The law can be slow to adapt to emerging technologies such as cryptocurrency, however practitioners can still use existing tools to solve immediate problems for their clients.
With a thorough knowledge of existing legal avenues, legislation changes are not always essential to achieving a good result.
Litigation and dispute resolution lawyer Daniel Wignall has seen this play out firsthand in a recent asset recovery exercise involving cryptocurrency. Using existing asset recovery tools, Mr Wignall says that practitioners can investigate, trace and ultimately recover cryptocurrencies held by bankrupts.
As the trustee is investigating a bankrupt’s assets, they may find that the bankrupt owned or traded in cryptocurrency. This typically sets off a chain of events where the trustee will take steps to secure known cryptocurrency to prevent the dissipation of that asset and, if necessary, make further inquiries into cryptocurrency trading activities.
Those inquiries will aim to ascertain whether:
- the bankrupt has failed to disclose any other cryptocurrency that remains in their possession or control, or
- there are any voidable transactions claims arising from cryptocurrency trading.
Cryptocurrency exchanges operating in Australia are required to comply with Australia’s anti-money laundering and counter-terrorism financing legislation, which includes requirements to implement ‘know your customer’ (KYC) identification procedures.
These procedures require trading platforms to ensure customers provide 100 points of identification to be registered as a user. The KYC procedures are crucial to enabling trustees to identify the owner or controller of a cryptocurrency account.
The typical inquiries a trustee will undertake include:
- writing to cryptocurrency exchanges requesting information (as one may write to banks or share registries)
- invoking the Official Receiver’s information-gathering powers to further investigations
- conducting ‘tracing’ investigations to identify the end recipient of cryptocurrency transactions.
While tracing cryptocurrency to a specific wallet address can be a relatively straightforward process for trustees and their advisors, securing – and realising – the cryptocurrency can be another challenge altogether.
The steps necessary to secure any cryptocurrency will depend on a range of factors, particularly the way the cryptocurrency is held and whether the bankrupt is assisting the trustee in their inquiries.
If the cryptocurrency is held on a cryptocurrency trading exchange, the trustee may direct the bankrupt to hand over details of any account passwords or private keys. A trustee should also write to all trading platforms within Australia to:
- ascertain whether any accounts are held in the bankrupt’s name
- instruct them to freeze all such accounts, and
- deliver up details of any access codes and passwords under the powers granted to trustees under the Bankruptcy Act 1966.
Where is the cryptocurrency held?
Cryptocurrency can be held in a software – or ‘soft’ – wallet (such as Metamask), or offline in a hardware – or ‘hard’ – wallet (such as a Ledger or Trezor). A software wallet may be computer software or a mobile or web-based application, whereas a hard wallet is a device the size of a small USB stick that stores the user’s private access keys. Both hard and soft wallets may pose difficulties for trustees looking to recover the asset, which is where legal practitioners can provide value to the investigation process.
Where cryptocurrency is stored on a hard wallet, securing the cryptocurrency requires the trustee to physically obtain the hard wallet device itself as well as the access password or pin. Alternatively, locating the ‘seed’ recovery phrase to the wallet (a 12 or 24 random-word passphrase) can be used to recover the cryptocurrency in the event the wallet device is misplaced or destroyed.
Hard wallets can be easily concealable and the assets they hold can very quickly be moved to another location or account. If a trustee suspects a bankrupt is seeking to hide cryptocurrency, swift and decisive legal action may be required to prevent the dissipation of those assets, including via the courts where necessary.
Under section 130 of the Bankruptcy Act 1966, a trustee may, in some circumstances, apply to a court for a warrant to search a premises in which they suspect there is property of the bankrupt, or property connected with a bankrupt’s examinable affairs. If any relevant property (such as a hard wallet) is located, the trustee is then empowered to seize that property or secure it against interference.
In order to succeed in an application of that nature, the trustee must satisfy the court that there are reasonable grounds to issue a warrant.
Broadly, lawyers must collect and present evidence to satisfy the court that the issuing and execution of the warrant will:
- assist the trustee in their investigations into the bankrupt’s examinable affairs, and/or
- enable the trustee to seize property of the bankrupt that has vested in the trustee (normally, property that has otherwise not been disclosed by the bankrupt).
In a recent search warrant application, wallet addresses and the results of a ‘tracing’ exercise were used to successfully satisfy the above. The tracing revealed the bankrupt’s assets had been transferred through various cryptocurrency wallets and were held in numerous cryptocurrencies, including Ethereum and Ripple.
Evidence filed in support of the application also included comprehensive information on how cryptocurrency is held and transferred. Further, it demonstrated the ease with which hard wallet devices can be concealed to substantiate how issuing the warrant would assist the trustee’s investigations.
Executing the search warrant
If the court accepts the evidence and issues the warrant, it is then executed with the assistance of police and legal advisers, whose experience in identifying cryptocurrency wallets is particularly useful. Experience finding wallets, seed recovery phrases or other property that may be related to the bankrupt’s cryptocurrency trading activity is crucial to maximising the opportunity to act on a warrant.
During a recent warrant executed by police and Mr Wignall, the trustee located and seized several hard wallet devices and other IT equipment. The trustee also seized other evidence that led to discovery of significant, but previously undisclosed, cryptocurrency accounts that were accessed or controlled by the bankrupt. Those efforts enabled further investigation into the bankrupt’s cryptocurrency trading activity.
The above process shows how existing regulation interacts with modern technology. What used to be the ‘wild west’ is now being reined in by laws that existed before the inception of cryptocurrency.
A couple of reflections to keep in mind:
- Now that trading platforms in Australia are required to properly identify all account holders, truly anonymous cryptocurrency trading is increasingly difficult to achieve.
- Trustees will increasingly need to rely on their investigative powers, such as those used in the above case, as cryptocurrency becomes a more frequent asset in bankrupt estates.
- For bankrupts attempting to hide or conceal assets via cryptocurrency, the courts are alive to those issues and may assist trustees to locate and secure cryptocurrency assets.
If you are looking to recover cryptocurrency held by insolvent entities it’s important to know the traditional routes available, and look to expert advisers to maximise your recovery efforts should a search warrant be obtained. Though the legislation is slow to adapt to new technologies, the example detailed in this article demonstrates how existing laws can be used to achieve results.