Virtual Currencies: Regulation and Risks

VIRTUAL CURRENCIES: REGULATION AND RISKS

Demetra Herdes

The legislative and judicial system has traditionally been slow to adapt to emerging technologies, leaving gaps through which innocent parties can be exploited. Although there are laws in place that impact the use of blockchain and cryptocurrencies, they are mostly unregulated and have been used with ill intent. In addition, most well-known cryptocurrencies were used and popularised by self-determined communities whose ethos has sometimes been ‘code is law’.1 This idea suggests that code regulates the behaviour of internet users.2 This article identifies legislation applicable to virtual currencies, its gaps, and provides examples of how courts have dealt with cryptocurrency scams.

Regulation and Lack Thereof

Much like the rest of the world, Ireland does not have any cryptocurrency-specific legislation.3 The financial legislation most likely to sketch the legal landscape is the Prospectus Directive, the European Union Markets in Financial Instruments Directive, the Alternative Investment Fund Managers Directive, and the Fifth Anti-Money Laundering Directive (5AMLD).4

5AMLD has been transposed into Irish law by the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021. This statute defines virtual assets as digital representations of value that can be digitally traded or transferred, and that can be used for payment or investment purposes. This definition expressly excludes digital

1 Robbie Morrison, Natasha CHL Mazey and Stephen C Wingreen ‘The DAO Controversy: The Case for a New Species of Corporate Governance?’ (2020) 3 Frontiers in Blockchain < https://www.frontiersin.org/article/10.3389/fbloc.2020.00025> Accessed 1 March 2022. 2 Primavera De Filippi, Samer Hassan ‘Blockchain technology as a regulatory technology: From code is law to law is code’ (2016) Volume 21 First Monday <https://doi.org/10.5210/fm.v21i12.7113> Accessed 1 March 2022. 3 A&L Goodbody, ‘Blockchain Ireland: The Legal 500 & The In-House Lawyer Comparative Legal Guide’ (December 2019) 3. 4 Maura McLaughlin, Pearse Ryan, Caroline Devlin and Declan McBride ‘Ireland’ in Michael S Sackheim and Nathan A Howell (eds), The Virtual Currency Regulation Review (3rd edn 2020) II.

representations of fiat currencies, securities or other financial assets.5 Through this amendment, persons offering services of exchange between virtual and fiat assets or between different forms of virtual assets, transfer services for virtual assets and custodial wallet providers, in other words, storage services,6 must apply customer due diligence, report suspicious transactions and implement procedures to prevent money laundering and terrorist financing.7

Cryptocurrency mining is an entirely unregulated activity.8 By contrast, the Revenue Commissioners confirmed that ordinary taxation principles do apply to economic activities involving virtual currencies and produced a manual offering guidance on this.9

Risk

In 2017, the Central Bank of Ireland issued a warning regarding Initial Coin Offerings (ICO), pointing to their unregulated nature. This makes them more vulnerable to fraud than other financial instruments such as bonds or equities, and to the possibility that investors will be left without an exit option. As there are no regulations directing the disclosure of information related to cryptocurrency ventures or assets, consumers are always at risk of making under-informed investment decisions.10 The European Securities and Markets Authority also highlighted that inadequate information along with flaws in the technology behind crypto can lead to consumers being the victim of cyber-attacks.11

In criminal law, cryptocurrencies such as Bitcoin and Ether have often been connected to drug offences and the Darknet, however, fraud and theft are now the biggest cryptorelated crimes.12 Chainalysis reported that $7.7 billion worth of virtual currencies were

5 Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021, s4(c). 6 ibid. 7 Criminal Justice (Money Laundering and Terrorist Financing) Act 2010. 8 McLaughlin et al (n 4) VI. 9 Revenue, Tax and Duty Manual Part 02-01-03, ‘Taxation of cryptocurrency transactions’ <www.revenue.ie/en/tax-professionals/tdm/income-tax-capital-gains-tax-corporation-tax/part02/02-01-03.pdf>Accessed 13 March 2022. 10 Department of Finance, ‘Discussion PaperL Virtual Currencies and Blockchain Technology (March 2018) <https://assets.gov.ie/6284/070219124115a1199ab02f0c4a8ba5589a7f40985a63.pdf> accessed 1 March 2022. 11 European Securities and Markets Authority Statement (13 November 2017) https://www.esma.europa.eu/sites/default/files/library/esma50-157829_ico_statement_investors.pdf accessed 1 March 2022. 12 Chainalysis, Crypto Crime Report (February 2022) 79. 143

taken by scammers in 2021,13 and that crypto based crime rose by 79% from 2020. The rise was mostly driven by the growth of Decentralised Finance (DeFi)14, which aims to create a financial ecosystem operating through smart contracts, thus eliminating the need for middlemen such as banks or lawyers. However, this sector is still emerging, and with new software protocols come code vulnerabilities ready to be exploited by hackers.15

Additionally, some hackers claim, ‘code is law’. They may extend its meaning to suggest that each actor is responsible for the code it created and thus should suffer the consequences of leaving openings for hackers. Andean Medjedovic, a 19-year old math and coding prodigy, claimed this after he exploited a weakness in the code of Indexed Finance, a DeFi platform, stealing $16 million. The teenager refused to return any funds, so the platform took legal action against him. Andean missed his first court appearance in December of 2021, prompting the court to issue an arrest warrant. This may be the first time a court will rule on the ‘code is law’ principle. It has been emphasised that the phrase was originally used to argue that the internet’s software code was only similar to law, and should not be interpreted literally.16

Approach Likely to be Taken in Ireland

The Central Bank of Ireland does not regard any cryptocurrency as legal tender, but as a speculative asset.17 This view, along with the definition provided by the Criminal Justice (Money Laundering and Terrorist Financing) (Amendment) Act 2021, suggest that an Irish Court of Justice will regard cryptocurrency as property.

