D'Aloia – High Noon for Crypto-Tracing

Summary

The High Court judgment in D'Aloia v. Persons Unknown and others [2024] EWHC 2342 (Ch) is arguably the most significant crypto judgment of 2024. Critical deficiencies in the claimant's blockchain tracing analysis, evidence presented at trial and pleadings were ultimately fatal to his claims seeking to recover assets misappropriated by fraudsters. In addition to serving as a cautionary tale for professionals working in crypto recovery, it also sets out in unprecedented detail the methodologies applicable to crypto tracing.

A previous judgment in the proceedings¹ was the first reported case in which the service of legal proceedings via NFT was approved. RPC's earlier article on that judgment can be read here.

Background

The claimant was scammed into transferring approximately £2.5 million worth of Tether (USDT) to an online platform called td-finan, which he mistakenly believed was associated with the reputable brokerage TD Ameritrade. In reality, td-finan was a fraudulent website operated by anonymous individuals, and the claimant’s funds were subsequently moved through a complex network of blockchain wallets, intermingled with other funds, and ultimately cashed out as fiat currency.

The claimant pursued constructive trust and unjust enrichment claims against the unknown fraudsters and various cryptocurrency exchanges and platforms, to which it was alleged the misappropriated funds could be traced. One of the exchanges involved was the Thai-based exchange Bitkub, which was the focus of the trial, as by that time some of the claims against other exchanges/platforms had been resolved or were the subject of an extant summary judgment application.

Notably, the claimant’s case against the crypto exchange OKX had been struck out prior to trial after the claimant’s blockchain analysis expert abandoned their original position. The expert ultimately agreed with OKX’s analysis that the wallet that they had identified as having received the claimant's USDT had in fact not done so. Although the expert presented an alternative tracing analysis, this would have required OKX to completely redo its evidence.² The same blockchain tracing expert also provided evidence in the Bitkub trial.

The claims

Constructive trust

The claimant argued that since the unknown fraudsters could not have acquired beneficial title to the stolen USDT, Bitkub, as the alleged recipient of the funds, held them on constructive trust for its benefit.

On the key issue of whether a constructive trust could be established against Bitkub, the judge determined that, while such a trust could exist in principle, it did not apply on the facts of the case. The judge found that such a trust could arise against the fraudsters when property was transferred under a contract used as an instrument of fraud, as was found to be the case between the claimant and td-finan.³

A similar constructive trust claim had been pursued in the earlier case of Piroozzadeh v Persons Unknown and Others [2023] EWHC 1024 (Ch).⁴ In that case, the claimant initially obtained an interim proprietary injunction over their stolen assets that had been traced to Binance. However, the injunction was discharged due to the claimant’s failure to disclose a potential defence available to Binance, namely that Binance was a bona fide purchaser of the USDT.

The bona fide purchaser defence arose from the way cryptoassets are deposited at Binance. Once deposited, cryptoassets are "swept" into one or more unsegregated wallet addresses (often referred to as omnibus wallets), where they are pooled with deposits from other users and treated as part of Binance’s general assets. The user's Binance account (which is independent of any blockchain wallet address) would be credited with the equivalent amount of the deposited cryptoasset, allowing the user to draw against the balance, akin to a conventional banking arrangement.

Binance argued that, through this mechanism, a cryptoasset deposited at Binance is effectively purchased by Binance in exchange for an account credit. In such cases, where Binance had no knowledge of any fraud, any proprietary rights the beneficiary might have had in the "swept" cryptoasset would not survive.

Similarly, Bitkub also employed an omnibus wallet system. However, it was unable to rely on the bona fide purchaser defence (or any other equitable defences⁵) because it was found to have acted in a commercially unacceptable manner: Bitkub was found to have permitted the relevant transactions to proceed despite being aware of the money laundering risks they posed. This level of awareness constituted actual notice of the fraud.

Nevertheless, the claimant’s constructive trust claim ultimately failed for two decisive reasons. First, the claimant's tracing analysis was insufficient to prove that Bitkub had received the claimant's funds, which is discussed further below. Second, the funds the claimant said could be traced to Bitkub had already been transferred away, leaving no asset at the exchange over which a constructive trust based on a proprietary claim could be made. This second matter might not have been fatal had the claimant pleaded a knowing receipt claim,⁶ but no such claim was pleaded.

Unjust enrichment

The claimant also advanced a claim in unjust enrichment. The requirements for such a claim are as follows.⁷

1. Has the defendant been benefited, in the sense of being enriched?
2. Was the enrichment at the expense of the claimant?
3. Was the retention of the enrichment unjust?
4. Are there any defences?

Of the requirements above, the claimant ultimately failed on the second one, as the inadequacy of their tracing analysis prevented them from establishing that Bitkub had been enriched at the claimant's expense. Even if this analysis had not been defective, the claim would still have failed due to the limitations of the tracing framework available under common law, the regime governing unjust enrichment claims..

Tracing principles

Before addressing the deficiencies in the claimant's tracing analysis, it is important first to examine the underlying tracing methods available in such claims.

The starting point is to distinguish between the concepts of "following" and "tracing." While both processes involve tracking assets that may represent property belonging to the claimant, they are distinct in legal terms. An overview of each is provided in the table below.

Adding to the complexity, the term "tracing" is often used as a general term to encompass both "following" and "tracing," as has been the case throughout this article.

A claimant may choose one methodology or the other, provided it is applicable. For example, equitable tracing cannot be used to support a common law claim.

