*This article may require a fundamental understanding of cryptocurrencies and decentralised ledger technologies.

It has been almost 13 years since the creation of Bitcoin, the original cryptocurrency. Yet, cryptocurrencies[1] are only just being taken up by mainstream businesses. In 2021, companies such as Tesla, Mastercard, and PayPal finally adopted cryptocurrencies,[2] while banks such as Morgan Stanley and Goldman Sachs are offering cryptocurrency investments to their clients.[3] Bitcoin has even attained the status of legal tender in El Salvador.[4] It is likely that other businesses in Singapore will follow suit in due course.

However, with greater adoption comes greater scrutiny. Difficult novel issues emerge once we look deeper into how cryptocurrencies and decentralised ledger technologies (“DLTs”) will interact with or even replace the traditional financial and record-keeping systems which the world is accustomed to. This article seeks to briefly explore the issues that Singapore is likely to face as a result of the rise of cryptocurrencies, particularly in the areas of fraud and insolvency.

The characteristics of cryptocurrencies in brief

There are various characteristics of cryptocurrencies and DLTs that make them prime candidates for the revolution and innovation of many aspects of our lives. Some notable characteristics are:

  1. Decentralisation: The ledger technologies used by cryptocurrencies are decentralised in nature. This means that control of the cryptocurrency network in question is not in the hands of a single entity but distributed across numerous stakeholders across the network.  This generally works by each member of the network maintaining a copy of the ledger. For a change in the ledger to be made, consensus on the proposed change has to be reached by at least the majority of the participants in the network. decentralised ledger in question to work without the need for trust between participants of the network (as compared to traditional systems like banks, which require bank customers to trust the bank), and can potentially increase efficiency and lower transaction costs. Some cryptocurrencies have a greater degree of decentralisation than others. The more distributed the control over the cryptocurrency network is, the higher the degree of decentralisation.
  2. Immutability: Decentralised ledgers are immutable – once a change or record is made in the ledger, it cannot be altered unless at least the majority of the participants in the network agrees to make the change. Decentralised ledgers are designed to make it very difficult or costly for a single entity or a group of persons to amass majority control in order to effect changes (also known as 51% attacks). This ensures the integrity of decentralised ledgers.
  3. Anonymity: Cryptocurrencies are pseudonymous. While participants in the network are unidentified, transactions are executed using public addresses. It is not possible to identify individuals from the addresses, but cryptocurrency exchanges and other businesses providing crypto services are increasingly required to have in place know-your-customer (“KYC”) and anti-money laundering (“AML”) protocols, which invariably require their users to provide authentication of their identities. Coupled with the fact that everything on the decentralised ledgers is open to be examined by anyone, it may not be impossible for identities of users to be uncovered.

Unfortunately, the features of cryptocurrencies and DLTs that make them such promising and exciting technologies for the future are the same ones which enable creative side-stepping of the traditional systems which detect and prevent fraud.

Cryptocurrencies as a medium for fraud

Given the decentralised, (pseudo-)anonymous, and immutable characteristics of cryptocurrencies and DLTs, the capacity of cryptocurrencies to be used for fraud is indubitably an area of concern.[5] Some possible scenarios which exploit the unique characteristics of cryptocurrencies are:

  1. Fraudsters may trick victims into transferring cryptocurrencies to their accounts. Transfers of cryptocurrencies may take place on a peer-to-peer basis, without intermediaries like exchanges or banks. The absence of intermediaries, which in traditional systems are likely to have various checks in place to detect fraud, makes the transfers much easier to execute. Transfers may also be immediate. Depending on the degree of anonymity of the transfer method, the victim and investigators may not be able to trace the final destination of or the persons associated with the transfer. The transaction also cannot be reversed, given the immutability of decentralised ledgers.
  2. Wrongdoers may take advantage of the anonymous nature of cryptocurrencies for their dealings. While most cryptocurrencies offer pseudo-anonymity, some such as Monero seek to shield transaction details from easy discovery. To circumvent KYC and AML policies that are quickly becoming the norm on cryptocurrency exchanges, cryptocurrency transfers may take place (a) “off-exchange”[6], or (b) “off-chain”.[7]
  3. Cryptocurrencies may be used for money-laundering. Monies of questionable origin may be converted to cryptocurrencies and then put through a series of operations, such as transfers across multiple accounts or converted into different crypto-assets, to eliminate the possibility of tracing. New crypto-asset classes which are less liquid and have subjective values such as non-fungible tokens (commonly referred to as “NFTs”) are particularly susceptible.

Further adding to the attraction of cryptocurrencies as a medium for fraud is the fact that the ledgers used are decentralised and exist wholly on the Internet. This means that criminal proceeds may be easily transferred out of jurisdiction and out of reach. It is for this reason that legal proceedings involving cryptocurrencies will likely always attract cross-border considerations.

