Blockchain vulnerabilities – crypto hacks, blockchain forensics and legal challenges
It is often assumed that blockchain based digital currencies and applications are safe and secure. In fact, blockchain ecosystems including cryptocurrencies such as bitcoin and Ether, smart contracts that power a plethora of transactions, and blockchain exchanges have many vulnerabilities. Like many other financial systems, blockchain based systems are subject to all manner of hacks, frauds scams, and vulnerabilities. They happen at the speed and anonymity of the Internet. There are, understandably, numerous legal challenges when it comes to obtaining civil remedies for these Internet based crimes. This is as true, and perhaps even more so, for blockchain hacks, scams, and frauds as it is for a whole host of other Internet crimes and wrongs.
I had the pleasure yesterday to participate in a McCarthy Tetrault Masterclass on the subject of “Blockchain vulnerabilities – crypto hacks, blockchain forensics and legal challenges.” The other two panelists were Ari Redbord from TRM Labs and Ana Badour, partner and co-head of McCarthy Tetrault’s Fintech Group. Ari, Ana, and I discussed the hacks, frauds, forensic tools and countermeasures that are being used by lawful authorities and businesses to address blockchain vulnerabilities. Ana and ARI also provided an overview of regulatory measures being adapted to address legal issues associated with digital currencies including FATF guidance, AML legislation, Travel rules, OFAC sanctions against particular cryptocurrency exchanges, and FinCEN guidance on cybercrime and ransomware. I also talked about the availability and practicality of using civil remedies to address losses from the use of blockchain based systems and some recent OSFI developments that could impact blockchain applications.
Below are some prepared materials I drew upon in my talk on blockchain vulnerabilities – crypto hacks, blockchain forensics and legal challenges.[i]
Blockchain vulnerabilities, hacks, frauds and scams
There are trillions of dollars invested in blockchain based digital currencies. Bloomberg recently estimated that the cryptocurrency market is now worth more than U.S. $3 trillion. There are well recognized financial risks associated with cryptocurrencies volatility. But, this has not seemed to have dampened the market for these items.
The technical vulnerabilities associated with blockchain are not as widely recognized. Blockchain is often touted as being secure, immutable and “unhackable”. There are, however, many vulnerabilities associated with cryptocurrencies and their ecosystems, some human and some technical. This should not be surprising. We can learn a lot from history. As Jesse James showed in the wild west, Charles Ponzi showed us in 1920, and as hackers show us day in and day out, no matter how secure a financial institution, financial application, or financial asset is, someone will try to find a way to steal it, defraud or trick people out of it, or hack it. Sadly, the same is true with digital currencies.
While losses from hacks and vulnerabilities are hard to estimate, by one account hackers have stolen nearly $2 billion worth of cryptocurrencies in the two year period between 2017-2019. Some hacks are by lone hackers, but many are by sophisticated cybercrime organizations. According to a recent article In the MIT Security review, the hype that these assets are unhackable are “dead wrong”. According to the article:
In short, while blockchain technology has been long touted for its security, under certain conditions it can be quite vulnerable. Sometimes shoddy execution can be blamed, or unintentional software bugs. Other times it’s more of a gray area—the complicated result of interactions between the code, the economics of the blockchain, and human greed. That’s been known in theory since the technology’s beginning. Now that so many blockchains are out in the world, we are learning what it actually means—often the hard way. [ii]
A comprehensive article on the subject confirmed the many vulnerabilities associated with blockchain technology saying:
Blockchains are relatively new and there are countless news stories of people losing money through compromises in the components of blockchain ecosystems. Blockchain technologies are not invulnerable and have actually many known vulnerabilities, just as with any software….[iii]
Another recent article came to the same conclusion stating:
Until recently, blockchains were seen as an “unhackable” technology powering and securing cryptocurrencies — but that’s no longer the case…
In other words, forget what you heard from Bitcoin boosters — just because information or currency is on a blockchain doesn’t necessarily mean that it’s more secure than any other form of storage…
In fact, the same qualities that make blockchain technology so secure may also be the source of several unique vulnerabilities — a stark reminder that despite the hype, cryptocurrencies can’t entirely sidestep the vulnerabilities of any other banking systems.[iv]
One group of researchers recently concluded, as “distributed ledger software by nature, blockchain inevitably has software issues.” They found, among other things, by studying the bitcoin, Ethereum, Monero, and Stellar blockchains that some blockchain modules related to consensus, wallet, and networking were “highly susceptible to vulnerabilities”.[v]
As with every other financial system, there are opportunities for fraud. One vector is fraud associated with online marketplaces. An Ontario example involved the downfall of crypto asset trading platform QuadrigaCX (Quadriga). It resulted from fraud committed by Quadriga’s co-founder and CEO Gerald Cotten. Clients entrusted their assets to Quadriga, which provided false assurances that those assets would be safeguarded. In reality, Cotten spent, traded and used those assets at will. Operating without any proper system of oversight or internal controls, Cotten was able to misuse client assets for years, unchecked and undetected, ultimately bringing down the entire platform and losses to customers of $169 million. Approximately $115 million of the losses arose from Cotten’s fraudulent trading on the Quadriga platform. He opened Quadriga accounts under aliases and credited himself with fictitious currency and crypto asset balances which he traded with unsuspecting Quadriga clients. He sustained losses when the price of crypto assets changed causing a shortfall in assets to satisfy client withdrawals. He covered this shortfall with other clients’ deposits, in effect, operating a Ponzi scheme. Cotten also lost an additional $28 million while trading client assets on three external crypto asset trading platforms without authorization from, or disclosure to, clients. He also misappropriated millions in client assets to fund his lifestyle.[vi]
There are other types of fraud cases as well. For example, in the U.K. case, Ion Sciences vs Persons Unknown and Others,[vii] Ion and its Director were induced by persons unknown to transfer bitcoin in the belief that they were investing in a legitimate initial coin offering (ICO), but later discovered that the recipient was a scam. They transferred £577,002 in the form of some 64.35 bitcoin to the fraudster’s Coinbase account in the belief that they were making investments in real cryptocurrency products. A substantial part of the bitcoin transferred or their traceable proceeds ended up at accounts held by the the Binance and Kraken exchanges.
