Partner Nicola McKinney discusses the legal challenges posed by crypto fraud in STEP Journal



January 15, 2024

With civil fraud lawyers in England and Wales seeing a steep rise in crypto fraud over the past two years, Partner Nicola McKinney explores the changing legal landscape for the recovery of stolen digital assets.

 

Nicola’s article was published in Step Journal: Issue 6 2023, and can be found here.

Crypto fraud has sharply increased in the past two years, according to data from Action Fraud and the Financial Conduct Authority, both of which recorded rises in the number of victims as well as the total sums lost.

The trend is unlikely to come as a surprise to English civil fraud lawyers, who have in the past two years seen a steep rise in fraud cases pursued through the English courts. In their 2023 report on crypto crime, blockchain analysis company Chainalysis identified romance scams as the most prevalent form of crypto scam, with high levels of impersonation and investment scams also recorded.

Investments into digital assets are often carried out by individuals without the assistance of professional advisors, and this has created target-rich field for fraudsters, particularly with older or less sophisticated would-be investors, who are investing in digital assets for the first time or with a very limited resource pool such as a pension pot.

Romance scams rely on the pretence of a romantic or friendly relationship being developed by the scammer with a victim, who is then persuaded to send money to purchase digital assets.  Investment scams rely on fake websites and platforms – which are becoming increasingly sophisticated – to draw in potential investors, and who then send fiat or digital currency with the purpose of purchasing crypto assets, but in fact directly into the wallets of fraudsters.

Victims of crypto fraud will be faced with a series of hurdles in order to try to recoup their losses.  Criminal proceedings are particularly complex because most scams are international, with anonymous scammers beyond the reach of national law enforcement.  Even where there is a defendant to arrest, charge and prosecute, the aim of the proceedings is generally not to recover assets for a victim.

Others who have suffered losses will turn to fraud lawyers.  Seeking remedies through the courts – or threatening proceedings – can be a successful way to obtain information or recover assets, but in some cases the expense will put those steps beyond the reach of victims.

In many respects attempts to recover digital assets bear little difference from more traditional forms of fraud.  Delay can be catastrophic. Identifying enforcement prospects, and locating the stolen (or substitute) assets, is often a first step, before proceedings for recovery or damages are actually commenced.

However, even with the transparency of transactions on the blockchain, the pseudonymous nature of the technology means that tracking transfers is easier than identifying the fraudsters. Following or tracing funds is likely to require a robust and costly blockchain analysis and report, especially where a victim’s digital assets have been mixed with others in the course of a series of ‘hops’ through digital wallets.

English courts, and other common law jurisdictions, have proved willing to grant orders in aid of recovery efforts, including disclosure orders under Norwich Pharmacal[1] and Banker’s Trust jurisdictions, and freezing injunctions to prevent the dissipation of assets within an identified digital wallet. Early cases required courts to engage with fundamental concepts such as whether crypto currency is capable of amounting to property or being held subject to a constructive trust.

While the merits of those arguments has been accepted numerous times (albeit in interim proceedings), there are likely to be cases over the next few years which continue to advance the jurisprudence specific to crypto frauds.

Further, as judges have gained in experience with digital assets, applications have already been met with increased scrutiny. For example, where worldwide freezing orders might have been granted quite easily by English courts in early applications, the recent case of Piroozzadeh[2] made it abundantly clear that the ordinary, and rigorous, duties on applicants and legal advisors relating to ‘full and frank disclosure and fair presentation’ apply in these cases as elsewhere.

The legal landscape for the recovery of stolen digital assets has evolved quickly, and much more so than the regulatory framework.  However, the road to recovery for victims is still a bumpy one.

 

[1] Norwich Pharmacal v Customs and Excise Commissioners [1974] AC 133

[2] Piroozzadeh v Persons Unknown and Others [223] EWHC 1024 (Ch)