The Singapore High Court in The Micro Tellers Network Ltd and others v Cheng Yi Han and others [2020] SGHC 130 recognised that cryptocurrencies are assets which can be “easily disposed of”. In that case, the plaintiffs sued the defendants for alleged fraudulent misrepresentations that caused the plaintiffs to transfer fiat money and cryptocurrencies to the defendants. The plaintiff successfully obtained a Mareva injunction to prevent the defendants from disposing of these assets.

The regulations currently being put in place by governments primarily seek to combat terrorism financing and money laundering and usually manifest as requirements for businesses in the crypto-sphere to be licensed (which usually require the businesses to comply with KYC and AML protocols). While the imposition of KYC requirements may help  identify fraudsters and trace the whereabouts of the victims’ assets, as mentioned above, KYC requirements may be easily circumvented using “off-exchange” or “off-chain” transactions, or with laundering methods.[8]

For persons who have fallen victim to fraud involving cryptocurrencies, there may be little recourse given the difficulties in tracing and retrieving cryptocurrencies.[9] In Singapore, one of the first contested legal matters involving cryptocurrencies is Quoine Pte Ltd v B2C2 Ltd [2020] 2 SLR 20 (“Quoine v B2C2”). In this case, an oversight in the trading algorithm of the cryptocurrency exchange, Quoine Pte Ltd (“Quoine”), resulted in a trader, B2C2 Ltd (“B2C2”), obtaining a windfall from Bitcoin-Ether trades executed at rates which were approximately 250 times more favourable to B2C2. Upon realising the mistake, Quoine reversed the transactions, and B2C2 sued. While the lawsuit was eventually decided based on contract law and equity, it should be noted that Quoine was able to reverse the transactions unilaterally because the cryptocurrencies in question remained in Quoine’s custody on its trading platform. This was a function of Quoine being a centralised cryptocurrency exchange with the power to manage the accounts of its customers unilaterally. If the mistaken trades were instead executed on decentralised cryptocurrency exchanges (which have been gaining momentum in 2021 due to the rise of decentralised finance or DeFi), it would not have been possible for them to be reversed because of the immutability of decentralised ledgers.

A similar case was reported in Vancouver, Canada. In Copytrack Pte Ltd. v Wall 2018 BCSC 1709 (“Copytrack v Wall”), Copytrack Pte Ltd (“Copytrack”), a Singapore company in the business of blockchain-based business content management and automated copyright enforcement, mistakenly transferred 530 Ether – instead of 530 of the much less valuable CPY token – to the defendant, Mr Wall. Upon Copytrack’s request for the Ether to be returned, Mr Wall claimed that the Ether were no longer under his control because his account was hacked and the Ether were transferred to other accounts. Copytrack then commenced legal action to recover the Ether from Mr Wall by alleging, among other things, conversion and wrongful detention. While the Court noted that “the proper characterization of cryptocurrency, including the Ether Tokens, is a central issue in this case, and one that informs the analysis of whether Copytrack’s claims in conversion and detinue can succeed”, a conclusion on the question could not be arrived at because of the lack of evidence put before the Court and the fact that it was a summary judgment application. Nonetheless, in part because Mr Wall passed away while legal proceedings were still ongoing, the Court found that the matter could not proceed to trial and decided that it was undisputed that the Ether were the property of Copytrack and therefore should be returned to Copytrack. The Court thus granted the order for Copytrack to be allowed to trace and recover the Ether from “whatsoever hands those Ether Tokens may currently be held.

Whether the order granted in Copytrack v Wall will ultimately bring relief to Copytrack most likely depends on whether Copytrack is able to identify the persons behind the accounts holding the Ether in question. Given the difficulties already discussed, the decision may well be a Pyrrhic victory for Copytrack.

Despite the difficulties, it may not be advisable (and may not even be possible) to ignore or avoid cryptocurrencies. Instead, individuals and businesses should seek to familiarise themselves with cryptocurrencies and DLTs, and be educated and properly advised on the potential pitfalls when interacting with them.

Cryptocurrencies in the world of insolvency

The unique characteristics of cryptocurrencies and DLTs also make their interaction with traditional financial and legal systems akin to trying to fit a round peg into a square hole. Much of this derives from the still-undetermined question: what are cryptocurrencies? Should they be treated as money, securities, commodities, or some other type of asset? This affects how cryptocurrencies should be managed in the context of insolvency.