Private key security attacks are also a known means of allowing malicious actors to steal cryptocurrencies. A private key allows individuals to access funds and verify transactions. An attacker who has discovered a vulnerability in an elliptic curve digital signature algorithm, for example, can recover a user’s private key. If a private key is stolen, it is difficult to track any related criminal activity and recover the relevant blockchain asset.[viii]
There are several examples of private key security attacks. A recent one involved the cryptocurrency exchange Cryptopia, a New Zealand exchange that operated globally. In January 2019 Cryptopia’s servers were hacked and private keys held by the exchange were used to transfer cryptocurrencies to an undisclosed external exchange. Somewhere between 9 and 14 per cent of its cryptocurrency was stolen, valued at around NZD $30 million. Cryptopia temporarily suspended its operations and eventually was put into liquidation. The case resulted in a lengthy decision by a New Zealand Court in Ruscoe v Cryptopia Limited (in liquidation)  NZHC 728 (8 April 2020), which had to decide how the remaining assets of the exchange should be distributed as between account holders and unsecured creditors. The court decided that cryptocurrencies were property and that Cryptopia was a trustee of separate trusts, one for each cryptocurrency with the beneficiaries being all account holders holding currency of the relevant type.
Another example of a private key security attack was described in the U.K. case, Fetch.AI Lrd & Anor v Persons Unknown Category A & Ors  EWHC 2254 (Comm) (15 July 2021). It involved fraudulent trading using a person’s trading account with the cryptocurrency exchange Binance. It was perpetrated by unauthorized access to the plaintiff’s private key. The hackers obtained access to the accounts maintained by the plaintiff and were able to trade the crypto assets in the account by adopting massive undervalues for the products traded with the result that, in the aggregate, losses totaling in excess of US$2.6 million were sustained over a very short period.
Hackers have also been known to steal the keys to cryptocurrency wallets.[ix]
Of course marketplaces, like almost every other organization in Canada are subject to data breaches from a myriad of sources. One of the best known examples is Mt Gox, one of the first bitcoin exchanges which was based in Tokyo. During its heydays in the early 2010s, Mt. Gox was responsible for more than 70% of global bitcoin transactions. In 2011 hackers used stolen credentials to transfer bitcoins. Deficiencies in network protocols also resulted in several thousand bitcoins being “lost”. Reportedly, 850 million bitcoins, representing 6% of bitcoins in circulation at the time, were stolen over several years.[x]
Despite all the security features blockchain offers, individuals and organizations are still susceptible to phishing attacks. This scam attempts to obtain a user’s credentials without their knowledge through various tricks such as email. For example, fraudsters send wallet key owners emails posing as a legitimate source asking users for their credentials using fake hyperlinks.[xi]
SIM swap attacks are also not uncommon. Earlier this week an Ontario teen was arrested for allegedly stealing $46 million in crypto currency in a SIM swap attack. Reportedly, the police, who were assisted by the FBI and U.S. secret service, seized multiple pots of cryptocurrency valued at more than $7 million. In another case, BlockFi which offers crypto services for individuals and institutional clients was subject to a SIM swap attack. In this case, only personal information and no funds were accessed.[xii] In another case hackers stole data from Coinsquare, a cryptocurrency trading platform, also using a SIM swapping technique, but the hackers were also unable to use the data to steal any crypto assets.[xiii]
Hackers have also been known to exploit technical weaknesses in blockchain systems. An example of this is the Poly network hack which occurred In August 2021. Multiple blockchains including Ethereum, Binance Smart Chain, and Polygon were attacked. The hack targeted the Poly Network, a cross-blockchain interoperable bridge that enables users to transfer crypto-assets from one blockchain to another. Transfers are accomplished by locking tokens on a source blockchain and unlocking them on a destination one. After a transaction has occurred on a source blockchain, the Poly Network Keepers sign blocks of the source blockchain that contain the original transaction. The keeper then submits the signed block to a smart contract manager on the destination blockchain. The smart contract manager assesses the signatures’ validity, and if it is valid then the contract executes the transaction on the destination blockchain. The hacker exploited a vulnerability in the EthCrossChainManager smart contract manager. Essentially the hacker was able to create fake transactions that allowed him/her to unlocked tokens on the destination blockchain without locking them on the source blockchain. The hacker did this by changing and compromising trusted entities called “keepers” stored in the EthCrossChainData contract that facilitate the cross chain transactions to unlock tokens on the destination blockchain without locking the tokens on the source blockchain, essentially managing to duplicate tokens across two blockchain networks. By taking control of the keepers the attacker was able to trick EthCrossChainManager contract into executing cross-chain transactions that weren’t real on the source blockchain. The hacker was able to duplicate over $600 million worth of tokens across the networks by exploiting Poly Networks’ cross-chain protocol, making the tokens still in control by the original users uncollateralized and the valuable tokens under the hacker’s control. People with tokens on the source blockchain suffered losses. The hacker later returned funds to the Poly Network.[xiv]
