In D'Aloia v Person Unknown & Others  EWHC 1723 (Ch), the English court has, for the first time, granted permission for service of proceedings to be effected by non-fungible token (NFT) on the blockchain.
The option to serve by NFT may be vital for victims of cryptocurrency fraud in circumstances where it is possible to identify a relevant wallet address but the identity of the defendant behind the address is unknown. Service by way of blockchain technology also provides immutable and verified proof of effective service given its tracing functions (see Hogan Lovells alert The US$4.5 billion Bitfinex hack – five things you should know).
In D’Aloia, the claimant fell victim to a scam in which he was fraudulently deceived into transferring approximately 2.1 million Tether (a cryptocurrency, also referred to as USDT) and 230,000 USD Coin (another cryptocurrency, referred to as USDC) to two wallets associated with a fake online brokerage website, namely "www.tda-finan.com", which was registered in Hong Kong and operated by persons unknown.
The claimant instructed an expert in crypto investigatory work who traced the assets to several private addresses administered by five cryptocurrency exchanges (the exchange defendants) located in different countries outside the jurisdiction.
The claimant made applications for a freezing injunction in respect of the assets transferred to the wallets, disclosure orders requiring the exchange defendants to provide information to enable the claimant to trace the assets and/or identify the persons unknown, permission to serve the exchange defendants out of jurisdiction and to serve the persons unknown by NFT into the wallets.
Continuation of a trend
This decision followed earlier English authorities which recognized cryptocurrency as "property", thereby enabling the court to make them the subject of a proprietary or freezing injunction (see Hogan Lovells alerts Cryo-currency? Hong Kong court grants freezing injunction over bitcoins and Into the Unknown – cryptocurrency is property, says English Court in blackmail dispute).
It has also been previously established that, under English law, the location of a cryptoasset is likely to be the place where the person who owns it resides or is domiciled. Since the claimant was domiciled in England, the USDT and USDC, of which he was deprived as a result of the fraudulent misrepresentation by the persons unknown, were also deemed to be located in England.
The court also accepted that the claim itself was governed by English law because the relevant damage occurred in England when the English assets were misappropriated.
Novel forms of alternative service
In Hong Kong, Order 10, r.1 of the Rules of the High Court (Cap. 4A) provides that a writ can be served in person, by registered post or by inserting through letter box. Similar to the position in English law, any alternative methods of service can only be done with the court's permission.
In cryptocurrency disputes, when the interim relief sought is against anonymous defendants, novel forms of alternative service may become necessary. For example, alternative service via email was permitted in a recent English case (see Hogan Lovells alerts Into the Unknown – cryptocurrency is property, says English Court in blackmail dispute).
In this case, in addition to service by email which was the method of communication between the claimant and the persons unknown, the court allowed alternative service by airdropping NFTs into the wallets, suggesting that "it is likely to lead to a greater prospect of those who are behind the tda-finan website being put on notice of the making of this order, and the commencement of these proceedings". Airdropping in this sense simply means uninvitedly transferring a digital asset to a wallet address on the blockchain.
It should be noted that the court was hesitant to order service by NFT only without service by email, so it remains to be tested in court whether service by NFT alone is sufficient for valid service, especially when there are no email exchanges or any other communication between the claimant and the fraudsters.
Exchange defendants as constructive trustee
The court found there to be a good arguable case that the exchange defendants held the misappropriated assets on constructive trust. The effect was that the exchange defendants could be held liable for breach of trust if they failed to take action to ringfence the relevant cryptocurrencies once they had been notified. This was particularly significant as it provides a direct avenue for a claimant to seek redress against the exchange, especially when the identities of the fraudsters are unknown.
However, there are practical issues with ringfencing the fraudulent cryptocurrencies because deposits are often mixed in with other users' cryptocurrencies in an exchange.
It is also worth noting that this was a without notice application, which means that the court made this preliminary finding without the benefit of submissions from the exchange defendants.
New hope for victims of cryptoasset scams
This decision demonstrates the English courts' commitment to embracing new technologies within the context of crypto-based disputes. It will be interesting to see if Hong Kong courts will join forces and utilise blockchain technology in court proceedings.
The service of court documents is just one potential application for blockchain technology in dispute resolution. Blockchain is, in theory, also capable of being used in circumstances such as disclosure, digital signatures and document exchange.
On the other hand, the preliminary finding on cryptocurrency exchanges acting as constructive trustees of misappropriated cryptocurrency is a wake-up call for exchanges to invest in compliance and security infrastructure to prevent frauds in the first place.
Close attention should be paid to these proceedings as they progress to see if the court provides further analysis on this issue and what kinds of obligations are imposed on a cryptocurrency exchange that is found to be a constructive trustee.
Authored by Byron Phillips, James Wise, Hazel Law, Nigel Sharman, and Vanessa Hung.