In recent years, cryptocurrencies have emerged with a few different proposals. Some see crypto as a new, alternative currency, whilst others see it as a path to financial freedom. But regardless of their use case, it must offer safety.
Their rising prominence is undeniable, with top cryptocurrencies like Bitcoin and Avalanche experiencing notable rallies in 2023. It comes in waves, and it seems that Bitcoin is seeing another rally in the second half of 2023. When Bitcoin rallies, all cryptocurrencies see a spike in attention.
However, as these digital assets gain value and prominence, they become increasingly attractive targets for fraud and misappropriation. In 2023, the U.S. Securities and Exchange Commission (SEC) ramped up its enforcement actions related to crypto assets significantly, indicating a growing concern over malpractices in this sector.
The previous year saw crypto crime reaching unprecedented levels, with over $3.5 billion in losses due to fraud, theft, and scams. This surge in cryptocurrency fraud necessitates a focused approach towards asset recovery.
In light of these developments, the concept of cryptocurrency asset recovery has become a central focus for many people. For private companies, this demand needs to be met by recognising the need for specialised services in this domain.
The cryptocurrency market hasn’t just expanded; it has diversified into many areas, particularly with the advent of Non-Fungible Tokens (NFTs) and decentralised finance (DeFi) platforms. These advancements, while innovative, have also opened new avenues for fraudulent activities.
The total market capitalisation of cryptocurrencies isn’t quite at the levels of its previous peak, but it’s slowly making its way back. The current market cap is heading towards $1.5 trillion, up from ~$832 billion in November 2022. This growth is underpinned by technological advancements such as zero-knowledge systems, along with a shift in market sentiment. But it still has one major obstacle: trust.
Fraudulent Activity is on the Rise
The scale of cryptocurrency fraud has been surprising for those who believed in its early security promises. In 2023, the SEC's increased enforcement actions indicate a significant rise in crypto-related financial misconduct. In 2022, Chainalysis claimed that crypto crime hit an all-time high, with illicit addresses receiving around 20 billion US dollars in 12 months. The FCA themselves reported a rise in reports from 1,619 in 2019 to a staggering 6,372 in 2021.
2022 was marked as a notably difficult year for crypto crime, setting new records in fraud, theft and scams. Ransomware, a form of cryptocurrency-based crime, is one area that saw a particularly big rise.
It becomes even more clear when comparing cryptocurrency to traditional finance. The City of London police reported that investment fraud in general saw a 15% rise in 2022. When comparing this to investment frauds involving cryptocurrencies (in the US), the number is around 183% in 2022. In fact, the FBI claimed that investment fraud was the cause of the most amount of losses of any scam, of which cryptocurrency represented the majority of such scams. This is somewhat unprecedented given how new this asset type is, and how big traditional scams were in the first place.
When losing funds to a scam, the victim of course wants to reclaim these lost funds. The evolving picture of cryptocurrency fraud, therefore, presents not only a challenge for investors and regulatory bodies but also the importance of developing effective asset recovery.
The Challenge of Cryptocurrency Asset Recovery
Crypto’s greatest strengths are also its greatest threats—this has always been the case, and it is no different when it comes to scam response. Cryptocurrency asset recovery presents a unique set of challenges due to the decentralised nature of these assets.
Cryptocurrencies are essentially strings of computer-generated code, accessed and controlled by owners through private keys. These private keys maintain the anonymity of digital wallets, making it difficult to identify the owners or the locations of these assets. This inherent anonymity complicates the process of asset recovery. Whilst there is often a public record of virtual currency transfers, it’s anonymised, meaning it isn’t tied to personal information.
If a scammer received funds in a UK bank account, they would be instantly identified, unless they held a bank account under a false identity. This is difficult, because of all the regulations surrounding opening a bank account. This is the case for most developed countries, though of course, international scams remain a big threat. For cryptocurrency, one can open a wallet with zero personal information attached.
The Challenge of Decentralisation
Unlike traditional banking systems, blockchains operate without a central authority, rendering them immune to control or access by legal authorities. This situation mirrors the anonymity once offered by offshore banking, providing a degree of creditor protection that complicates asset recovery efforts. Since blockchains are not under the jurisdiction of any centralised system, legal entities cannot easily manipulate or access these assets without the complete private key.
The international aspect of cryptocurrency transactions adds another layer of complexity. The global nature of these transactions often places them beyond the jurisdictional reach of domestic courts. Identifying defendants or the geographical scope of transactions can be formidable, if not impossible.
This global reach requires innovative legal strategies, such as the use of Norwich Pharmacal orders for pre-trial discovery, to potentially identify wrongdoers and trace funds. However, even with these tools, the challenge remains significant due to the encrypted identities and the need for creative and experienced approaches to asset recovery.
Tracing and Recovering Crypto Assets
Tracing and recovering assets in cases of blockchain-related fraud is a technically challenging process. The core issue stems from the high level of anonymity and the transparency of transactions on the blockchain. While the blockchain is a public ledger documenting all transactions, the identities of the individuals involved are encrypted. This encryption provides some sort of anonymity.
