A recent decision by the Hong Kong Court of First Instance in the liquidation case of Gatecoin ruled that cryptocurrencies are “property” and are capable of being held on trust.
The ruling was broadly welcomed, clarifying the nature of cryptocurrencies and the interests of investors when depositing cryptocurrencies with exchanges.
The decision affirms the proprietary nature of cryptocurrencies in Hong Kong, and has significant implications for players in the cryptocurrency market, namely:
- The decision offers greater certainty with respect to the legal status of cryptocurrencies, and pertaining rights and obligations under the law;
- For cryptocurrency exchanges and their investors, the terms and conditions of use of the exchange are a key factor in determining whether the cryptocurrencies deposited are held on trust for an investor. Exchange users must carefully examine the terms and conditions; and
- In an insolvency context, cryptocurrencies held on trust for exchange users will be returned to users if the exchange is wound up. In contrast, cryptocurrencies that are assets of the exchange will be realised to fund the costs of the liquidation and made available for distribution to unsecured creditors of the insolvent exchange.
Gatecoin operated a cryptocurrency exchange platform where customers opened accounts and deposited cryptocurrencies or fiat currencies for trading purposes. In March 2019, Gatecoin was wound up, and joint and several liquidators were appointed.
The liquidators applied, under section 200(3) of the Companies (Winding up and Miscellaneous Provisions) Ordinance (Cap. 32), for directions from the court on: (1) characterisation of the currencies held by Gatecoin; and (2) allocation of the currencies to Gatecoin’s customers.
TERMS AND CONDITIONS
Gatecoin had updated its terms and conditions on a few occasions. Prior to the winding up they contained no express declaration of trust and expressly disclaimed any fiduciary relationship between Gatecoin and its customers. The terms and conditions further provided that currencies may be stored in pooled blockchain asset accounts or omnibus fiat accounts.
In practice, the currencies deposited by Gatecoin’s customers were treated as Gatecoin’s assets. Gatecoin was able to use the cryptocurrencies in its wallets as it saw fit, including to carry on trades in its own right. Gatecoin’s audited financial statements treated the cryptocurrencies it held as its assets and “customer deposits” as liabilities.
The court decided that Gatecoin held the currencies in its own right under this latest version of the terms and conditions, and not on trust for its customers.
The practical implication of this decision is that for customers who accepted the latest terms and conditions, the “customer deposits” held by Gatecoin formed the assets of Gatecoin in the liquidation process. Investors making these deposits had no proprietary claim to the currencies in their accounts and would be treated as unsecured creditors of Gatecoin.
CRYPTOS ARE ‘PROPERTY’
The decision is significant in that the court confirmed that cryptocurrencies fall within the definition of “property” and are capable of forming the subject matter of a trust.
Prior to this decision, the court had granted interlocutory proprietary injunctions over cryptocurrencies without any party suggesting that cryptocurrencies were not “property”. The decision that cryptocurrency is property also aligns the Hong Kong position with that of other common law jurisdictions, which recognise the proprietary nature of cryptocurrencies.
THE WAY FORWARD
The case highlights the importance of the terms and conditions of cryptocurrency exchanges, which govern the extent to which an exchange is entitled to deal with users’ assets and protection (if any) offered in case of the exchange’s insolvency. Notably, cryptocurrencies held on trust for investors will be returned to investors in the event the exchange is wound up.
Under the existing and incoming licensing regimes in Hong Kong for centralised virtual asset trading platforms, licensed operators of virtual asset exchanges will be required to hold client money and cryptocurrencies on trust. This will ensure that all user or client assets will at all times be segregated from the assets of the exchange operator itself.
In contrast, similar to Gatecoin, unlicensed exchanges and trading platforms often hold client assets in their own right, as if the client assets are actually assets of the exchange operator itself. Users should be aware of the risks of depositing assets with unlicensed trading platforms and consider using trading platforms or other custodial solutions that ensure clear segregation of user assets and recognise the proprietary nature of cryptocurrencies.
Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by e-mailing Howard Wu (Shanghai) at email@example.com