Bitcoin and cryptocurrencies have emerged in the wake of the coronavirus pandemic as assets held by institutional, corporate, high net worth, and retail investors alike.
While other articles have covered the tax, securities, or estate planning implications of buying bitcoin and other cryptocurrencies, we focus on the considerations of civil litigants and fiduciaries when it comes to these assets.
As Bitcoin and other cryptocurrencies gain further acceptance in the portfolios held by persons, corporations, trusts, and estates, fiduciaries and civil litigants must be aware of how courts will handle claims when the ownership or stewardship of these assets becomes disputed.
Despite the proliferation of Bitcoin among investors and in the news, case law regarding Bitcoin in civil litigation is sparse, and even more so in the context of estates and trusts.
Bitcoin is a digital currency that was created in January 2009. Unlike fiat currency, bitcoin is created, distributed, traded, and stored with the use of a decentralized ledger system, known as the blockchain. Physical bitcoins do not exist, rather balances are kept on a public ledger accessible to all. Bitcoins are not backed or issued by any government, central bank, or business entity. Bitcoin’s history has been turbulent thus far, with wide swings in price sometimes happening day-to-day or hour-to-hour.
Bitcoins are registered to Bitcoin addresses in the blockchain. Creating a Bitcoin address requires the creation of a random valid private key and the corresponding Bitcoin address. This computation can be done in a split second. Uncovering a user’s private key, however, is currently not feasible given present computing standards. Users can tell others or make public a Bitcoin address without compromising its corresponding private key. To be able to spend their bitcoins, the owner must know the corresponding private key and digitally sign the transaction. The network verifies the signature using the public key, and the private key is never revealed. If the private key is lost, the Bitcoin network will not recognize any other evidence of ownership; the coins are then unusable, and effectively lost.
Thus, Bitcoin users cannot reverse transactions that result from mistake or fraud, nor can they appeal to a trusted third party, such as a bank, to reverse such a transaction. Rather, received bitcoins are fully under the control of the person or entity that possesses the private key associated with the recipient’s Bitcoin address. The recipient is the only person who can return the funds.
All Bitcoin transactions are public, a consequence of its blockchain distributed ledger technology. Knowledge of a Bitcoin address reveals every incoming and outgoing Bitcoin transaction associated with the address. While superficially anonymous, in reality, the use of Bitcoin is more pseudonymous: once an address is linked to a person or entity, privacy evaporates. Moreover, the distributed ledger allows tracing of bitcoin back to its generation, by following the trail of Bitcoin addresses through which the bitcoin has traveled.
Cryptocurrencies, including Bitcoin, can be used to pay for goods and services, as well as for investing in some areas around the world, and users participate in the transactions directly without the involvement of a bank. While cryptocurrencies may be used legally in many countries, some countries restrict them, others make them completely illegal, and some even punish users with jail time. These countries include: China, Saudi Arabia, Egypt, Zambia (restricted); Mexico (illegal); and Bangladesh, Vietnam, Morocco, Algeria, Bolivia, Ecuador, and Nepal (punishable by jail).
Cryptocurrency exchanges allow users to buy or sell cryptocurrencies for conventional exchanges. Many exchanges operate like a third-party escrow service and charge a per-transaction fee, providing a convenient method to exchange digital and conventional currencies using online accounts. Moreover, many users store their cryptocurrencies with exchanges, which can serve similar functions to personal digital wallets. Often, exchanges store portions of their digital assets offline, using private keys stored away from the internet to mitigate the risk of cyber theft.
All of these aspects of Bitcoin and other cryptocurrencies make them unique assets that can be difficult to recover directly in litigation. Parties may improve their opportunity to recover cryptocurrency assets by using a combination of pre-complaint diligence, common sense, and leaning on limited case law of matters involving cryptocurrency in civil litigation.