Another well known example of a technical weakness exploit is The DOA, an unincorporated organization called Slock.it UG (“Slock.it”). The DAO was a Decentralized Autonomous Organization, a term that describes a “virtual” organization embodied in computer code and executed on a distributed ledger or blockchain. The DAO was created by Slock.it and Slock.it’s co-founders, with the goal of operating as a for-profit entity that would create and hold assets through the sale of DAO Tokens to investors that would be used to fund projects. After DAO Tokens were sold, but before The DAO was able to commence funding projects, an attacker used a flaw in The DAO’s code to steal approximately one-third of The DAO’s assets. The hacker began to divert the cryptocurrency Ether (ETH) from The DAO, causing approximately 3.6 million ETH, or 1/3 of the total ETH raised by The DAO offering, to move from The DAO’s Ethereum Blockchain address to an Ethereum Blockchain address controlled by the hacker. Luckily, before the hacker could move the ETH from that address Slock.it’s co-founders and others endorsed a “Hard Fork” to the Ethereum Blockchain. The “Hard Fork,” restored the DAO Token holders’ investments as if the hack had not occurred.[xv]
Hackers can also engage in Routing Attacks. Blockchains rely on real-time, large data transfers. Hackers can intercept real-time large data transfers such as by hijacking IP prefixes or dropping connections momentarily, preventing the system from reaching consensus. Blockchain participants aren’t aware of the threat, but behind the scenes, fraudsters may have extracted confidential data or currencies. [xvi] There are vulnerabilities in the routing information protocol that is used to specify how IP packets are forwarded to their destinations over the Internet (the Border Gateway Protocol (BGP)). Using a so called BGP Hijacking Attack, a hacker can manipulate BGP and intercept the blockchain network to route traffic to destinations determined by the hacker. [xvii]
Other examples of technical weaknesses were a cryptographic flaw in the cryptocurency Zcash that could have been exploited to make unlimited counterfeit Zcash and in bitcoin’s main client, Bitcoin Core, that had a flaw that could have let attackers mint more bitcoins than the system was supposed to allow. [xviii]
There can also be underlying cryptosystem vulnerabilities in other components such as blockchain wallets. They usually work with a public and private key pair for signature and are as secure as the underlying cryptosystem they use. The public-key algorithm used for these keys have known attacks that can be applied. [xix]
Blockchains are also subject to other types of attacks to steal crypto-assets. A well recognized attack vector is the “51% vulnerability attacks” which most cryptocurrencies are, at least theoretically, susceptible to. Blockchains commonly use proof of work as their protocol for verifying transactions. This process, also known as mining, involves nodes spending vast amounts of computing power to prove themselves trustworthy enough to add information about new transactions to the database. If a miner or pool of miners are able to gain control of a majority of the network’s mining power they can arbitrarily manipulate and change blockchain information such as by reversing a transaction and initiating a double-spending attack by creating an alternative version of the blockchain (a fork). These attackers can make the fork the authoritative version of the chain and proceed to spend the same cryptocurrency again (double spending). Examples of 51% attacks occurred on a series of smaller coins including Verge, Monacoin, and Bitcoin Gold that resulted in thefts of an estimated $20 million. There was also a 51% attack against Ethereum Classic, where an attacker who gained control of more than half of the network’s computing power was trying to rewrite the transaction to steal more than $1 million. In another case, the mining pool “ghash.io” accounted for more than 42% of the total bitcoin mining power. The fact that a single mining pool represented such a high proportion was a serious concern, and many miners dropped out of the pool.[xx]
Future developments in technologies will also undoubtedly present new security challenges that blockchain systems will need to address. For example, quantum computing has the capability of breaking the encryption deployed in blockchains and cryptographic codes, upending basic security assumptions. It is expected that quantum computers will one day be able to break a blockchain’s cryptographic algorithms quickly and make the encryption obsolete. To stay ahead, there will be a need to transition to quantum-resistant schemes to mitigate potential security risks.[xxiii]
There are many provincial rulings by securities regulators that, as set out in CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets (CSA SN 21-327), securities and derivatives legislation may apply to persons or companies that are in the business of trading contracts or instruments that have an underlying interest in assets that are frequently referred to as crypto assets such as bitcoin, Ether, and anything commonly considered a crypto asset, digital or virtual currency, or digital or virtual token that are not themselves securities or derivatives because these contracts or instruments satisfy the definition of a security or a derivative as defined in securities legislation.[xxiv]
For OSFI regulated FIs, there are some recent developments.