The use of chain analysis and other advanced digital tools has become integral in tracking crypto assets. These tools can examine the blockchain, identify patterns, and potentially link digital wallets to real-world identities. So, when a scammer receives stolen funds into a wallet, the activity of this wallet can be monitored.
However, the effectiveness of these tools can be limited by the sophistication of malicious actors who often use techniques like "coin mixing" or "chain hopping" to obscure the trail of transactions.
A multidisciplinary and pragmatic approach is essential in tackling blockchain-related fraud. This approach combines technical knowledge with legal and investigative skills to take on the anonymised web of digital transactions. Legal professionals, for instance, may employ novel legal tools like the equitable remedies of Norwich Pharmacal orders or injunctive relief, which have shown potential in addressing the challenges of blockchain transactions.
These remedies can compel third parties to disclose information or cease certain activities, providing a legal avenue for asset recovery. However, the global and decentralised nature of the internet, much like the blockchain, means that a legal approach cannot always be taken. This means a bigger reliance on a tech-driven approach would be needed.
Legal Challenges in Crypto Asset Recovery
One of the primary issues revolves around the classification of cryptoassets as property within the traditional legal framework. Although courts generally seem to accept cryptocurrencies as a form of property, there is debate and lack of uniformity in this recognition around the world which impacts the recovery process.
This uncertainty affects the ability of asset holders to obtain effective legal remedies, such as proprietary injunctions, aimed at freezing the movement of crypto assets.
Another challenge is determining the jurisdiction for legal proceedings involving cryptoassets. The decentralised nature of crypto makes it hard to pinpoint the jurisdiction relevant to a case. This was evident in the Ion Science case, where the English Commercial Court found England to be the appropriate jurisdiction based on a few reasons, including the location of the company’s bank account and the applicable law (lex situs) of the cryptoasset.
The utility of obtaining an enforceable court order poses yet another challenge. In the Ion Science case, the company successfully obtained proprietary injunctions and freezing orders against cryptocurrency exchange platforms to uncover the identities of the owners of the stolen crypto. However, many other cases highlight the limitations of the court process, particularly when access to private keys is uncertain or unattainable.
Crypto Fraud and Asset Recovery (CFAAR) Network
The sophistication of crypto-related frauds has brought about networks like the Crypto Fraud and Asset Recovery (CFAAR) network. Launched by a group of legal professionals, from lawyers and forensic accountants to corporate intelligence experts, CFAAR aims to develop (and share) best practices in the evolving space of crypto disputes and asset recovery.
This network brings together some of the world's leading experts in crypto disputes, placing the UK and common law jurisdictions at the forefront of global crypto dispute resolution.
CFAAR addresses the increasing need for a coordinated and robust response to theft, ICOs, and ransom attacks. Its founding members, which include firms like Asset Reality and Essex Court Chambers, have been instrumental in leading the first crypto-related disputes before the English courts and pioneering global crypto fraud investigations.
The network actively seeks global professionals in the crypto sphere to join its inclusive community. It hosts regular meetings, seminars, roundtables, conferences and social events to promote new skills and network globally. CFAAR serves as an authoritative voice in crypto-related judicial and regulatory reviews and consultations, providing a platform for professionals to collaborate and innovate in the field of crypto asset recovery.
Practical Steps in Cryptocurrency Asset Recovery
The recovery of stolen or misplaced cryptocurrency assets requires swift, deliberate actions, combining technical expertise and legal acumen. The first steps to asset recovery include:
As soon as the theft is discovered, act promptly to secure any remaining assets. Change all passwords, activate two-factor authentication, and ensure the physical safety of hardware wallets... Keep backup keys stored securely in different locations and regularly update wallet software to enhance security. If possible, transfer funds to a different wallet.
Reporting to Authorities
Report the incident to authorities with detailed transaction IDs, wallet addresses, and timestamps, among other related information. Engaging law enforcement and cybercrime units, especially when it is substantial theft, can initiate the legal process and potentially trace criminals. International cooperation, involving agencies like the FBI and firms like Chainalysis, can expand the scope of recovery efforts.
In complex cases or where substantial losses are involved, seek the assistance of professionals specialising in crypto asset recovery. They can offer expertise in advanced transaction layering techniques and legal nuances. The team at Englebert are rolling out services that help victims of fraud to recover their lost assets.
Role of Cryptocurrency Exchanges
Exchanges can assist in the recovery process by sharing transaction information and freezing suspicious accounts. Adherence to KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures by regulated exchanges facilitates the tracing of thieves' identities and clamps down on attempts to launder stolen assets. However, limitations arise with non-custodial wallets and international jurisdictional issues, along with wallets and transactions not associated with such exchanges.
In conclusion, the viability of cryptocurrency asset recovery is a complex topic. It’s becoming increasingly talked about due to the rising influence of crypto, and the rise in fraud that it has brought with it.
Despite the inherent challenges that crypto poses when it comes to asset recovery, it’s not a lost cause. Combining legal efforts with innovative technologies, it’s becoming increasingly possible to track down and identify lost assets. For more information on asset recovery, please speak to one of our experts.
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