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Head of Blockchain and Digital Assets Matt Green dissects the recent case of D’Aloia v Persons Unknown, exploring the key takeaways for practitioners and analysing the impact of this judgment on crypto asset tracing and recovery. 

Matt’s commentary provides a different view of why things went wrong for the claimant, and why it feels unfair for a victim of fraud to lose in this way.  

Matt’s article was published in Thomson Reuters Regulatory Intelligence, 6 November 2024, and can be found here.

In D’Aloia v Persons Unknown & Others, Fabrizio D’Aloia was a victim of fraud involving losses of around £2.5 million, including 2 million Tether tokens. The tokens moved along the blockchain, co-mingling with other funds, and within a single credit of 400,000, it was alleged that 46,291 of D’Aloia’s Tether landed, for the purpose of this case, at a wallet address associated with a customer of Thai crypto-currency exchange Bitkub.

That customer was a Ms Hlangpan, who appears to have received more than 13 million Tether between January 7, 2022, and May 31, 2022. A review of the investigator’s report noted the 13 million came from numerous sources, including an address attributed to another scam and sanctioned wallet addresses associated with the North Korean hacking group Lazarus.
Following disclosure by Bitkub of Hlangpan’s customer information, D’Aloia’s investigator found that her source of income included a website widely reported as selling fake goods or failing to make delivery following purchase. This has the hallmarks of money laundering, and Bitkub’s own witnesses said Hlangpan was a money mule who, to quote the judgment “allowed her Bitkub account to be used for the purposes of money laundering”. The claim against Hlangpan remains active.

Reaction to the judgment has been widely negative. A win for Bitkub, who refuted D’Aloia’s claim, and a loss for D’Aloia, following a failure to explain tracing methods properly. Some have questioned why the judgment is so heavily weighed against D’Aloia, given his funds were clearly at the hands of now-identified money launderers and how a victim could lose in such a case.

The judgment provides a snapshot of the case against one particular defendant, Bitkub, and does not tell the whole story: claims against fraudsters and purported money launderers remain at play. This was also the first time a judge was able to review and critique a cryptocurrency tracing report in a substantive trial (as opposed to interim relief), so there is some sympathy for filing evidence that may not be to the judge’s satisfaction, and all parties are now guided on what judges may expect.

It is also worth considering whether D’Aloia was pursuing the wrong party or, more precisely, included a claim against Bitkub where, on the face of it, there was no wrongdoing against D’Aloia.

Background

D’Aloia invested in the fake investment platform TDA-Finan and sought to recover funds from the following:

· Those who stole from him, including TDA-Finan, being a category of first defendant.
· Those who, following a tracing exercise using blockchain analytical software, ended up with his funds (being the customers of crypto exchanges, including Bitkub), being a category of second defendants.
· The cryptocurrency exchanges whose customers were the second category defendants mentioned.
D’Aloia believed that Bitkub had committed wrongdoing and held his assets as a constructive trustee. This judgment specifically deals with D’Aloia’s claim against Bitkub, with applications for summary judgment made against four of the defendants.

Among other things, the judgment has been notable for addressing three main problems, including evidentiary burdens for tracing cryptocurrencies, matters related to pursuing exchanges and the status of Tether being property at common law. Mention was also made of the exchange’s future onboarding and expectations. Although interesting in law, some of these challenges were avoidable, as Bitkub was accused of having liability for wrongdoing to D’Aloia from the outset. The focus should be, and in this instance remains, on the first and second category defendants.

Reviewing fund movement and mixing

To recover misappropriated crypto-assets, practitioners must understand their movement and whereabouts and consider if they have been mixed with other funds. Here, the pleaded case used the term “identifiable cryptocurrency,” leaning on legal principles concerning proprietary claims (i.e., whether the Tether identified at Bitkub are D’Aloia’s Tether).
Bitkub asserted that as the Tether had been mixed with those of third parties, it was not proven those funds were deposited at Bitkub itself. The judge drew distinctions between following common law, in which the actual asset itself remains identifiable, and tracing in equity, where the asset can be substituted for another asset (e.g., if £100,000 cash was used to purchase a car, the proprietary right is now in the car).

The judge noted that common law principles prevented D’Aloia from following the Tether through a mixed fund. Despite evidence that Tether Ltd had records to evidence following, those records were not submitted. In theory, common-law following could be used where there is suitable evidence to show assets moving through a mixer and where they remain identifiable. This then leaves tracing in equity, which relies heavily on an explanation of methodology.

The investigator said they observed reliance on “first-in, first-out” (FIFO) accounting methods to evidence tracing and the deposit of D’Aloia’s funds at Bitkub. While the investigator sought to use FIFO, the judge said, “I accept it was never the approach that he in fact attempted to apply.”

The overarching criticism concerned inconsistencies with that particular tracing exercise and the explanations given on methodology, which had failed to detail evidence that D’Aloia’s funds were those deposited at Bitkub.

Seemingly, there were no questions as to whether other defendants received D’Aloia’s funds or, indeed, whether Hlangpan received his funds. It was whether his funds moved from Hlangpan’s address to Bitkub’s address as a matter of provable fact, given co-mingling. Whether this distinction was required to make a recovery is questionable, given the target should have been Hlangpan and not Bitkub (without further evidence of wrongdoing).

The judge said the law was not limited to specific tracing techniques and that “other methods, if methodologically sound and properly evidenced, are available to a party seeking to trace assets, at least in the context of claims arising out of fraud.” It in no way prevents fraud victims from making claims against parties who hold their funds.

