Lack of regulation is driving crypto crime, says legal expert

Chris Middleton Profile picture for user cmiddleton February 22, 2023
A lawyer explains how the dispersed nature of cryptocurrencies becomes a nightmare for victims when things go wrong.

An image of some bitcoins over an image of the earth
(Image by Tamim Tarin from Pixabay )

For their proponents, digital tokens such as cryptocurrencies represent a fairer, ‘people’s alternative’ to the old financial world in which power continues to rest with the dollar, national banks, and ancient, self-interested institutions. 

A compelling argument in tough times. But of course, not everything is rosy in the crypto garden either. Yet despite 2022’s crypto crash and the ‘winter’ that followed with the FTX fraud and other setbacks, many speculators still see the potential to get rich without the need for old money, gold, or share ownership.

But the volatility of many crypto valuations – in which crashes and booms can happen at internet speed – plus the preponderance of Ponzi schemes, money-laundering, and other financial crimes reveal the flipside of the digital coin. A realm where the old boys’ club has simply been replaced with a tech bros’ network, replicating many problems of traditional finance with added layers of anonymity and technobabble.

This dark side is increasingly problematic for lawyers, who find themselves creeping forward in an opaque world, seeking clarity where financial schemes often seem underwritten by hope and promises rather than verifiable assets. And this is despite the blockchain supposedly being an auditor’s dream; the reality is rather different.

The ability to trace, seize, or retrieve digital assets is a growing challenge in legal disputes, as the trail may lead across continents and into countless different jurisdictions, according to Neil Williams, Deputy Head of Complex Crime at law firm Reeds Solicitors. Put simply, in a decentralized world, who can one sue when a customer is ripped off? 

But while most of the media’s focus is on criminal activities in the crypto world, Williams says that much legal work at present is in civil cases, where individuals frequently just want their money back or to trace where their digital holdings – such as a hacked wallet – have gone.

So why is lawyers’ casework soaring? After all, weren’t cryptocurrencies and other tokens supposed to solve the inequities of old financial models? The answer is simple, he says:

Because of the lack of regulation! And, the lack of legislation regarding digital assets and how they should be treated in law. Though regulation is on the horizon in some cases, it isn't here yet. So how we should deal with digital assets is essentially what courts have been left to decide.

In other words, although regulation is anathema to crypto purists, its absence is driving and enabling financial crime, leaving people unprotected when things go wrong.

Meanwhile, some questions that are coming before the courts – case by case and precedent by precedent – seem remarkably basic, and yet may have profound implications. And this reveals just how vague the new financial world really is, says Williams:

Are they assets, for a start? Are they tangible or non-tangible? These questions are emerging as cases progress through the courts. And jurisdictional issues come to the fore, such as whether or not civil remedies or orders can even be applied to digital currencies. 

It's an evolutionary process, which is what common law is, essentially. But it reveals how in many ways legislation is behind how the courts are treating these things. There is no legislation at the forefront, which ordinarily, you would see in other areas of law. 

But we are slowly building towards giving people confidence that when they go to court, when they make an application, there are remedies available in the complete absence of regulation.

The challenge of jurisdiction 

Can Williams give an example of the types of problems he deals with? He says:

Yes. Without specifically referring to the case, but after an initial coin offering [ICO] had been put forward, the court granted permission for what's known as a Bankers Trust Order to be applied outside the jurisdiction against the cryptocurrency exchanges. 

What this essentially means is that you can get information about the KYC [Know Your Customer] details of the account, which the exchange holds: details about the person or entity that are in charge of the wallet. And that gives you an opening for further tracing of assets later on. 

Things like that are important because without the determination of those cases, you simply don't know how remedies would be applied. The next case will use that as a precedent, and so on. 

It's a snowball effect through the system, because if you know that you can get a civil order applied internationally, then that helps when you're budgeting, when you're looking at the pros and cons of doing an asset trace yourself in the absence of the authorities – whether it's viable and cost-effective to do that.

Williams reveals just how international these problems can be:

There's a client, who's an Irish national domiciled in the Middle East. He was in London when he realized that his wallets had been hacked. So, there are already jurisdictional issues in play.

While he was in London, he reached out to us, and we instructed investigators on his behalf. We made a complaint to the UK authorities, who then reached out to America because the exchanges were said to be based there. 

We then instructed American lawyers to make an application in the US courts for the exchanges’ details, which were then provided. And then a line was drawn to Germany, so we had to go over to Germany, and so on and on…

So, jurisdiction. It's very difficult to find out where things are actually happening [in the crypto world]. It just flows around the world. So, having some certainty that if you're making an application, there is a nexus for the UK courts to get involved.

But he adds:

In our case, although the complaint was made in the UK, and UK authorities did investigate, there was actually nothing the UK courts could do [to retrieve his crypto holdings] because it’s a US exchange and the person turned out to be in Germany.

In other words, while crypto promises a utopian dream of the seamless flow of wealth around the world, that becomes a huge problem when your wealth is flowing against your will. How do you stop it, and from what jurisdiction can you launch a legal claim?

According to Williams, this vagueness is something that crypto exchanges are actively pursuing. He adds:

It’s the lack of regulation of the exchanges that causes these issues. One major exchange is currently disputing that they are jurisdictionally tied to a specific location because of the nature of the assets. An interesting argument!

Indeed. But does this suggest that operators will keep moving ahead of regulations and legislation to jurisdictions that are less likely to ask difficult questions? Williams says: 

Yes, but it would be ever-decreasing circles. Ultimately, if they want to operate in the US market, for example, then the US will say, ‘If you want to do business here, you'll do what we say.’

As a UK-based lawyer, however, Williams laments the lack of clarity coming from the British government. He argues:

Crypto needs regulation before it can be accepted as mainstream currency, but HMRC guidelines are wishy washy for taxable purposes. It’s wishy-washy guidance from them because they don't have a legislative marker or flag to tie their advice to.

I think cryptocurrencies are here to stay. The authorities are slowly realizing that, but are not taking the lead, so there's a real risk of the market spiralling out of control. 

Now, I suppose one attraction is that the market is uncontrolled, it's often decentralized, and people want anonymity. But ultimately, you have to get real. If you want to invest in these areas – as a serious investment – then you need a lynchpin of regulation.

The frustration we see from clients at present is that there is no effective state assistance when dealing with digital assets that have been lost, or problems that have arisen. And all people are looking for is some element of certainty. 

We’re no longer just talking about the early adopters of digital coins, but rising numbers of people who need protection – people who’ve lost thousands of dollars in a scam, but don’t want to pursue it because, at the moment, it’s just not worth it.

My take

At present, financial crimes, frauds, and civil cases tend to work in favour of the wrongdoers. It’s like the proverbial falling tree in the forest. If you can’t pinpoint where, jurisdictionally, the offence took place or can be pursued, can it be said to have happened at all?

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