For as long as cryptocurrencies have been around, lawyers have pondered over the existential question of what exactly they are.
That question may arise in a number of different contexts — e.g., in a public offering of cryptocurrencies, in the taxation of cryptocurrency transactions, or in the insolvency of a cryptocurrency exchange. That last example has recently been played out in the High Court’s decision in Ruscoe & Moore v Cryptopia Limited 2020 (in liquidation). This is a landmark decision, which considers the legal nature of cryptocurrencies for the first time in New Zealand.
From its founding in 2014, Cryptopia operated as a cryptocurrency trading exchange. The exchange was established by two enthusiasts seeking to provide a platform for themselves, and others, to trade cryptocurrencies. As cryptocurrencies gained popularity, the platform became self-promoting, having more than 900,000 users at its peak. Most users were based offshore.
All cryptocurrencies on the exchange were held in Cryptopia’s ‘hot wallets’ (which were connected to the internet) or ‘cold wallets’ (which were not).
Trading was brought to an abrupt halt in January 2019, when Cryptopia’s servers were hacked and an estimated $30 million worth of cryptocurrencies were stolen. The company was put into liquidation in May 2019, at which point Cryptopia held cryptocurrencies worth around $170 million — both for itself and for its customers.
The liquidators sought instructions from the Court as to the categorisation and distribution of Cryptopia’s cryptocurrency assets.
The legal issues
The two key issues before the Court were:
Is cryptocurrency “property” as defined in section 2 of the Companies Act 1993 and, as a related issue, can cryptocurrencies form the subject matter of a trust? (the Property Issue)
Was Cryptopia holding cryptocurrency on trust for account holders through the provision of its storage and exchange services? (the Trust Issue).
In essence, these issues pitted account-holding customers against general creditors, with the liquidators on the sideline as an interested bystander.
The Property Issue
The Court endorsed the “classic statement” of the definition of “property” in the 1965 House of Lords case National Provincial Bank Limited v Ainsworth. The Court was satisfied that cryptocurrencies meet all four of the requirements for “property” established by that case: identifiable subject matter, identifiable by third parties, capable of assumption by third parties, and some degree of permanence or stability.
In the course of reaching this conclusion, the Court dispensed with the “simplistic” argument that cryptocurrencies are mere information, primarily because “the whole purpose behind cryptocurrencies is to create an item of tradeable value not simply to record or to impart in confidence information or knowledge”.
The Trust Issue
Cryptopia was found to be holding each type of cryptocurrency stored by it on a separate express trust for the relevant account holders. The Court reached this conclusion based on the inherent nature of the relationship between Cryptopia and each account holder. Account records, customer information, and marketing all strongly implied that Cryptopia was acting as a “custodian” for account holders. The subject matter of each trust was easily identifiable by reference to Cryptopia’s structured query language (SQL) database, which recorded each account holder’s details, including their account balance.
The combined effect of the Court’s decision on these two issues is that the cryptocurrencies stored by Cryptopia are held for the sole benefit of the relevant account holders and, so, are excluded from the pool of assets available to general creditors.
Expect more ground-breaking case law to come from Cryptopia’s collapse.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed, or your usual Bell Gully advisor.