You've been airdropped: English court approves service by NFT and finds it arguable that cryptocurrency-exchanges hold misappropriated assets as constructive trustees
In D’Aloia v (1) Persons Unknown (2) Binance Holdings Limited & Others [2022] EWHC 1723 (Ch), the English court approved service of proceedings by NFT and found that it was arguable that cryptocurrency exchanges owed constructive trustee duties to cyber-fraud victims.
The theft
The Claimant was the victim of a scam in which he was induced to transfer around 2.1 million USDT and 230,000 USDC by scammers operating a fake online brokerage website, asking investors to place cryptocurrency into two wallets to trade on its platform. The Claimant ultimately discovered the scam when he tried to withdraw funds and found his account was blocked.
Digital investigators traced the Claimant's cryptocurrency deposits to number of cryptocurrency exchanges. The majority of the stolen crypto was held at Binance.
The application
The Claimant sought what has become the standard suite of relief in applications against persons unknown regarding crypto-assets, seeking an interim proprietary injunction and Bankers Trust disclosure relief compelling the disclosure of information from the relevant cryptocurrency exchanges about the identity of the account holder. Both orders were granted.
The two key aspects of interest in the case - alternative service by NFT and cryptocurrency exchanges potentially holding misappropriated assets as constructive trustees – are considered below.
Alternative service by NFT
Alternative service applications are common in crypto cases where interim relief is sought against unknown persons. For example, alternative service via email was permitted in AA v Persons Unknown, Re Bitcoin [2019] EWHC 3556 (Comm). And in Reyes v Persons Unknown [2021] EWHC 1938 (Comm) both Binance and Tether Holdings Limited (the holding company behind the USDT token) were ordered to use their best endeavours to bring the proceedings to the attention of the persons unknown to the extent they could using the contact details they held for them. More generally in cybercrime cases involving anonymous defendants, the courts have approved a number of novel forms of alternative service, including by text, Facebook Messenger and WhatsApp.
In this case, in a first in this jurisdiction, the Court granted an order for alternative service by 'airdropping' NFTs into the two wallets to which the Claimant had transferred the relevant cryptocurrency (as well as by sending to the email address that had been used by unknown persons to correspond with the Claimant).
The term 'airdropping' simply refers to the transfer (typically unsolicited) of a digital token to an address on a blockchain and is often used in the context of ICOs to distribute and build interest in a particular coin. Using that functionality to allow the service of legal proceedings is an interesting innovation. It appears from the judgment that the judge would have been hesitant to have ordered alternative service solely via NFT without also ordering service by the more traditional alternative route of email. It therefore remains to be seen whether alternative service via NFT airdrop will become a standalone method of alternative service in future cases (albeit it ought in principle to be, at least in cases where no other information is known about unknown fraudsters beyond a wallet address).
The decision follows the same development in the US, where in LCX AG, -v- John Does Nos. 1 – 25 a service token was airdropped into a wallet. The token contained a hyperlink to the relevant Court documents, which would have allowed the claimant to track whether the documents had been accessed and log the relevant IP address.
Crypto-exchanges as constructive trustees?
The issue of cryptocurrency exchanges holding misappropriated assets on constructive (or resulting) trust previously arose in the Reyes case mentioned above. There is limited analysis of the issue in that case although the judge did identify a potential obstacle to such a finding: if a cryptocurrency exchange could assert that it was a bona fide purchaser for value without notice of the fraud, which could (on the right factual matrix) break the necessary chain of causation. This case provides little by way of additional analysis, and it must be borne in mind that it represents a finding made at a without notice hearing without the benefit of submissions from the defendants, and only to a (relatively low) good arguable case standard. It therefore reflects only an interim position.
However, if that analysis is subsequently followed, crypto exchanges could potentially face claims for breach of trust by fraud victims in respect of any misappropriated cryptocurrency held on their platforms if they fail to ringfence the relevant cryptocurrency once they have been notified that they hold them. Relevant to this issue is the fact that cryptocurrency deposited into a cryptocurrency exchange will typically be mixed with other users' cryptocurrency, although of course the exchange has its own internal bookkeeping system keeping track of user deposits. As such, one of the many areas of interest arising from these proceedings as they develop is whether or not simply ringfencing funds within such an internal system, rather than at the blockchain level, would be sufficient to comply with obligations potentially imposed on an exchange that is found to be a constructive trustee.
Comment
These proceedings have rightly been hailed as a significant milestone in offering victims of crypto fraud an additional potential route to serve proceedings on fraudsters where limited other information besides their crypto wallet address is known. However, the proceedings may prove even more significant still if they ultimately help resolve, on the balance of probabilities following a contested trial, the question of whether exchanges do hold identifiable misappropriated cryptocurrency as constructive trustees. The implications of such a finding would be significant and close attention will be paid to the proceedings as they progress.