Jul 7, 2023

Chasing cryptoassets – down the rabbit hole

There are an estimated 1,500 exchanges through which investors may purchase rights to cryptoassets, such as Bitcoin, Ethereum and USD Tether, to name a few. Cryptoassets is a catchall term encompassing different kinds of assets, including cryptocurrencies, NFTs, and digital assets.

As recent events have shown, the fates of investors and markets alike are in the hands of the exchanges themselves, or in those of the individuals responsible for their management. Creditors with proprietary claims and insolvency practitioners face a similar, diverse set of novel challenges when seeking to recover valuable cryptoassets.

Fundamentally, parties must first determine the question of:

  • whether an exchange held assets on behalf of investors; or
  • whether investors held assets in their own name.

This is a subtle but important difference; in the first scenario, the exchange will have taken possession of the relevant private keys, with the effect being that the exchange owns the cryptoasset. In this case, investors would rank as unsecured creditors in any exchange’s insolvency. In the alternative, investors would own the assets outside of the exchange’s insolvency. It would then be open for investors to bring their own proprietary claims against the persons responsible for, or implicated in, any attempt to deprive them of their assets.

In either case, a detailed analysis of the agreements governing the rights of investors is crucial to answering this primary question. Such an analysis would also enable insolvency practitioners to focus their resources on returning value to the company’s creditors, for whom they would ultimately be responsible for.

Next, parties must be prepared to undertake an extensive analysis into the whereabouts of the relevant cryptoassets. This analysis will require a party to ‘follow’ or ‘trace’ the assets in question.

In this context, ‘following’ is the process of following a cryptoasset in which a creditor claims an interest as it moves from hand to hand, or wallet to wallet, identifying what has happened to the same asset. Conversely, to ‘trace’ an asset is to identify whether the cryptoassets have been used to acquire substitute cryptoassets or proceeds, such as fiat currency upon converting the relevant cryptoassets.

Following or tracing the proceeds of cryptoassets does not in itself provide a remedy; they are part and parcel of the evidential process that must first be followed to establish a party’s most appropriate remedy. The ease at which cryptoassets may be followed or traced will depend on a variety of factors, including:

  • whether cryptoassets go through “mixers”, or intermediary wallets;
  • the use of complex trust structures to mask the legal ownership history of a cryptoasset or its proceeds;
  • cryptoasset price or market volatility, which may reduce (or increase) the value of recoverable cryptoassets; and
  • the jurisdiction in which the ultimate recipient, who holds either the cryptoasset itself or its substitute proceeds, resides.

The following, or tracing, analysis should be completed with the assistance of forensic accountants and investigators with expertise in blockchain technology.

The pursuit of cryptoassets is a time-consuming and lengthy process which requires considerable financial resources and expertise. Ontier’s lawyers are experienced in leading recovery actions with the support of third-party commercial funders, ATE insurance providers, and forensic specialists to carefully manage risk and achieve recoveries.

Please contact our team of experts if you have any questions or require any further information.

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