Technology and Cyber Security Incident Reporting Advisory (August 2021) The Advisory is intended to support a coordinated and integrated approach to OSFI’s awareness of, and response to, technology and cyber security incidents. It has very broad criteria for reporting incidents including cyberattacks, third party breaches, extortion threats, and impacts to financial market settlements.
Technology and Cyber Risk Management (Draft Guideline) (November 2021) The Guideline establishes OSFI’s expectations related to technology and cyber risk management. It deals with, among other things, cyber security and technology operations. Cyber Security: “Outcome: A secure technology posture that maintains the confidentiality, integrity and availability of the FRFI’s technology assets.” Technology Operations: “Outcome: A technology environment that is stable, scalable and resilient. The environment is kept current and supported by robust and sustainable technology operating processes.”
Both of these OSFI documents may be relevant to, among other things, blockchain based trading systems and decentralized finance.
Obtaining remedies for Internet based wrongs are a continuing exercise of wac a mol. Obtaining effective civil remedies against blockchain hackers is, without doubt, challenging. They act at the speed of the internet, anonymously, almost always reside and act from foreign jurisdictions, and are notorious for covering their tracks including by peeling their stolen crypto assets to obfuscate recoveries. While it is possible to investigate and trace transfers of cryptocurrencies from public blockchains, recovering those assets or tracing those assets once converted into fiat currency can be difficult.
There are however several cases that show that if the attacked party acts quickly there are legal remedies that can be used to try to recover stolen or transferred crypto assets.
An example is the U.K. case AA v Persons Unknown & Ors, Re Bitcoin  EWHC 3556 (Comm) (13 December 2019). In this case a Canadian insurance company (the Insured Customer) was subject to a ransomware attack that encrypted and locked up its computer systems. It had cyber insurance from an English insurer (the “Insurer”). The Insurer hired an incident response company (IRC) which negotiated the decryption software for a ransom of US $950,000 which was paid with 109.25 bitcoins to an address that was provided.
Note, I could have chosen fact a fact pattern from other reported cases because the problems in obtaining remedies are very similar, only the alleged criminal behavior is different. For example, in the U.K. case Fetch.ai Ltd and another v Persons Unknown Category A and others (July 2021) the hacker used the plaintiff’s private key to fraudulently trade cryptocurrencies at massive undervalues using the plaintiff’s trading account. In the U.K. case, Ion Sciences vs Persons Unknown and Others,[xxv] there was a transfer of bitcoin to a scam artist in a coin offering (ICO) fraud.
In the AA v Persons Unknown case, the Insurer hired Chainalysis Inc., a blockchain investigations company who was able to track 96 of the bitcoins that were held by an exchange known as Bitfinex. The rest of the funds were converted into a fiat currency.
The Insurer then commenced legal proceedings in the UK (based on its subrograted rights) against the unknown hacker that made the ransom demand (the first defendant), the unknown person who held/controlled the 96 bitcoins (the second defendant), and two entities trading as the Bitfinex exchange.
The relief claimed and the court’s order are described below.
An order that the hearing be conducted in private and for an anonymity order
The Insured asked for an order that the hearing be conducted in private and for an anonymity order. This order was granted. The publicity would have defeated the object of the hearing. The overarching purpose of the application was to assist the applicant in its efforts to recover the 109.25 bitcoins that were unlawfully extorted. If the hearing was held in public there is a strong likelihood that the object of the application would be defeated because it would potentially tip off the persons unknown to enable them to dissipate the bitcoins. There would also be the risk of further cyber or revenge attacks on both the Insurer and the Insured Customer by persons unknown. There could also be a risk of copycat attacks on the Insurer and/or the Insured Customer.[xxvi]
Norwich, Bankers Trust and Freezing Order Application
The Insurer asked for disclosure orders requiring the operators of the exchange to provide specified information in relation to the crypto currency account owned or controlled by the second defendant. The Insurer relied on the well established Norwich Pharmacal disclosure jurisprudence that permits courts to require innocent intermediaries (in this case the exchange) that becomes mixed up in a wrongful act to provide information necessary for claimants to pursue their claims such as the identities of their account holders and information about the accounts. The Insurer also relied on the Bankers Trust jurisprudence which permits orders to be made against financial institutions to disclose confidential documents to support a proprietary claim in fraud or to trace assets or their proceeds that are the subject of a proprietary injunction.
The insurer also asked for a worldwide Mareva injunction order to freeze all the assets of the hackers.
This part of the motion was adjourned at the request of the Insurer because of uncertainty whether the Bankers Trust and Norwich orders could be made and served against institutions outside of the UK. (In the UK there must be a jurisdictional gateway before service of a claim outside the UK can be ordered). This illustrates, in part, some of the cross jurisdictional challenges of getting civil remedies against rogue foreign persons.
A Bankers Trust order was, however, made in the Ion Sciences vs Persons Unknown and Others (unreported) 21 December 2020 (Commercial Court), and Fetch.AI Lrd & Anor v Persons Unknown Category A & Ors  EWHC 2254 (Comm) (15 July 2021) cases.