Following

Following faces significant limitations when an asset is mixed with other identical assets. "Things in action"⁸ (such as a bank account balance) cannot be followed through such mixtures because, once mixed, the asset ceases to be identifiable. In contrast, a "thing in possession"⁹ can, in principle, be followed as long as it remains identifiable.

Consequently, the judge had to consider the nature of the underlying USDT. The judge's key findings were that:

• USDT was neither a chose in action nor a chose in possession, but a distinct form of property not based on any underlying legal right; and
• based on the limited evidence before the court, USDT remained identifiable when mixed, due to internal ledger records maintained by Tether Limited.

However, despite the judge’s finding that USDT could, in principle, be followed, even when commingled with other USDT, the claimant had not introduced the Tether Limited ledger records into evidence which would have been necessary to underpin the analysis. As a result, the claimant could not rely on this method.

Tracing

Tracing can be conducted under either common law or equitable principles, depending on the legal framework in which the claim is brought. In this case, common law tracing was of no use because it cannot trace through mixed funds.¹⁰ As a result, the claimant could only rely on equitable tracing, which does allow tracing through mixed funds. Consequently, only the claimant's constructive trust claim (based in equity) remained viable, while the unjust enrichment claim (based in common law) could not proceed.

Tracing through mixed funds

When tracing through mixed funds, several tracing methodologies can be employed. A key factor in determining the appropriate approach is whether the mixture consists solely of funds from innocent victims or also includes the fraudster's own funds. In this case, the tracing analysis was based on the assumption that all the funds involved were derived from victims.

The available methodologies in such circumstances were outlined in Charity Commission for England and Wales v Framjee [2014] EWHC 2507 (Ch), including:

• FIFO (First In, First Out): Originating from Clayton’s Case,¹¹ this method assumes that the first funds deposited are the first to be withdrawn;

   

• pro rata, where funds are distributed among victims in proportion to the amounts owed to them; and

   

• rolling charge, where each payment from a mixed fund is analysed to ensure that no contributor receives more than their proportionate share of the lowest intermediate balance while their funds were still in the account.

The judge noted that while each of these approaches was arbitrary, they were equally arbitrary to all parties and would not favour one party over another. The judge also noted that other methodologies besides those outlined above could be permissible, citing Federal Republic of Brazil v Durant International Corpn [2015] UKPC 35.

The claimant's tracing evidence

In this case, the claimant’s expert purported to apply the FIFO methodology.

A significant portion of the judgment focused on deficiencies in the claimant's tracing evidence. The key failings can be summarised as follows:

• Inconsistency of results and methodology. The claimant’s expert submitted two reports at different stages of the proceedings, each based on different blockchain analysis software. These produced significantly divergent results, with the amount of USDT traced to Bitkub being notably lower in the second report. This inconsistency severely undermined the expert's credibility.

   

• Mislabelled and poorly explained methodology. Although both reports purported to have used FIFO, an objective and mechanical exercise, it later emerged that the expert had not followed FIFO strictly. Instead, he had applied a more subjective methodology referred to as "customer FIFO," stated to have been informed by his experience with organised crime groups and training from the applicable blockchain analysis software maker. An explanation of this methodology was provided only days before trial by way of a solicitors' letter, which was described by the judge as being "in only broad and contradictory terms that are impossible to apply to the transfers in issue in this case".

   

• Partisan methodology. The judge noted that the expert’s objective seemed geared towards supporting the claimant’s case, rather than strictly tracing the funds in a neutral, fact-based manner, and therefore favoured the claimant over other innocent parties.

As a result, the judge rejected the claimant’s expert evidence, and the claimant was unable to establish through tracing that the misappropriated USDT had reached Bitkub. This evidentiary gap proved fatal to the claimant's constructive trust claim.

Comment

D'Aloia is highly significant as it marks the first time in this jurisdiction that a claimant’s crypto tracing analysis has been scrutinised in a judgment following a contested hearing. Tracing analysis is commonly used in cryptocurrency claims, but since such claims often target unknown fraudsters, they are rarely contested, leaving the analysis largely unexamined. Here the claimant's decision to target cryptocurrency exchanges led to contested hearings, exposing shortcomings in the tracing analysis.

From a careful reading of the judgment, it appears that the blockchain analysis software's output was used without adequate explanation or evidence of thorough scrutiny. As the judge remarked, "the process [was] driven by the system as opposed to the expert." This approach was rightly criticised in the judgment, and moving forward, such analysis is likely to face much closer scrutiny, including at interlocutory hearings, in light of this decision.

While the deficiencies in the tracing methodology were a key focus in the judgment, it is important to note that even if the tracing analysis had been successful, the claim would still have failed due to inadequacies in the pleadings and evidence. For instance, the fact that the stolen USDT was no longer held by Bitkub need not have been fatal if the claimant had pleaded accessory liability, such as knowing receipt. With the appropriate evidence from Tether Limited, the claimant might also have been able to follow the stolen USDT, potentially preserving his unjust enrichment claim.

Additionally, the court’s recognition that USDT attracts property rights has rightly been hailed as an important milestone, as previous findings on this point were only made on an interim basis. However, this is more of a technical milestone than a substantive one, given the broad consensus in prior case law and the views of the Law Commission. Indeed, the matter was not contested at trial.

In many respects the judgment serves as a cautionary tale for practitioners working in crypto recovery who going forward will need to learn the expert, pleading, and evidential lessons from the case to ensure that they are not repeated.