November 07, 2018

Challenges in Discovering Perpetrators of International Cryptocurrency Frauds

Eric S. Rein – April 23, 2018

The use of cryptocurrencies is increasing at a staggering pace. As cryptocurrency use becomes mainstream, its use as a form of payment and storage as an asset will increase across industries and among companies and individuals.

Cryptocurrency itself is a string of computer-generated code. This line of code is accessed by an owner's unique and secret passcode, or "private key." Each owner's cryptocurrency is kept in their individual "Virtual Wallet." Virtual wallets are anonymous, as are the virtual currency balances. The transfer of cryptocurrency is based upon the block chain protocol, a public decentralized ledger that identifies transactions by a digital code with no link to a person or place.

A cryptocurrency account currently functions similarly to how offshore banking worked, prior to the U.S. Internal Revenue Service's crackdown on anonymous personal foreign accounts. The cryptocurrency account is anonymous and can be maintained anywhere in the world. Since block chains are decentralized, they are not subject to any central authority (such as a bank or other financial institution) that might be legally compelled to provide a court with access or control over assets in its possession. Without the complete private key, no court or legal authority can manipulate ownership of a block chain asset.

At the moment, the obstacle faced by creditors is to identify the holder and/or recipient of the transaction. Currently, offshore fiduciaries are being used to maintain the computer, private key or Virtual Wallet. Absent jurisdictional authority, a U.S. court is powerless to compel the fiduciary to turn over assets. However, a U.S. court could compel the party to turn over the account or information about the transaction. The court's contempt powers could be used to coerce compliance. Arrest and incarceration can be utilized. See In Re Lawrence, 279 F.3d 1294, 1300 (11th Cir. 2002); FTC v. Affordable Media Inc., 179 F.3d 1228, 1229 (9th Cir. 1999). But, on cruel and unusual punishment grounds, incarceration cannot be imposed forever. If the asset is more important than personal freedom, a court's power of compliance is limited.

There are two equitable remedies that exist under English common law which could be flexibly applied to these evolving transactions. One existing remedy is the equitable pre-trial discovery device known as a Norwich Pharmacal order, requiring third parties to disclose information to potentially identify the wrongdoer, to trace funds and to assist prospective plaintiffs in determining whether a cause of action exists. It may be possible that identification information might be obtained from "know your customer" information if the transaction involves a bitcoin exchange. Proceedings could be instituted against "the bitcoin holder with the public key number…" However, the hurdle still exists to identify the holder or recipient.

The second equitable remedy is injunctive relief. Courts have granted world-wide injunctions, particularly when the impugned conduct is occurring online and globally, such as over the internet. In Google Inc. v. Equustek Solutions Inc., 2017 SCC 34, the Supreme Court of Canada recently held that injunctive relief can be ordered against somebody who is not a party to the underling lawsuit, even if that third party is not guilty of wrongdoing. In Equustek, Google was ordered to stop displaying search results globally for any Data Link websites. "The problem in this case is occurring online and globally. The Internet has no borders—its natural habitat is global. The only way to ensure that the interlocutory injunction [order] attained its objection was to have it apply where Google operates—globally." Id. Thus, if the third party to a block chain transaction can be identified, there may be a remedy to discover information and wrongdoing.

Courts will need to apply not only new remedies, but expand existing ones. Anti-money laundering laws and "know your customer rules" requiring the collection of personal data of customers are being imposed on certain cryptocurrency exchanges. But, the challenge of recovery will still require creativity and experience from existing litigation procedures while the rules and regulations catch up to this evolving technology.

Eric S. Rein is the litigation chair at Horwood Marcus & Berk Chartered in Chicago, Illinois.


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Eric S. Rein – April 23, 2018