The Insurer also sought a proprietary injunction in respect of the bitcoin held at the account of the exchange. The claim for which the relief was sought was in restitution and/or constructive trust against all four defendants. The Insurer claimed that the sum of $950,000 that was paid out belonged to the Insurer. That money was used to purchase bitcoin and the proceeds of that money could be traced into the accounts with Bitfinex and Bitfinex was constructive trustee of those funds on behalf of the Insurer.
This claim raised a number of issues.
A central issue was whether bitcoin is “property”, as proprietary remedies can only be granted in respect of property. There are some cases that held that to be property a thing had to be a “chose in possession” or “chose in action”. While the issue was not free from doubt, the court concluded that “for the purpose of granting an interim injunction in the form of an interim proprietary injunction that crypto currencies are a form of property capable of being the subject of a proprietary injunction”. In coming to this conclusion the court relied on Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth  1 AC 1175 as being definable, identifiable by third parties, capable in their nature of assumption by third parties, and having some degree of permanence, and a decision of a Singapore court in B2C2 Limited v Quoine PTC Limited  SGHC (I) 03. He also relied the UK Jurisdictional Task Force (“UKJT”) which published a legal statement on Crypto assets and Smart contracts. The court also relied on two prior English authorities where crypto currencies were treated as property, Vorotyntseva v Money -4 Limited t/a as Nebeus.com,  EWHC 2598 (Ch) where a worldwide freezing order iwas made in respect of a substantial quantity of bitcoin and Ether, and the case of Liam David Robertson (unreported 15th July 2019) where an asset preservation order over crypto currencies was made.
The court also concluded that it was a proper case to make the proprietary injunction.
Although as noted above, the court adjourned the request for the Norwich and Bankers Trust order, some of the relief asked for was granted as ancillary relief to the proprietary injunction. Specifically, the Court ordered that information be provided of the identity and address of the exchange operators and the hackers. This included that the exchange identify the hackers and provide any information they had about them and that the hackers identify themselves. The court was satisfied that that information was necessary to police the proprietary injunction and would also be appropriate to be provided by way of pre-action disclosure in the action.
There was no follow up decision, so it is not clear whether the crypto assets or any of the fiat currencies were actually recovered.
Other Commonwealth cases have reach similar results on whether crypto currencies are property. For example, the New Zealand case, Ruscoe v Cryptopia Limited (in liquidation)  NZHC 728 (8 April 2020), concluded that cryptocurrencies were “property” “within the definition in s 2 of the New Zealand Companies Act and also probably more generally”. The Court also held that these digital assets, being property, are capable of forming the subject matter of a trust.
This conclusion was echoed in the more recent U.K. case, Ion Sciences vs Persons Unknown and Others (unreported) 21 December 2020 (Commercial Court). There Ion Sciences and its sole director, Duncan Johns, were victims of alleged initial coin offering (ICO) fraud. The court stated it was “satisfied that there is at least a serious issue to be tried that cryptoassets such as bitcoin are property within the common law definition of that term.” The court granted a proprietary injunction and a worldwide freezing order against persons unknown to preserve the transferred bitcoin or their traceable proceeds and an ancillary disclosure order to identify the alleged fraudsters. The court also made a Bankers Trust order against two cryptocurrency exchanges operating outside of the U.K. and an order to trace the transferred bitcoin or their proceeds that were the subject of the proprietary injunction.[xxvii]
Another recent U.K. case reached the same conclusion and made orders similar to those made in the Ion Sciences case in Fetch.ai Ltd and another v Persons Unknown Category A and others (July 2021). The plaintiff’s private key was somehow accessed in breach of confidence and used to fraudulently trade cryptocurrencies at massive undervalues using the plaintiff’s trading account. The court, relying on a breach of confidence legal claim, granted a proprietary injunction including against non-UK residents, a worldwide freezing order, and a Bankers Trust disclosure order. The injunction was based on the “simple proposition that, when property is obtained by fraud, equity imposes a constructive trust on the fraudulent recipient, with the result that the fraudulent recipient holds the legal title on constructive trust for the loser”.
Further the court held it had the jurisdiction to make the order against the defendants even though they resided outside of the jurisdiction based on the nuances of the U.K. jurisdictional gateways.
Is the civil law adequate to address blockchain security and vulnerabilities?
Many of the legal remedies discussed in the U.K. AA v Persons Unknown and other U.K. cases are likely available in Canada. The Supreme Court recently confirmed in Google Inc. v. Equustek Solutions Inc., 2017 SCC 34 that Canadian courts have broad jurisdiction to grant orders “where just and equitable” to do so. This includes the following types of orders discussed in the U.K. cases that could be useful in a digital currency security/vulnerability/hacking or ransomware case.
