptoassets, it would not have been available to Bitkub, as it did have actual notice due to the suspicious activity on Hlangpan’s account, in breach of Bitkub’s own AML policies.
Takeaways
While this is undoubtedly a significant decision in the developing law relating to crypto-frauds, some important questions remain at large in terms of crypto exchanges’ liability to victims of fraud – e.g., Does a constructive trust arise where exchanges fail to act?
Exchanges should take note of the finding that Bitkub’s awareness that Hlangpan had breached withdrawal limits (and therefore policies regarding suspicious account activity) would have been fatal to the defences it sought to run of good faith change of position, ministerial receipt and the alleged impossibility of counter-restitution. The case demonstrates that to rely on these defences, exchange platforms will need sufficient AML and know your customer (KYC) policies in place and ensure compliance. Exchanges are vulnerable to properly particularised claims by victims of fraud if stolen assets are traceable to them.
This case also highlights the importance of having robust and coherent expert evidence as to tracing in cases involving transactions on the blockchain. The High Court found the evidence of both experts ‘not to be especially helpful’ in a case ‘where much turns on their work to understand the flow of funds, if any, from Mr D’Aloia to the [Bitkub] wallet’. The High Court was especially critical of D’Aloia’s expert, finding his evidence to be ‘chaotic and, ultimately, contradictory’. This was fatal to D’Aloia’s claim, as it meant he was unable to demonstrate that his funds had reached a Bitkub wallet. This has been a theme in cases purporting to find third-party exchanges liable for the fraud of others – where the methodology relied on to trace stolen funds through multiple wallets on the blockchain has been obscure, self-serving and/or novel.
[1] [2024] EWHC 2342 (Ch).
[2] [2023] EWCA Civ 83. See also our February 2023 On the Record blog post.
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