THREAD: New Zealand High Court rules that crypto held by the insolvent Cryptopia exchange is property and was held in trust for the account holders. Good news for some but not all account holders. Read on https://twitter.com/courtsofnz/status/1247770583737102336

As background, Cryptopia filed for liquidation in 2019 after it was reportedly hacked and some - but not all - of the crypto was stolen.

This decision arose from a request by the Cryptopia liquidators for directions from the court about the remaining crypto, since the legal issue of whether the crypto was held in trust had important implications for different groups of claimants.

If the crypto was held in trust, any crypto must be returned to the Cryptopia account holders and cannot be sold to satisfy the claims of other creditors. As creditors would likely get 50% of their claims otherwise, they had an interest in defeating a trust.

To hash this out, the court appointed different sets of lawyers to represent the interests of regular creditors and account holders. The liquidators stayed neutral.

The two key issues were: (1) is crypto property? and (2) if it is property, was it held in trust? The NZ court found crypto is property. This is in line with various decisions in England & Wales, Singapore and Canada. See thread here. https://twitter.com/evanmthomas/status/1220394841412132864

The more critical question was whether the crypto was held in trust. The court found that it was, relying primarily on evidence that Cryptopia held the keys but recorded account holders’ holdings in a SQL database, without ever treating the crypto as its own.

As well, the last version of Cryptopia’s terms and conditions from 2018 added explicit language that crypto was held in trust, so by then Cryptopia was aware it could be considered a trustee and accepted that role.

While the account holders “won”, this isn’t a great outcome for all account holders. The court found that there was a separate trust for each type of crypto, which means that the loss due to the theft falls on the account holders who held the stolen crypto.

For example, all of the ETH was stolen, so ETH holders won’t get back any ETH unless it’s recovered, though presumably they will have an unsecured claim for damages if nothing else.

Also, if the value of a type of crypto has gone down in the past year, holders have effectively been forced to ride it all the way down.

But if you held crypto of a type that wasn’t stolen, the decision implies you should get it back in kind, in full, which means you keep any upside.

Interestingly, the court found an intention to create a trust primarily from the basic operating model of custodial crypto exchanges: holding crypto in pooled wallets with an off-chain database for recording customer holdings.

Acting as a trustee means hefty legal duties, and offering trustee services is a regulated activity in many jurisdictions. So custodial crypto exchanges may want to think about whether a customer or regulator can argue they are acting as trustees.

As for customers, if crypto held on an exchange is held in trust, that may expand the legal remedies for customers if the crypto is lost or stolen.

For example, even if the principals of a crypto exchange are not personally trustees, if they benefit from a breach of trust or assist in a breach of trust, there can be significant personal liability for the principals.

Similar exposure may exist for third parties, such as other exchanges used to liquidate crypto embezzled or stolen from a trust, as there can be liability for receiving trust assets when a reasonable person would be on notice of a breach of trust.

Disappointingly for property law fans, the court didn’t analyze in detail whether Cryptopia held the crypto under a bailment, another relationship where a party like a warehouse controls but does not legally own another party’s property, so is not a trustee.

The court mentions bailment in only one paragraph, saying there was no evidence of a bailment. The reasoning seems to be that there was no bailment because Cryptopia alone knew the private keys.

This doesn’t make a lot of sense. A bailment requires relinquishing control of property. Cryptopia’s exclusive knowledge of the private keys means it had exclusive control of the crypto, so that seems perfectly consistent with a bailment.

But overall this is a well-reasoned decision that protects the expectations of customers that when they hold crypto on an exchange, that crypto is still “theirs” and isn’t available to the exchange or the exchange’s creditors.