Norwich orders: Norwich orders can be used to compel non-parties to disclose information or documents in their possession required by a claimant. Norwich orders have increasingly been used in the online context by plaintiffs who allege that they are being anonymously defamed or defrauded and seek orders against Internet service providers to disclose the identity of the perpetrator. Norwich disclosure may be ordered against non-parties who are not themselves guilty of wrongdoing, but who are so involved in the wrongful acts of others that they facilitate the harm. Norwich also supplies a principled rationale for granting injunctions against non-parties who facilitate wrongdoing.[xxviii]
Bankers Trust orders: Bankers Trust orders, named after the English Court of Appeal case Bankers Trust Co. v. Shapira,  W.L.R.1274 (C.A.) are also available in Canada.[xxix] These orders can be made in a proper case to make a discovery order directed to a financial institution to be used for the purpose of following and tracing the lost or surrendered crypto assets.
Mareva Injunctions: Mareva injunctions are also available in Canada. They are used to freeze assets in order to prevent their dissipation pending the conclusion of a trial or action. A Mareva injunction can require a defendant not to dissipate his or her assets and often requires the assistance of a non-party such as a financial intermediary which can be ordered to assist if it is just and equitable to do so. Banks and other financial institutions have, as a result, been bound by Mareva injunctions even when they are not a party to an underlying action.[xxx]
Proprietary Remedies: Some causes of action such as the torts of conversion and detinue, and remedies like tracing orders and constructive trusts depend on digital currencies being “property”. It is likely that they will be recognized as such in Canada as they are in the U.K., New Zealand, Singapore, and elsewhere. The issue arose in the B.C. case Copytrack Pte Ltd v Wall,  BCSC 1709 where the plaintiff had mistakenly transferred to the defendant 530 Ether tokens valued at the time at $495,000 instead of 530 CPY tokens valued at $780. When the defendant failed to return the Ether tokens Copytrack sued the defendant alleging the torts of conversion and detinue and asked for “An order that Copytrack be entitled to trace and recover the 529.8273791 Ether tokens received by Wall from Copytrack on 15 February 2018 in whatsoever hands those Ether tokens may currently be held.” The judged noted the difficulty in characterizing them, but nevertheless concluded that “regardless of the characterization of the Ether tokens, it is undisputed that they were the property of Copytrack, they were sent to Wall in error, they were not returned when demand was made and Wall has no proprietary claim to them. While the evidence of what has happened to the Ether tokens since is somewhat murky, this does not detract from the point that they should rightfully be returned to Copytrack”.
Copytrack adds to the developing jurisprudence throughout the commonwealth which has recognized digital currencies as being a form of property and in which proprietary remedies have been ordered
There are however, significant challenges even with these remedies.
There is always a problem of being able to determine the cause of a loss, to be able to trace the transactions to particular sources where crypto assets can be frozen, and to move quickly enough before the digital currencies are traded or converted to fiat currencies and dissipated without a trace. Tracing assets also gets more complicated when the asset is transferred from one crypto currency to another one, especially when the fraudsters engage in “peeling” to obscure or hide digital currencies obtained illicitly.
Tracing the transfers of cryptocurrency assets is something that experts have been able to do. In the Colonial Pipeline case, the FBI was able to track multiple transfers of bitcoins and identify that approximately 63.7 bitcoins, representing the proceeds of a victim’s ransom payment, had been transferred to a specific address. This tracing was also done by experts in the AA v persons Unknown, Ion sciences and Fetch cases. An expert in tracing transfers of cryptocurrencies from CipherTrace also gave evidence in a 2019 Canadian case involving $1.4 million bitcoins confiscated in a crypto seizure by Canadian police.
Worldwide freezing orders are also not particularly helpful where the fraudsters are anonymous and operate in foreign (and non-friendly) countries, particularly once stolen crypto currency has been dissipated.
A significant issue in all these cases is whether relief can effectively be obtained where the unknown defendants or innocent intermediaries such as cryptocurrency exchanges have no connections to Canada. Under Canadian law for a court to assume jurisdiction, there must be personal jurisdiction (also known as territorial competence) over the defendant. For the common law under the Supreme Court case Club Resorts Ltd. v. Van Breda, 2012 SCC 17, various presumptive connecting factors are applied to determine if there is personal jurisdiction over a person. There is also a framework for identifying new factors. One of the presumptive connecting factors is a tort committed in the jurisdiction. For cases of fraud committed in a Canadian province, the test is likely to me met. For blockchain based cryptocurrencies there is a question as to where the situs of the asset or tort may be. This has not yet been resolved in Canada. Two U.K. decisions, however, have suggested that the lex situs of a crypto asset is the place where the person or company who owns it is domiciled.[xxxi] This would often be enough for a Canadian court to assume personal jurisdiction over a perpetrator of a fraud. However, in a complicated case the courts might struggle as did the U.K. courts in the AA v Persons Unknown, Ion Sciences, and Fetch cases.
The more challenging issue is when a Canadian court will grant a remedy against a foreign based defendant or innocent third party such as a cryptocurrency exchange. As the Equustek case confirmed, common law courts can make worldwide orders against defendants (depending on the cause of action). Orders can also be made against innocent intermediaries who get “mixed up” in the tortious or other wrongful acts of others. However, Canadian courts are often reluctant to exercise their enforcement jurisdiction outside of Canada.[xxxii] There will likely, therefore, be cases where the courts will have to decide how far they can go in making extra-territorial orders. There will also be cases where even if orders are made, or are made on terms that protect foreign entities (such as the “Babanaft” Mareva injunction orders),[xxxiii] the orders will not be immediately enforceable or be enforced by foreign courts.
