Crypto Fraud, Custody and the Courts

A recent UK High Court decision in Jones v Persons Unknown underscores the complex questions crypto fraud cases raise around ownership, custody and third-party rights. The Court declined to overturn a previous fraud judgment, despite a non-party exchange claiming its customers’ Bitcoin had been wrongly taken to satisfy it. Our Dispute Resolution team examines the background to the case and explores how courts approach custody arrangements, mixed funds and third-party claims in fraud disputes.

What you need to know

• An investor previously in 2022 succeeded in its claim for fraud against two unknown fraudsters and Huobi Global Ltd, a cryptocurrency exchange.
• Huobi owned the wallet that stored the stolen Bitcoin.
• The Court made an order for the return of the Bitcoin against Huobi.
• Huobi transferred the Bitcoin from an unconnected wallet and then deducted the Bitcoin from the account belonging to Kyrrex Ltd, another cryptocurrency exchange.
• Kyrrex sought to have the judgment annulled on the basis that it was directly affected by it through the loss of the Bitcoin from its account.
• The Court refused the application and stated that Kyrrex’s claim lay against Huobi which held its Bitcoin, under its terms of business.

Background

Mr Jones, a Bitcoin investor was persuaded by two unknown fraudsters to transfer 90 Bitcoin to a fake investor platform. Expert evidence produced by Mr Jones identified an exchange wallet, referred to throughout the case as the ‘Targeted Wallet’, owned by Huobi, into which Mr Jones’ Bitcoin was transferred and stored. Mr Jones brought a claim against the fraudsters and Huobi on the basis that it owned and controlled the Targeted Wallet.

Neither the fraudsters nor Huobi participated in the proceedings. The Court granted freezing injunctions against the fraudsters. The Court also made an order against Huobi for the return of the 90 stolen Bitcoin and a further 8 Bitcoin to cover interest and costs on the basis that the exchange had duties towards Mr Jones.

Huobi transferred the Bitcoin from an unconnected wallet and then deducted the equivalent amount from an account held by Kyrrex in the Targeted Wallet.

Application to annul the judgment

Two years later, Kyrrex, sought to have the judgement set aside on the basis that although it was not a party to the proceedings, it was directly affected by the ultimate judgment.

Kyrrex argued that it had been directly affected by the judgment through the loss of the Bitcoin in its account in the Targeted Wallet. Kyrrex claimed that the expert evidence produced by Mr Jones in the proceedings which traced the stolen Bitcoin to the Targeted Wallet was incorrect. Expert evidence obtained by Kyrrex showed that Huobi transferred Bitcoin from an unconnected wallet which did not contain Mr Jones’ stolen Bitcoin but mixed funds belonging to Kyrrex and its customers.

What is crucial to note is that under Huobi’s terms and conditions, the Targeted Wallet was defined as a custodial wallet. As a result, the cryptocurrencies contained in the wallet, as a matter of law, belonged to its customers. However, in practice, Huobi treated the Targeted Wallet as a source of funds from which it could add and deduct cryptocurrencies at will, provided that it kept an account record of what cryptocurrencies it owed to each account holder.

The decision

The Court refused the Kyrrex’ application to set aside the judgment on the basis that Kyrrex failed to show that it had been directly affected by the judgment. The Court held that while the judgment was based on the assumption that Mr Jones’ Bitcoin was stored in the Targeted Wallet, the order for the return of the Bitcoin did not specify the wallet from which the Bitcoin was to be repaid. It was the choice of Huobi to draw Bitcoin from an unconnected wallet address and reimburse itself from the Targeted Wallet, rather than a direct consequence of the order. The Court found that Kyrrex was only indirectly affected by the judgment, and that any claim it had lay against Huobi under its terms of business.

The Court also noted that Kyrrex had delayed in making its application and Huobi had since been deregistered. Accordingly, prejudice would be caused to Mr Jones should the judgment be set aside and the proceedings reopened.

Conclusion

This case illustrates that cryptocurrencies differ widely, and exchanges operate under varied models. The ownership rights of participants can vary significantly depending on each exchange’s terms of business. Therefore, participants in cryptocurrency markets must pay attention to both an exchange’s terms of business and how it operates in practice. As with any cryptocurrency fraud, acting quickly is crucial to protecting and enforcing your rights over the assets you hold.

For more information, please contact a member of our Dispute Resolution team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.

People also ask

[1] [2020] 4 WLR 35.

[2] [2021] EWHC 2254 (Comm).

[3] [2022] EWHC 667 and [2023] EWCA Civ 83.).

[4] [2022] EWHC 2954 (Comm).

[5] [2022] EWHC 1723 (Ch).

[6] [2022] EWHC 2543 (Comm).

[7] 26 January 2023, unreported.

[8] 28 January 2021, unreported.

[9] 6 March 2023, unreported, EWHC HHJ Pelling KC.