Virtual currencies have also been treated as property in Irish criminal cases. In a set of High Court proceedings18, the Criminal Assets Bureau sought an order under section 3 of the Proceeds of Crime Act 1996, to prevent the respondent from disposing of Ether acquired in the course of drug dealings. In a set of earlier proceedings in the same case,

13 ibid 78. 14 ibid 5. 15 ibid 5-6. 16 Jan Oster, ‘Code is code and law is law – the law of digitisation and the digitalization of law’ (2021) International Journal of Law and Information Technology 101. 17 Centra; Bank of Ireland, ‘Explainer - What are cryptocurrencies like bitcoin?’ <https://www.centralbank.ie/consumer-hub/explainers/what-are-cryptocurrencies-likebitcoin#:~:text=Explainer%20%2D%20What%20are%20cryptocurrencies%20like,currencies% 20that%20use%20physical%20cash> accessed 1 March 2022. 18 Criminal Assets Bureau v Neil Mannion [2018] IEHC 729. 144

such an order had been granted for Bitcoin, but was not been sought at all for the very same Ether, as this virtual currency was not trading at the time.

The respondent claimed that the Criminal Assets Bureau were acting in an ad hoc and highly discretionary manner when reviewing his electronic equipment, specifically the wallet containing his Ether.19 While noting that the approach taken was less than ideal, Steward J asserted that it is ‘impossible’ for the State to prepare policies for every eventuality or act that could ever arise, as ‘there is no way to foresee every eventuality and plan for it’.20

The respondent also argued that seeking to obtain an interlocutory order on the Ether in this later set of proceedings is an abuse of process, against the rule that a party cannot raise a claim in subsequent litigation which should have properly been raised in previous proceedings.21 He argued that the Ether should have been dealt with in earlier proceedings, as it could be bought and sold at that time, even if it was not trading and even if it had a lower value. The High Court considered that the Ether had simply been overlooked in the first set of proceedings, as the commencement of its trading was not guaranteed, and may have well never happened. In granting the interlocutory order, the Court highlighted that the creation of virtual currencies was a giant economic and technological leap for society and that its effects are not yet fully grappled with, which made the oversight of the Bureau understandable in the eyes of the Court.22

Regarding both the Bitcoin and Ethereum as property to be seized, the Court granted the section 3 order. The judgement suggests that in the absence of legislation that specifically deals with the intricacies of cryptocurrency23, the courts will enforce already existing laws, to prevent individuals from benefiting from their wrongdoings.

Remedies Offered in Other Jurisdictions

The view that virtual currency is property has been adopted in the UK,24 when a company fell victim to an Initial Coin Offering fraud. Its sole director was persuaded by persons unknown to transfer Bitcoin and invest in cryptocurrency products. The

19 ibid [18]. 20 ibid [66]. 21 ibid [18]. 22 ibid [63]. 23 ibid [68]. 24 Ion Sciences v Persons Unknown and Others (unreported) 21 December 2020 (Commercial Court).

currency was traced through two cryptocurrency exchanges that held information about the owners of the accounts. The applicants sought a proprietary injunction, which the Court granted, making the case that Bitcoin is property under the common law definition. In granting this, along with a worldwide freezing order, the Court confirmed it is possible to grant injunctions against persons unknown, if they can be sufficiently differentiated from other users of the website. The freezing order was granted even though there was no evidence that assets could be caught by it. An ancillary disclosure order was granted against Binance Holdings Ltd, as there was a real possibility that the information they could provide would lead to the location of the applicant’s property, and that without this information, the identity of the respondents would have never been discovered.

In November 2021, the largest ever recovery of cryptocurrency fraud proceeds was ordered at the request of the US Department of Justice and the US Attorney’s Office for the Southern District of California.25 The liquidation of $56 million worth of virtual currency resulted in the case of US v Glenn Arcaro26 the promoter of BitConnect. This instance was the largest cryptocurrency fraud ever criminally prosecuted. It resembled a Ponzi scheme, by convincing people to invest in cryptocurrency using their service, which would return incredibly high profits. The money was then used to pay back earlier investors, making it seem like the scheme was working. The U.S. Government took into custody the cryptocurrency, which will be sold, and the proceeds will be distributed to the victims.

Conclusion

Although legislative gaps exist, there are laws aiming to protect consumers from virtual currency scams. Because such currencies are likely to be seen as property, courts will strive to enforce existing criminal legislation, such as the Criminal Proceeds Act 1996 in cases of theft. Lastly, ‘it is not up for individuals […] to choose […] whether they intend to comply with regulation by law or with regulation by blockchain.’27 It is thus

25 The United States Department of Justice $54 Million in Seized Cryptocurrency Being Sold as First Step to Compensate Victims of BitConnect Fraud Scheme (November 16 2021) Press Release Number 21-1133 https://www.justice.gov/opa/pr/56-million-seized-cryptocurrencybeing-sold-first-step-compensate-victims-bitconnect-fraud Accessed 1 March 2022. 26 US v Glenn Arcaro; 21-CR-02542-TWR. 27Oster (n 16).

submitted that the ‘code is law’ principle would offend the rule of law, a fundamental notion underpinning legal systems in most liberal democracies.28

28 Raymond Byrne, J Paul McCutcheon, Laura Chaillane, Emma Roche-Cagney, Byrne and McCutcheon on the Irish Legal System (Seventh edn, Bloomsbury Professional 2020) [1.63]. 147