The upshot of all of this is that if you or your clients are subject to a loss of crypto assets stored on a public blockchain, or paid out as a ransom in a ransomware attack, there are things you can do to try and recover them, but you must act quickly and with the right team. You will need a good forensic blockchain investigator – some of the leaders in this area are being used repeatedly in these cases. You will need to move very quickly to obtain a proprietary tracing and constructive trust injunction, Norwich and Bankers Trust disclosure orders, a worldwide Mareva injunction, and an anonymity and evidence sealing order. You will also need to reach out to crypto currency exchanges or other entities that are holding transferred assets to get their cooperation. You will also need foreign counsel ready to help get a Canadian order enforced in foreign jurisdictions. You will also need to be lucky.
This article was first posted on www.barrysookman.com.
[i] I would like to thank the research assistance of Ella Hantho, an Articling Student with McCarthy Tetrault and the usual fabulous research help from McCarthy Tetrault’s research librarians and especially Martha Stortz, Susan Caird and Jason Wong. Thanks also to Ana Badour for reviewing and providing some comments on a prior draft of this post (errors, if any, of course, are all mine.)
[ii] Mike Orcutt, “Once hailed as unhackable, blockchains are now getting hacked” (19 February 2019), online: MIT Technology Review <https://www.technologyreview.com/2019/02/19/239592/once-hailed-as-unhackable-blockchains-are-now-getting-hacked/> (“Orcutt”)
[iv] Victor Tangermann, “Blockchains Were Supposed to Be “Unhackable.” Now They’re Getting Hacked” (17 May 2021), online: Futurism <https://www.futurism.com/blockchains-unhackable-getting-hacked> (“Tangermann”)
[v] Xiao Yi, et al, “Diving Into Blockchain’s Weaknesses: An Empirical Study of Blockchain System Vulnerabilities” (23 October 2021) [unpublished, archived at Cornell University arXiv.org, online: <https://arxiv.org/abs/2110.12162>]
[vii] (unreported) 21 December 2020 (Eng. Commercial Court) (“Ion Sciences”)
[viii] Saurabh Singh, A.S.M. Sanwar Hosen, and Byungun Yoon, “Blockchain Security Attacks, Challenges, and Solutions for the Future Distributed IoT Network” (26 January 2021) 9 IEEE Access 13938-13959, online:<https://doi.org/10.1109/ACCESS.2021.3051602> (“Singh et al”)
[ix] Tangermann (supra)
[x] Jake Frankenfield, “Mt. Gox” (25 March 2021), online: Investopedia <https://www.investopedia.com/terms/m/mt-gox.asp>; Cameron Keng, “Bitcoin’s Mt. Gox Goes Offline, Loses $409M — Recovery Steps and Taking Your Tax Losses” (25 February 2014), online: Forbes <https://www.forbes.com/sites/cameronkeng/2014/02/25/bitcoins-mt-gox-shuts-down-loses-409200000-dollars-recovery-steps-and-taking-your-tax-losses/?sh=5e5c7b6d5c16>
[xi] Estevao Costa, “The Benefits and Vulnerabilities of Blockchain Security” (19 October 2021), online: CENGN < https://www.cengn.ca/information-centre/innovation/the-benefits-and-vulnerabilities-of-blockchain-security/> (“Costa”)
[xii] BlockFi, “Incident Report” (14 May 2020), online: <https://blockfi-s3-static-prod.s3.amazonaws.com/pdf/Incident+Post+Mortem%2C+May+14%2C+2020.pdf>; These articles discuss the steps BlockFi took following the breach: Paddy Baker, “BlockFi Says Hacker SIM-Swapped Employee’s Phone, No Funds Were Lost” (19 May 2020), online: CoinDesk <https://www.coindesk.com/markets/2020/05/19/blockfi-says-hacker-sim-swapped-employees-phone-no-funds-were-lost/>; Robert Anzalone, “BlockFi Hires New Chief Security Officer After Last Month’s Hack” (16 June 2020), online: Forbes <https://www.forbes.com/sites/robertanzalone/2020/06/16/blockfi-hires-new-chief-security-officer-after-last-months-hack/?sh=242bc5354c57>
[xiii] Joseph Cox, “Hackers Plan to Use Stolen Cryptocurrency Exchange Data for SIM Swapping” (2 June 2020), online: Vice <https://www.vice.com/en/article/n7wnvb/hackers-coinsquare-data-bitcoin-sim-swapping>; iZoologic, “Inside Job – Coinsquare Data Theft Facilitated by Former Employee” (2 June 2020), online: iZoologic <https://www.izoologic.com/2020/07/02/inside-job-coinsquare-data-theft-facilitated-by-former-employee/>; JD Alois, “Coinsquare CEO Responds to Data Breach” (10 June 2020), online: Crowdfund Insider <https://www.crowdfundinsider.com/2020/06/162583-coinsquare-ceo-responds-to-data-breach/>; This article explains how SIM swapping is being used to by hackers to gain access to personal information and cryptocurrency wallets: Joseph Cox, “Hackers Are Breaking Directly Into Telecom Companies to Take Over Customer Phone Numbers” (1 October 2020), online: Vox <https://www.vice.com/en/article/5dmbjx/how-hackers-are-breaking-into-att-tmobile-sprint-to-sim-swap-yeh>