Similarly, there were provisions in the expert’s evidence dealing explicitly with FIFO, co-mingling of funds and methodology, albeit not to the judge’s satisfaction. There may be some sympathy here, given there is no clear precedent for how courts may receive evidence or expect it to be presented.

Pursuing crypto exchanges

Crypto exchanges play a vital role in cases like this. As investigators trace the movement of funds across blockchains, it is usually unknowable who controls those assets until they are deposited at a crypto exchange, which can provide their customers’ identities following onboarding procedures. On that basis, pursuing them for wrongdoing from the outset is undesirable without substantial evidence.

D’Aloia broadly made two claims: one for constructive trust and one for unjust enrichment.

Constructive trust

As to a constructive trust, the claim advanced that Bitkub held the Tether as a trustee, with D’Aloia as beneficiary, on the basis that Bitkub held those assets on the victim’s behalf. This is not unusual but relies on the exchange having had custody of the assets.

This claim failed on several bases, but largely because it had not been proven Bitkub received D’Aloia’s Tether. Similarly, if the tracing had been sufficiently evidenced, the actual Tether deposited had been withdrawn. This can be resolved by making a personal claim against Hlangpan (which D’Aloia did) and not Bitkub itself. In that respect, the intended trustee was likely the wrong party based on the evidence. The judge found that a constructive trust could be made against the TDA-Finan platform, although recognised concerns with deeming it fraudulent.

It is vital to ensure that the heads of the case are suitable and that the parties being pursued have clearly committed a wrongdoing and/ or that evidence shows they are suitably involved. Seeking urgent interim relief makes that consideration harder, particularly where assets can be dissipated at the click of a mouse, and goalposts can feel moveable as matters progress. Nevertheless, targeting a crypto exchange in this manner has proven to be unhelpful.

Similarly, accusing Bitkub of acting in a “commercially unacceptable” way was given some weight but used by D’Aloia only to counter a defence of bona fide recipient of the Tether.
Importantly here, Bitkub’s own obligations were to its customers, including Hlangpan. However, Bitkub had failed to implement its own anti-money laundering policies by allowing Hlangpan to make withdrawals beyond her allowable limit. The judge determined that as no trust had been established, Bitkub owed no duty to D’Aloia, and that anti-money laundering breach was a matter for Bitkub and Hlangpan. Unfortunately this gave D’Aloia little recourse.

Unjust enrichment

The unjust enrichment claim, which relied on Bitkub being enriched at the expense of D’Aloia, also failed because the tracing evidence was unsuitable and could not prove that it was at D’Aloia’s expense. Practitioners must ensure that all causes of action are properly considered, given the judge’s criticism of failing to include, for instance, a claim for knowing receipt. In any event, crypto exchanges should not be pursued without careful consideration and clear evidence of wrongdoing or involvement.

Exchange conduct and regulatory implications

The Court’s observations on Bitkub’s handling of suspicious transactions, while not the focus of the case, are noteworthy. The judgment hints that cryptocurrency exchanges might face more scrutiny of their AML and internal controls. Bitkub’s management of suspicious activities offers insight into what is expected from exchanges, particularly the need for diligence in monitoring and responding to potential fraud.

The findings suggest possible regulatory changes, advocating for stricter compliance in the cryptocurrency sector. Exchanges may need to improve their know-your-customer procedures and transaction monitoring to meet heightened expectations. The Court’s analysis can serve as a standard for assessing exchanges’ compliance measures and might influence regulatory bodies overseeing and enforcing industry standards.

Legal status of cryptocurrency

The substantive claims relied upon Tether’s categorisation as property at common law. All crypto assets were declared property under AA v Persons Unknown & Ors, Re Bitcoin [2019] EWHC 3556 (Comm) (December 13, 2019), and as ratified at the Court of Appeal level in Tulip Trading Ltd (A Seychelles Company) v Bitcoin Association For BSV & Ors [2023] EWCA Civ 83 (February 3, 2023). In both the context of Lavinia Deborah Osbourne v (1) Persons Unknown (2) Ozone Networks Inc [2022] EWHC 1021 (Comm) in which non-fungible tokens were declared property, and with the Property (Digital Assets Etc.) Bill introduced to parliament on September 11, 2024, a declaration that Tether is property is unsurprising. The sentiment here was to ensure D’Aloia could, in theory, rely on tracing and following principles of law and on ensuring those points could be ventilated properly, even where, as in this case, claims relying on those regimes fail.

Lessons for tracing reports, methodologies

The case underscores the importance of clear and thorough pleadings, especially in complex areas such as cryptocurrency and tracing. It also shows that pursuing crypto exchanges on the basis of wrongdoing from the outset is an unhelpful route to recovery.

If following receipt of a notice that they are or have been dealing with the proceeds of crime, and in the event they then allow funds to be transacted outside of permitted means as detailed in proceeds of crime legislation, then victims can bring clear claims for wrongdoing.

Although D’Aloia’s claim against Bitkub failed, subject to any appeal, the case offers insights into the legal status of digital currencies, potential difficulties in tracing digital assets with co-mingling and how traditional legal principles apply to modern forms of technology. Careful review of tracing reports and explanations of methodology must be front and centre. In any event, this judgment assists practitioners in identifying clear pitfalls and signposting how to avoid targeting the wrong parties.Whether this matter will result in a recovery for D’Aloia against the remaining defendants or whether this case is suitable for appeal is a matter for D’Aloia and his team.

(Matt Green, partner at Lawrence Stephens, and Brian Sanya Mondoh, barrister and attorney at law, founder at Blockchain Lex Group and CryptoMondays Caribbean)