Cryptocurrency – is it “property” and why does it matter?

Background

The recent High Court of New Zealand decision of David Ian Ruscoe And Malcolm Russell Moore v Cryptopia Limited (in liquidation) [2020] NZHC 728 (8 April 2020) considered the very much unchartered waters of the legal standing of cryptocurrencies as “property”.

The decision is an interesting one because it is an example of the courts adapting existing legal concepts to new technologies - in this case cryptocurrency. Many would think that cryptocurrencies would of course be property, but the judgment noted that it appeared to be the first occasion on which this issue had been before the courts in New Zealand. Given the novelty of the issue, the court also considered decisions from other courts in England and Singapore. The decision is also noteworthy because it demonstrates practical difficulties which members of the business community may have with new technologies - here it was insolvency practitioners, and how they should deal with cryptocurrencies where there were competing claims to it. 

Cryptopia Ltd (Cryptopia) operated a cryptocurrency exchange, allowing users to conduct online trading of a vast range of cryptocurrencies. Cryptopia generated income by charging fees for deposits, trades and withdrawals. Customers of Cryptopia were able to trade about 900 cryptocurrencies, more than any other exchange in the world at the time.

From its establishment to early 2017, Cryptopia operated as a global business with approximately 30,000 users. After the price of Bitcoin more than trebled in around November 2017, Cryptopia’s user-base increased to more than 900,000. However, in January 2019, a serious hack of Cryptopia’s servers caused between 9-14% of Cryptopia’s cryptocurrency holdings (valued at about NZD$30 million) to be stolen. Following the hack, Cryptopia was placed into liquidation while maintaining 960,143 account holders with a positive coin balance, 104,186 of which had a ‘deemed nil value’ as a result of the hack. 

At the time of liquidation, the liquidators estimated Cryptopia’s holdings of cryptocurrency to be worth approximately NZD$170 million.

In light of the novel legal issues involved and competing claims to cryptocurrency made by creditors and account holders, the liquidators applied to the court for the determination of: 

1. the legal status of the various cryptocurrencies held by Cryptopia. Specifically, the liquidators sought to determine whether those cryptocurrencies fell within the definition of property as defined by section 2 of the Companies Act 1993; and
2. if they were property, whether those digital assets were held on trust by the company for the account holders, and what the nature of such a trust was.

The liquidators needed guidance on those legal issues in order to assess what assets were the subject of the liquidation, and how those assets should be distributed in the liquidation. The liquidators’ position was further complicated because there were competing claims to Cryptopia’s assets by its creditors and accountholders.

Is cryptocurrency legal property?

Ruscoe was particularly concerned with the meaning of property as defined by section 2 of the New Zealand Companies Act 1993, namely that: ‘property means property of every kind whether tangible or intangible, real or personal, corporeal or incorporeal, and includes rights, interests, and claims of every kind in relation to property however they arise.’

Whether or not cryptocurrency is property is an important issue for legal purposes. If cryptocurrencies are property, then usual concepts of property law would apply to them – i.e. for the recovery of coins when they are stolen or fraudulently transferred, for use as a security, as an asset in a deceased estate and whether it can form the subject of a trust. All these are legal concepts which would flow from cryptocurrency being property.

His Honour noted an extract from the UK Jurisdiction Taskforce’s Legal Statement on Cryptoassets and Smart Contracts:

Why does it matter if a cryptocurrency asset is capable of being property. It matters because in principle proprietary rights are recognised against the whole world, whereas other – personal – rights are recognised only against someone who has assumed a relevant legal duty. Proprietary rights are of particular importance in an insolvency, where they generally have priority over claims by creditors, and when someone seeks to recover something that has been lost, stolen, or unlawfully taken.They are also relevant to the questions of whether there can be a security interest in a crypto asset and whether a crypto asset can be held on trust.

Given their nature, cryptoassets do not fit squarely within established categories of property.

For those reasons, Justice Gendall was required to consider the issue having regard to the characteristics of legal property, as provided for in the landmark English decision in National Provincial Bank Ltd v Ainsworth. In particular, Justice Gendall noted that: ‘before a right or an interest can be admitted into the category of property … it must be definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability.’ 