[xiv] For more detail about the Poly Network hack and a technical analysis of how exactly the hack occurred and the inherent vulnerability of the cross-chain protocol, see: Mudit Gupta, “Poly Network Hack Analysis – Largest Crypto Hack”(11 August 2021), online (blog): Mudit Gupta’s Blog <https://mudit.blog/poly-network-largest-crypto-hack/>; Mudit Gupta and Laura Shin, “Why did the Poly Network Attacker Return Half the Money They Stole” (13 August 2021), online (podcast): Unchained Podcast <https://unchainedpodcast.com/why-did-the-poly-network-attacker-return-half-the-money-they-stole/>; Harry Robertson, Poly Network says all $610 million stolen by a hacker has been returned after Tether released the final $33 million”, (27 August 2021), online: Markets Insider, <https://markets.businessinsider.com/news/currencies/poly-network-hack-610-million-tether-mr-white-hat-defi-2021-8>; Sumejja Muratagić-Tadić, “Tether Frozen in Poly Hack Return to Owners, Fueling Centralization Debate” (26 August 2021), online: Cryptonews.com <https://cryptonews.com/news/tether-frozen-in-poly-hack-returned-to-owners-fuelling-centr-11569.htm>
[xv] US, Securities and Exchange Commission, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Release No. 81207 (25 July 2017), online: <https://www.sec.gov/litigation/investreport/34-81207.pdf>
[xvi] Costa (supra)
[xvii] Singh et al (supra)
[xviii] Orcutt (supra)
[xix] Amiet (supra)
[xx] Singh et al (supra); Orcutt (supra); Amiet (supra)
[xxi] Singh et al (supra); Orcutt (supra); Amiet (supra)
[xxii] These are described in Singh et al (supra); see also: Orcutt (supra) and Amiet (supra). See also, “A Survey on the Security of Blockchain Systems”, Xiaoqi Li et al, Future Generation Computer Systems, Volume 107, June 2020, Pages 841-853, online: < https://www.sciencedirect.com/science/article/abs/pii/S0167739X17318332>
[xxiii] Nicole Smith, “Quantum’s Potential Impact on Blockchain Computing” (August 2020) ISSA Journal 12-16, online:< https://cdn.ymaws.com/www.members.issa.org/resource/resmgr/journalpdfs/feature0820.pdf>; Joseph J. Kearney, Carlos A. Perez-Delgado, “Vulnerability of blockchain technologies to quantum attacks” (July 2021) 10 Array 100065, online: <https://doi.org/10.1016/j.array.2021.100065>
[xxv] (unreported) 21 December 2020 (Eng. Commercial Court) (“Ion Sciences”)
[xxvi] According to the Court:
If the hearing were to be held in public there is a strong likelihood that the object of the application would be defeated. First of all, there would be the risk, if not the likelihood, of the tipping off of persons unknown to enable them to dissipate the Bitcoins held at the second defendant’s account with Bitfinex, the real possibility of reprisal or revenge cyber attacks on either the Insurer or indeed the Insured Customer by persons unknown, the possibility of copycat attacks on the Insurer, and/or the Insured Customer and the revealing of confidential information considering the Insurer’s processes and the Insured Customer’s systems which will be necessary on this application, in circumstances where the vulnerability of those very systems form the basis for the blackmail itself. Ultimately, the applicant contends it is necessary for the court to sit in private to secure the proper administration of justice…
I am satisfied that this is an appropriate case for the hearing to be heard in private, as I indicated at the start of the hearing saying I would give reasons in due course. My reasons are given now. First of all, I am satisfied for the purpose of CPR 39(3) that publicity would defeat the object of the hearing. It would potentially tip off the persons unknown to enable them to dissipate the Bitcoins; secondly, there would be the risk of further cyber or revenge attacks on both the Insurer and the Insured Customer by persons unknown; there would be a risk of copycat attacks on the Insurer and/or the Insured Customer and I am satisfied that in all the circumstances it is necessary to sit in private so as to secure the proper administration of justice.
[xxvii] For a summary of the case, see Scott Nodder, “Propriety Injunction and Bankers Trust Order made in fraud case involving crypto currency” (3 April 2021), online (blog): Womble Bond Dickinson <https://financialinstitutionsnews.com/2021/03/04/proprietary-injunction-and-bankers-trust-order-made-in-fraud-case-involving-cryptocurrency/>; Ben Packer, Michael Munk and Rose Lynch, “In Ion Sciences, the English courts take a traditional approach to determining governing law and jurisdiction in a dispute relating to cryptoassets” (19 March 2021), online (blog): Linklaters <https://www.linklaters.com/en/insights/blogs/fintechlinks/2021/march/the-english-courts-take-a-traditional-approach-to-determining-governing-law-and-jurisdiction>
[xxviii] Equustek at para. 31
[xxxi] Ion Sciences (supra); Fetch.ai Ltd and another v Persons Unknown Category A and others,  EWHC 2254 (Comm)