Bitcoin and other cryptocurrencies can be transferred almost instantly. Avoiding giving a potential defendant notice of a complaint or investigation is of great importance, and useful background knowledge can be gathered before filing a complaint. For instance, if a client transferred Bitcoin to a potential defendant, the client should have some records that demonstrate the receiving party’s Bitcoin address or addresses. Clients should consider employing forensic cryptocurrency experts to trace a potential defendant’s Bitcoin addresses, transfers, and spending patterns. This could assist in mitigating against the destruction of records and transfers of assets and determining the identity of a defendant’s vendors, should notice of a judgment lien ever be required.
While Bitcoin is popularly understood as a “cryptocurrency,” Bitcoin itself is a unique asset that shares similarities to certain assets but is not easily categorized as being exactly similar to traditional asset types.
In order to understand how a court might treat Bitcoin in litigation, we must first understand how courts and regulators classify Bitcoin as an asset, bearing in mind that the civil litigation case law dealing with Bitcoin and other cryptocurrencies is currently in its infancy.
Initially, the U.S. Securities and Exchange Commission (SEC) indicated that Bitcoin is not a security. Courts followed the lead of the SEC and held that: “Bitcoin itself is a commodity, not a security.”
Other courts have classified Bitcoin as “a digital representation of value,” a tangible asset, or an intangible asset. For instance, the Western District of Pennsylvania indicated that “[v]irtual currency is a digital representation of value that can be traded and functions as a medium of exchange. Each unit of virtual currency has a ‘blockchain’ that serves as an electronic public ledger of all transactions in that currency.” Balestra v. Cloud With Me Ltd., 2020 WL 4370392, at *5 (W.D. Pa. July 2, 2020) (quoting Audet v. Fraser, 332 F.R.D. 53, 59 (D. Conn. 2019)).
In Ox Labs, Inc. v. Bitpay, Inc., 2020 WL 1039012, at *5-6 (C.D. Cal. Jan. 24, 2020), the court considered whether Bitcoin was tangible or intangible property. The dispute arose in the context of which statute of limitations should apply, with the defendant arguing that “Bitcoins should be considered intangible property because it is a digital currency without a tangible form,” while the plaintiff argued that Bitcoin should be considered at least quasi-tangible property. The court ruled for the plaintiff, indicating that “Bitcoin is not merely an ‘idea that is entirely divorced from any physical form. Rather, it is dependent on blockchain, a public ledger which records all the transactions.” The court also found support from Commodity Futures Trading Commission v. McDonnell, 287 F. Supp. 3d 213, 228 (E.D.N.Y. 2018), which found that Bitcoins are commodities that can be regulated by the Commodities Futures Trading Commission.
Regardless of how courts categorize Bitcoin, they do recognize that those who possess it, or who care for it, are subject to traditional theories of litigation and recovery. Such theories include conversion, unjust enrichment, replevin, fraud, breach of fiduciary duties, and requests for declaratory relief.
Bitcoin and other cryptocurrencies have been the subject of actions involving escrow deals gone bad, cryptocurrency exchange collapses, bankruptcies, and improper transfers, bitter divorces, law firm breakups, outright fraud, and esoteric fights about issues particular to the cryptocurrency industry. Where a defendant has moved out of the United States or has transferred cryptocurrency out of the country, courts are called to address complicated issues of jurisdiction and authority.
John R. Brumberg is a Partner at Pietragallo Gordon Alfano Bosick & Raspanti, LLP. He is a member of the Litigation Group. John has experience successfully representing a wide variety of clients, from publicly traded companies involved in complex litigation to individuals making large personal injury claims. He has also served as counsel to numerous individuals and small businesses.
Peter St. Tienne Wolff is a Partner in the Commercial Litigation and Fiduciary, Estates and Trusts Litigation Practice Groups of Pietragallo Gordon Alfano Bosick & Raspanti, LLP. His practice includes fiduciary litigation in the Orphan’s Court and matters involving commercial and personal contracts, business torts, trade secrets, injunctions, professional liability, premises liability, employment, defamation, and requests for information under the Pennsylvania Right to Know Law.
This article has been published in PLI Chronicle: Insights and Perspectives for the Legal Community, https://plus.pli.edu.