His Honour considered cryptocurrency in the context of the four requirements for property set out by Lord Wilberforce in National Provincial Bank Ltd v Ainsworth. In doing so, Gendall J states from the outset that he is satisfied cryptocurrencies meet the definition of property in this case, and that his decision accords with the approach adopted in the UK Jurisdiction Taskforce’s Legal Statement on Cryptoassets and Smart Contracts. His Honour reached these conclusions on the four Ainsworth requirements:

1. identifiable subject matter was satisfied because computer-readable strings of characters recorded on networks of computers, established for the purpose of recording those strings, are sufficiently distinct to be capable of being uniquely allocated to an accountholder. Here, the unique public key means that data allocated to one public key will not be confused with another;
2. identifiable by third parties was satisfied by the existence of the private key. This aspect turned on the requirement at law that the owner of property must be capable of excluding others from using it. The combination of the private key, which is allocated to the account holder only, and the requirement that a transactor have both keys in order to make a transaction with a particular cryptocurrency is what gives the cryptocurrencies this necessary degree of control; 
3. capable of assumption by third parties was satisfied on the basis that cryptocurrencies can be, and many are, the subject of active trading markets; and
4. some degree of permanence or stability was satisfied by the blockchain methodology because the entire life history of cryptocurrency is available in the public recordkeeping of the blockchain. Similarly, His Honour noted that one cryptoasset stays in existence and stable unless and until it is spent, and the fact that standard cryptocurrency systems do not provide for the arbitrary cancellation of coins further supports the notion of permanence or stability.

His Honour then went on to consider three recent New Zealand cases which considered various kinds of digital information as property. His Honour referred to:

• Dixon v R [2016] 1 NZLR 678: in which it was held that a digital copy of CCTV footage constituted property within the Crimes Act 1961;
• Henderson v Walker [2019] NZHC 2184: where Thomas J extended the tort of conversion to purely personal digital information, including the content of private emails; and
• Commissioner of Police v Rowland [2019] NZHC 3314: where the court relied on an assumption that Bitcoin and Ethereum (two kinds of cryptocurrency) fell within the definition of property contained in section 5 of the Criminal Proceeds (Recovery) Act 2009.

His Honour noted that in the Dixon and Henderson decisions the courts accepted that the “orthodox” position that digital information is not property does not apply to cases involving digital assets. In those decisions, digital files were seen as property by distinguishing them from pure information. His Honour concluded that the principles in Dixon and Henderson applied to cryptocurrencies in the current case.

Decision

Simply, the outcome of the court’s decision was that yes, cryptocurrency is property within the meaning of section 2 of the Companies Act. His Honour also indicated that cryptocurrency was probably property in the common law sense, although was not required to decide that issue. His Honour concluded that cryptocurrencies constitute intangible, personal property and are clearly an identifiable thing of value.

Were the cryptocurrencies held on trust?

After deciding that the cryptocurrencies were property, His Honour then had to consider whether Cryptopia owned the cryptocurrency, or whether it held the cryptocurrency on trust for accountholders. 

His Honour concluded that, in the course of Cryptopia’s operations, a series of express trusts in favour of account holders arose in respect of their digital assets.
 
In particular, he found that Cryptopia was a trustee of a “pool” of each of the 900 cryptocurrencies which were held on the exchange – i.e. there was a separate trust created for each type of cryptocurrency. The beneficiaries of each of those trusts were the customers who had cryptocurrency stored on the exchange. In reaching that conclusion His Honour paid particular attention as to how the exchange was operated and the terms and conditions of the exchange itself. 

The effect of the decision was that the liquidators held the cryptocurrency on trust for Cryptopia’s customers, rather than them being assets of the company which would then be available for distribution to the creditors. 

Takeaway points

The important takeaways from this decision are:

1. For the purposes of the New Zealand Companies Act 1993, cryptocurrencies are property. Although it was not necessary to decide the point, His Honour also indicated that, in his view, cryptocurrencies are likely to be considered property under the general law.
2. For those involved in cryptocurrency trading, including those who operate exchanges, the decision illustrates:

• how a trust can arise in respect of cryptocurrency which is held on an exchange;
• the importance of the exchange’s terms and conditions; and 
• the obligations which the exchange platform may have in respect of its customers.

3. For insolvency practitioners, the case provides an example as to: 

• how a court will consider who “owns” cryptocurrency and how it may be dealt with during the course of a liquidation; 
• competing claims which may be made to cryptocurrency; and
• how an insolvency practitioner can take steps to resolve competing claims to novel assets such as cryptocurrency.

We are not aware of any Australian decision where the issue of cryptocurrency as property has been considered by a court, however the decision reached a similar outcome to a recent English decision of AA v Persons Unknown & Ors, Re Bitcoin [2019] EWHC 3556 (Comm). The reasoning in this decision is likely to be of assistance to Australian courts when the issue arises here.

Should you have any questions in relation to the status of cryptocurrency as property or the impact of the decision in respect of digital exchanges and/or insolvency, please do not hesitate to contact our Digital Assets team.