One of the very first issues that may arise in insolvency is whether cryptocurrencies qualify as assets which ought to be disclosed by a debtor. This has to be answered in the affirmative in the case of Bitcoin in El Salvador, where Bitcoin is recognised as legal tender. It is not so clear for other cryptocurrencies and in other jurisdictions. It is further complicated by the fact that cryptocurrencies often have functions built into their programming – for instance, they may be used as stores of value, security tokens (similar to stocks), and utility tokens (where the function of the tokens depends on what the network is designed to do). Cryptocurrencies is therefore an umbrella term used to describe numerous tokens, where the only commonality may be that they employ cryptography and DLTs.

Governments are therefore often caught in a bind when enforcing existing regulations on cryptocurrencies. The lawsuit by the US Securities and Exchange Commission (the “SEC”) against Ripple Labs Inc. (“Ripple”) in relation to an alleged unregistered digital asset securities offering comes to mind. In late 2020, the SEC charged Ripple for raising funds through the unregistered sale of digital assets known identified as XRP.[10] The SEC’s case depends on establishing XRP as a security. In the course of its defence, Ripple sought interrogatories from the SEC as to whether the SEC classified Ether as a security.[11] This is relevant to the fair notice defence that Ripple is relying on, which is essentially that Ripple was under the impression that Bitcoin, Ether, and XRP would be similarly classified by the SEC, and since the former SEC director had publicly stated that Bitcoin and Ether were both not securities, XRP should not be liable for breaching any securities law because the SEC did not provide fair notice.

Singapore has yet to come to a firm landing on how cryptocurrencies ought to be classified. This question was raised in Quoine v B2C2 in the context of whether Quoine could be said to be holding the Bitcoin in question on trust for B2C2. In its analysis, the Singapore Court of Appeal noted that “[t]here may be much to commend the view that cryptocurrencies should be capable of assimilation into the general concepts of property. There are, however, difficult questions as to the type of property that is involved.” The Singapore Court of Appeal eventually did not arrive at a firm conclusion because it found that there was no certainty of intention to create a trust.

How governments will classify cryptocurrencies continues to evolve, but it appears that it may not be possible to arrive at a one-size-fits-all solution given the vast variety of cryptocurrencies in existence. That said, creditors would almost definitely demand that debtors disclose their cryptocurrency holdings in the event of insolvency, given that all cryptocurrencies have a certain market value. The complication lies in how such disclosure may be compelled. Indeed, the pseudonymity of cryptocurrency transactions make it difficult for creditors to link debtors to their cryptocurrency holdings.

Even if debtors disclose their cryptocurrency holdings, enforcement would be an issue. Ownership and control of cryptocurrencies is defined by two things: the public key and the private key. The public key is like an account number, which anyone can use to transfer cryptocurrencies to. In contrast, the private key is held only by the owner of the cryptocurrencies associated with that public key, and is required for access and control. Therefore, in an insolvency situation, the receiver or trustee in insolvency (the “Insolvency Professional”) will have to obtain the private key before it can be said that the cryptocurrencies have been properly taken in.

Another issue is that of antecedent transactions – in many jurisdictions, undervalue transactions or transactions involving unfair preference can generally be clawed back. It remains to be seen if such doctrines can be extended to apply to transactions involving cryptocurrencies.

In Singapore, sections 224, 225, 361, and 362 of the Insolvency, Restructuring and Dissolution Act 2018 (the “Clawback Provisions”) govern antecedent transactions. A transaction entered into by an insolvent person could be challenged by the Insolvency Professional on the basis that it was:

  1. a transaction at undervalue (i.e. the transaction was for a consideration of significantly less value to the insolvent person); or
  2. an unfair preference (i.e. the transaction was one that put one or more of the insolvent person’s unsecured creditors in a better position than the other unsecured creditors).

Cryptocurrencies may well be subject to the broad wording of the Clawback Provisions. That said, this has not been determined by the Singapore Courts. Even if the Clawback Provisions apply to cryptocurrencies, it remains to be seen how they can be effectively enforced given the difficulties in tracing cryptocurrencies. If an insolvent person owns cryptocurrencies, it may be possible for the cryptocurrencies to be disposed of without the Insolvency Professional finding out. An insolvent person may also convert his traditional assets into cryptocurrencies and then dispose of the cryptocurrencies. Even if the Insolvency Professional becomes aware of the disposal of assets, it may be difficult for the disposed assets to be traced and recovered.

Conclusion

With the myriad of voices extolling the merits of cryptocurrencies and DLTs, it may be inevitable that they will play a significant role in how the world functions in the future. The difficulties presented go beyond the topics covered above, and will likely arise in areas such as contract law, property law, private international law, personal data and privacy law, and company law. While Singapore has already begun tackling these issues, more will likely need to be done given the inevitable rise of cryptocurrencies. It is therefore important for individuals and businesses to be aware of the potential issues that may be encountered, so that appropriate and timely advice may be obtained.

The article first appeared in INSOL's Small Practice Group Newsletter on 15 November 2021.