Introduction

Cryptocurrencies are undoubtedly digital assets popular among traders and investors in recent years. A landmark decision Re Gatecoin Limited [2023] HKCFI 914 handed down by the Hong Kong Court of First Instance confirms the proprietary nature of cryptocurrencies and that they are capable of being held on trust.

Background of the case

Gatecoin Limited (“Gatecoin”) is a Hong Kong company and was wound up by the Court on 13 March 2019. Gatecoin had since January 2015 operated a cryptocurrency exchange platform through which customers open and register an account with Gatecoin and deposit cryptocurrencies for trading or withdrawal purposes.

This decision was handed down upon an application made by Gatecoin’s liquidators to seek directions or determinations on (i) the characterisation of cryptocurrencies and fiat currencies held by Gatecoin; and (ii) the allocation of the cryptocurrencies and the fiat currencies to the customers.

The Court was specifically asked to determine whether the cryptocurrencies are held on trust for Gatecoin’s customers.

 

The Liquidators have identified 3 different sets of terms and conditions (“T&C”) which were in force at different time periods. Accordingly, there are the following 3 groups of customers registered with Gatecoin:

1.       Group A customers who registered their accounts agreeing to the 2016 T&C;

2.       Group B customers who registered their accounts agreeing to the Trust T&C; and

3.       Group C customers who registered their accounts agreeing to the 2018 T&C.

Whether cryptocurrency is “property”

In order to determine whether the cryptocurrencies are held on trust, the Court has to consider whether cryptocurrency is “property”, which is capable of forming the subject matter of trust.

 

The requirements for “property” were stated by Lord Wilberforce in National Provincial Bank v Ainsworth [1965] AC 1175. Before a right or an interest can be admitted into the category of property, it must be (i) definable, (ii) identifiable by third parties, (iii) capable in its nature of assumption by third parties, and (iv) have some degree of permanence or stability. 

The Court notes that the definition of “property” under s.3 of the Interpretation and General Clauses Ordinance (Cap. 1) is different from other jurisdictions. However, the definition of “property” in Hong Kong is an inclusive one and intended to have a wide meaning. Further, the Hong Kong courts have consistently applied and followed the principles expounded in Ainsworth when determining whether a right or interest meets all the requirements for property. On the basis of the above, the Court held that it is appropriate to apply and follow the reasoning in foreign jurisdictions.

After reviewing authorities in various common law jurisdictions, the Court held that cryptocurrency satisfies the 4 criteria for “property” as explained in Ainsworth and is a type of intangible property in that:

1.       Cryptocurrency is definable as the public key allocated to a cryptocurrency wallet is readily identifiable, sufficiently distinct and capable of being allocated uniquely to individual accountholder;

2.       Cryptocurrency is identifiable by third parties in that only the holder of a private key is able to access and transfer the cryptocurrency from one wallet to another;

3.       Cryptocurrency is capable of assumption by third parties in that it can be and is the subject of active trading markets where (a) the rights of the owner in that property are respected, and (b) it is potentially desirable to third parties such that they want themselves to obtain ownership of it; and

4.       Cryptocurrency has some degree of permanence or stability as the entire life history of a cryptocurrency is available in the blockchain.

Whether Gatecoin held cryptocurrencies on trust

Group A, B and C customers

The Court first held that the question whether the Currencies are held by Gatecoin on trust for Gatecoin’s customers (be it Group A, B or C) should be determined by construing the terms of the 2018 T&C. The earlier versions of the T&Cs (i.e. 2016 T&C and Trust T&C) have no application because the 2018 T&C came into force in March 2018 and superseded the Trust T&C. From that time onwards, all Gatecoin’s customers including Group A and B customers who registered their accounts when the 2016 T&C and Trust T&C were in force were required to click to acknowledge and accept the 2018 T&C before they could continue to access and use Gatecoin’s website.

If and to the extent that Group A and B customers have accepted and agreed to the terms of the 2018 T&C, the Court held that it should not ignore the contractual bargain reached between the parties and should not allow these customers to rely on the terms of the Trust T&C.

Based on the 2018 T&C, the Court held that the cryptocurrency is not held by Gatecoin on trust for the Customers but are held by Gatecoin in its own right for the following reasons:

1.       The 2018 T&C contains no express declaration of trust.

2.       The 2018 T&C expressly disclaims any fiduciary relationship between Gatecoin and its customer.

3.       The 2018 T&C provides that Gatecoin would be entitled to any accretions to the cryptocurrencies;

4.       All the cryptocurrencies deposited by Gatecoin’s customers were not segregated but were transferred to, and mixed with those cryptocurrencies deposited in the 18 Mother Wallets controlled by Gatecoin.

5.       Gatecoin was able to use the cryptocurrencies kept in the wallets it controlled in the way it saw fit including for the purpose of carrying on trades in its own right.

6.       There was no requirement for Gatecoin to hold an amount equivalent to the customer’s assets on account.

7.       In Gatecoin’s audited financial statements for the years 2016 and 2017, the cryptocurrencies held by Gatecoin were treated as its assets while the “customer deposits” were treated as liabilities.

Non-consenting Customers

Still, the above ruling does not conclusively determine the matter as one cannot rule out the possibility that there may be Group A and B customers who had registered their accounts before the 2018 T&C came into effect and did not access or use the Platform from March 2018 up to the date of the liquidation of Gatecoin (such that they did not accept or agree to the terms of the 2018 T&C) (collectively “Non-consenting Customers”).

The 2016 T&C is silent on the nature of Gatecoin’s holding of Currencies for Group A customers.  However, an intention to hold the cryptocurrency on trust was evidenced by the fact that:

1.       The person who was engaged to draft the Trust T&Cs was instructed by Gatecoin’s representative that Gatecoin held the property on behalf of its client and was instructed to incorporate express trust language in the Trust T&Cs.

 

2.       Gatecoin agreed to compensate the affected customers of the value of ETH stolen at the time the compensation was paid (as opposed to the time of the Hack). Such treatment was consistent with Gatecoin holding the ETH in customers’ accounts on trust.

 

3.       In any event, even if the 2016 T&C by itself did not create a trust, once the Trust T&C was adopted, they applied to Group A customers, rendering the relationship they had with Gatecoin to be one of trust. The 2016 T&C provided that Gatecoin might change the terms at any time without prior notice.

 

The Trust T&C contains express trust language and recognizes that accretion to cryptocurrencies belonged to the customers.

The Court further found that certainty of subject matter, certainty of object and certainty of intention were all present in relation to the Non-consenting Customers.  The Court agreed that Gatecoin holds the cryptocurrencies on trust for the Non-consenting Customers.

Takeaway

This case is a landmark decision confirming the proprietary nature of cryptocurrencies.  In determining whether the cryptocurrencies deposited on cryptocurrency exchanges are held on trust, the Court will consider, among others, the contractual terms and conditions governing relationships between the cryptocurrency exchange platform and customers and also the actual operations of the platform.

It is advisable for owners of cryptocurrencies who wish to deposit their cryptocurrencies on an exchange to understand clearly the terms and conditions they are entering into since these could significantly affect their rights, especially if the cryptocurrency exchange platform is wound up in the future. Given that Hong Kong now has a new licensing regime for virtual assets trading providers (VATPs), owners and investors of cryptocurrencies could consider trading in VATPs that are regulated by the Securities and Futures Commission. If in doubt, you are advised to consult a technology lawyer to better understand and protect your rights.

For enquiries, please feel free to contact us at:

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2023