The authors of this guest article argue that while the English courts await statutory or regulatory guidance on the legal status of digital assets, they are likely to continue using traditional legal tools to uphold the rights of investors in the sector.

How can one set about tracing the ownership and location of digital assets? The area has grown so fast, and with so many colourful stories of failed platforms and other gyrations, that the question is now urgent. The long-term viability of the space relies on practitioners being able to show that assets can be traced and restored to their rightful owners. Headlines about such assets getting “lost” are lethal – they must be plausibly answered. Prateek Swaika and Sagar Gupta ()Boies Schiller Flexner (UK) LL, delve into the details in this guest article. (More detail on the authors below.)

The editors are pleased to share these insights on such important topics, and invite replies. Jump into the conversation! Email tom.burroughes@wealthbriefing.com

With several high-profile insolvencies in the digital assets sector across the globe, including FTX, BlockFi and ThreeArrows Capital, investors are rightly worried about safeguarding their investments. Although digital assets followed the high-risk, high-reward model until recently, management and governance issues in crypto businesses have led to an increasing number of regulatory investigations and litigation across jurisdictions, posing ever increasing risks to investors.

In this climate, it is critical for investors to equip themselves with the right tools to recover digital assets and enforce judgments against these assets. As lawmakers and regulators struggle to keep up with the rapid innovation in the digital assets space, courts are having to develop innovative legal solutions for digital assets by reference to analogous rules such as traditional financial products.

In this piece, we explore the current state of play and recent developments in digital asset tracing and enforcement and the way forward for investors in this space.    

Why is digital asset tracing needed?
Limited regulatory oversight of the digital assets trading system has proven to be a fertile ground for wrongdoers to exploit the information asymmetries in the market and defraud investors including by siphoning digital assets through cross-border transfers. Scammers can layer transactions to conceal fund flows and elude financial surveillance. 

In the case of crypto transactions, bad actors can obscure the origin and destination of funds by using coin swaps, cross-chain bridges, mixing services and chain-hopping as well as transfer and dissipate funds at speed by making transfers to third-party intermediaries and services, such as dark pools, online casinos and P2P exchanges. Given the fast-paced and highly technical nature of the digital assets sector, the ability to trace transactions quickly is key to protecting investor rights.

As the digital assets industry continues to innovate at a rapid pace, what legal issues are arising? 
A major challenge under English law is the lack of clarity on how to characterise digital assets. Characterisation informs the rights and obligations of a digital asset – which in turn influences the tracing and enforcement options available to investors. For present purposes, we have assumed that digital assets carry personal property rights and are therefore valuable from an enforcement perspective. 

At present, English law recognises two kinds of property: “things in action,” where rights can only be enforced by legal action; and “things in possession,” where rights are attached to tangible property that is capable of physical possession. 

Digital assets do not fall neatly into either category, as they lack distinguishing legal features such as certainty, exclusivity, control, and assignability. In recognition of this grey area, the Law Commission has recommended the creation of a third category, data objects, which would need to meet the following criteria: (a) be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals; (b) exist independently of persons and the legal system (for example, on blockchain); and (c) be “rivalrous” (its use by one person inhibits its use by others).

What tools under English law can be repurposed for digital asset tracing and enforcement? 
Under English law, several interim remedies including disclosure and freezing orders can prove useful to investors to obtain information and injunctions in a timely manner. 

Disclosure and information orders can supplement claimants’ knowledge about the wrongdoing – and provide the information necessary for a tracing and enforcement exercise. Claimants can seek disclosure not only from the defendant, but even from innocent third parties caught up in the wrongdoing (e.g. online casinos, P2P exchanges, and banks). They can also apply for a disclosure order before tipping off the wrongdoer regarding their awareness of the wrongdoing. Recently, the English court granted an information order against a foreign cryptocurrency exchange to help identify the holders of the accounts into which the stolen cryptocurrency was transferred. 

To circumvent service issues, the English court has even permitted claimants to notify defendants about the claim through unconventional and creative means, including social media and via non-fungible tokens on the blockchain. 

English courts have also been willing to pass worldwide freezing orders in the context of cryptocurrency frauds. Such orders impede defendants from transferring the asset across borders or benefitting from the proceeds of a sale; they aim to prevent defendants from dissipating their assets in anticipation of a judgment being enforced against them.

Proprietary injunctions, which freeze the property specified in the court order, prohibit defendants from handling or disposing of the precise digital asset in the claim. The appointment of receivers, third-party debt orders, charging orders, and attachment of earnings are other useful tools.

What’s next?
While the English courts await statutory or regulatory guidance on the legal status of digital assets, they are likely to continue using traditional legal tools to uphold the rights of investors in the sector. The Law Commission has already acknowledged the difficulty of legal intervention in the digital asset space, and current legal remedies stretch the limits of what can be applied to emerging technology.

While legislative reform is ongoing and judicial precedent is not settled, parties wanting to minimise loss and maximise chances of recovery should seek advice from experienced legal counsel and specialist digital asset tracing agencies at an early stage.

About the authors

Prateek Swaika is a partner and Sagar Gupta is an associate at Boies Schiller Flexner, specialising in complex, high value disputes. 

Disclaimer
The opinions expressed in the article are those of the authors and do not necessarily reflect the views of Boies Schiller Flexner or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.