Q&A: Professional Negligence and Cryptocurrency (Part 1)

Q1: Why are solicitors likely to be instructing forensic accountants in relation to professional negligence claims against exchanges?

As the popularity of cryptocurrencies continues to mount, hacking and theft directed at individual cryptocurrency accounts and cryptocurrency exchanges have proliferated.

Surging cybercriminal activity in the cryptocurrency space has, not surprisingly, spurred a rise in litigation by cryptocurrency investors seeking redress for their lost cryptocurrency funds, including claims that others' negligence led to their losses. Proportionality and the cost of pursuing a claim are important issues, weighing up the potential costs and risks of pursuing such an action and the estimated amount that might be recovered.

Davidsons Forensic Accountants are regularly instructed by solicitors in relation to crypto matters, which usually involve establishing the ownership or ultimate destination of crypto assets. However, we believe there will be an increase in the number of claims brought against exchanges for negligence for failing to safeguard customers' assets.

There hasn’t yet been a negligence claim brought in the UK against an exchange; however, several such actions have been brought in the US, and the UK will surely follow their example.

Naturally, criminals gravitate to exchanges in jurisdictions with the weakest anti-money laundering defences. Controls are required, and exchanges often move jurisdictions to avoid having to satisfy regulatory requirements.

Our experience of dealing with exchanges is that most are cooperative, but there will be instances where an exchange won’t try to settle matters amicably. If the claimant and the exchange are based in the UK, making a claim may be less challenging.

The FCA stated that 85% of crypto asset firms that applied for registration failed to meet basic regulatory standards. These failings include a lack of anti-money laundering compliance, customer risk assessments, and ongoing monitoring. Crypto firms need to adapt and improve to enter the regulated space properly.

Regulators will expect crypto firms to ensure that they know who their customers are and where they are based. This is why locating customers and transactions is imperative. Knowing data such as domain names and IP addresses, combined with blockchain intelligence, will help an exchange improve its compliance systems. As an exchange grows, compliance programs will need to evolve and grow with it.

The Quincecare case relates to regulated banks. Exchanges are not regulated and do not employ the same level of fraud prevention techniques that banks employ. Exchanges operate far more administratively than banks, exercising less monitoring of the wallets they operate. Some exchanges employ software that can track cryptocurrency, which is the proceeds of fraud, but that is irrelevant in circumstances where a customer has fallen victim to push payment fraud.