Recovering crypto and digital assets

June 2023  |  FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

June 2023 Issue

Despite tribulations buffeting the crypto space over the last 12 months, including the crash of several exchanges, the long-term future for digital assets remains viable. In recent years, the space has moved beyond its niche beginnings, where it offered a relatively narrow set of products, to become much more varied. The emergence of diversified finance and non-fungible tokens (NFTs), for instance, has drawn considerable interest and publicity.

Over the last few years the size and trading activity of cryptocurrency markets increased rapidly. A rising number of companies worldwide are using cryptocurrency and other digital assets for a range of investment, transactional and operational purposes.

But while crypto and digital assets offer many advantages, they also pose significant challenges – not least in tracing and recovering these assets when they are misappropriated.

Today, the risk of crypto and digital asset fraud is significant. According to blockchain analysis company Chainalysis, malicious actors captured $14bn in digital currency in 2021, through fraud, theft and other forms of malfeasance.

Although crypto frauds often share many features with other, more familiar forms of fraud – be it Ponzi schemes, investment schemes, boiler room scams, advance fee fraud, phishing and so on – the nature of these assets can render the recovery process less fruitful, and legally more complex.

Down the rabbit hole

Advisers who specialise in tracking and recovering traditional assets face new hurdles when it comes to cryptoassets. Problems can arise when trying to trace blockchain-related fraud, for example; even though transactions within the chain are theoretically visible, and thus searchable with the right tools, the anonymity of underlying owners may lead to dead ends. Equally, it may not be easy to freeze cryptoassets that are in dispute.

There are, however, avenues experts can explore to track the movement of cryptoassets on blockchains, allowing them to identify targets for disclosure or freezing orders.

For cryptocurrencies, chain analysis makes it possible to follow specific bitcoins, for example, back through the blockchain to their origin. The same can be done for cryptoassets. A chain analysis combines visualisation tools, open-source intelligence and other datasets to deduce the location, behaviour or other details relating to the owner of a cryptoasset. Such information can then form the basis of court orders or real-world investigations, often spanning jurisdictions.

Successfully tracing and seizing cryptoassets is a complex multidisciplinary task requiring both legal and technical skills – but it is possible. Through a combination of lawyers, investigators and technical experts it is possible to explore the huge amounts of data generated by the blockchain to trace and recover assets.

Lawyers, forensic accountants, corporate intelligence advisers and asset recovery professionals, working in unison, can greatly improve success rates. The Crypto Fraud and Asset Recovery (CFAAR) network was established by leading lights in the field to provide key insights into digital and crypto fraud. The CFAAR’s goal is to invite global professionals in the crypto sphere to become part of an “inclusive community that will host regular meetings, seminars, roundtables, conferences and social events to provide opportunities for developing skills, ideas and networks globally”. The network will also act as an independent, authoritative body on judicial and regulatory reviews and consultations where cryptocurrency is involved.

An effective legal and technical team understands what is and is not possible, and knows the questions to ask and how to investigate. Even then, however, the recovery process can be challenging. Cryptoassets may be held in exchanges registered offshore, in jurisdictions chosen for their resistance to overregulation. This makes it difficult for courts to issue certain orders, such as the overseas production orders (OPOs) issued by courts in England and Wales. OPOs were introduced by the Crime (Overseas Production Orders) Act 2019 (COPOA) and give law enforcement agencies power to obtain electronic data from service providers based outside the UK for the purpose of preventing, detecting and investigating serious crimes. This data can then be used as evidence in criminal proceedings.

If digital assets are held outside a centralised exchange, the recovery process could prove even more problematic. A proprietary or freezing injunction could restrain further transactions and dispositions, but it may be difficult to enforce such an order if there is no third-party holder present. Courts may need to develop new search and seizure orders in such cases to promote enforcement.

The legal status of cryptocurrencies and digital assets under property law in the UK remains a contentious issue. The Law Commission of England and Wales has been consulting on a wide range of proposals concerning the private law treatment of digital assets in order to create some degree of legal certainty. Consensus has begun to form, with judges finding that cryptoassets are indeed property. Whether they are tangible or intangible assets remains in debate; many digital assets meet the definition of both.

Given the scope and pace of technological change, entirely new crypto regulation frameworks are being developed from base principles because existing approaches are not fit for purpose. As digital asset fraud rises, and as bankruptcies of digital asset platforms proliferate, the surrounding regulatory and legislative agenda needs to change to assist the tracing and recovery process.

© Financier Worldwide

BY

Richard Summerfield