We recently reported on the judgment in Nico Constantijn Antonius Samara vs Stive Jean Paul Dan [2022] HKCFI 1254, where the Hong Kong court granted proprietary remedies over misused bitcoin.
In the recent case of Yan Yu Ying vs. Leung Wing Hei [2002] HKCFI 1660, the court was faced with “rather unusual circumstances” and had to consider the functions of Bitcoin, the digital keys, their storage in “wallets” and how wallets are initialized, before deciding whether a preliminary proprietary injunction should be granted to the Plaintiff.
Factual background
The plaintiff claimed that the defendant stole her Bitcoins, after persuading her to put them in a “cold” wallet provided by the defendant. The defendant claimed to have helped the plaintiff purchase and set up a new Trezor wallet at a meeting. The plaintiff, believing she was the only person with the mining seed, transferred her Bitcoin to the wallet. When she later wanted to sell the Bitcoin, she discovered that they had gone.
It turned out that the wallet that the defendant claimed to have set up for the plaintiff at the meeting was not new Trezor hardware, but was hardware that the defendant had set up before the meeting and contained a wallet that he made.
Since the hardware was set up by the defendant, he had the discovery seed. As explained by the expert, Defendant could use the recovery seed to recreate the wallet and then gain access to the private keys associated with the subject Bitcoin that Plaintiff later transferred to the wallet (not knowing that Defendant had access to it even though Defendant did not have physical possession of Plaintiff’s Trezor hardware).
The Defendant’s defense was that he took the Trezor hardware delivered to the Plaintiff for the purpose of receiving the Plaintiff’s Bitcoin, pursuant to an exchange agreement, but the Plaintiff then refused to complete the transfer. There was then an accidental mix-up of the Trezor hardware so that the defendant ended up with the new wallet to be given to the plaintiff. Although he wasn’t sure if this was what happened, he simply wiped the hardware in his possession later that day and recreated his wallet with the recovery seed.
Features of Bitcoin, digital keys, their storage in wallets and how wallets are initialized
Using expert evidence, the court summarized the characteristics of Bitcoin and the role of digital keys in Bitcoin transactions:
- Bitcoin involves no physical coin;
- Bitcoin technology is a distributed, peer-to-peer system. Bitcoin users communicate with each other using the Bitcoin protocol;
- There is no central control or authority that issues Bitcoin. There is also no centralized ledger similar to traditional banking and payment systems. Bitcoin transactions are recorded in an open distributed ledger using blockchain technology;
- Ownership of Bitcoin is established through digital keys, Bitcoin addresses and digital signatures;
- A Bitcoin transaction is the operation that allows the payment of Bitcoin from one owner to another;
- Every Bitcoin transaction requires a valid signature to be included in the blockchain, which can only be generated with valid digital keys. Anyone who has a copy of these digital keys has control over the Bitcoin in that account;
- In the payment part of a Bitcoin transaction, the recipient’s public key is represented by the Bitcoin address, which is used in the same way as the recipient’s name on a check. The Bitcoin address is generated, and corresponds to a public key;
- Digital keys come in pairs, namely a private key and a public key.
- A Bitcoin transaction relies on a digital signature to verify ownership of Bitcoin that can be used by the payer. The digital signature used in Bitcoin is based on elliptic curve public key cryptography, of which the public key is generated from a randomly generated private key, and the Bitcoin address (used as the recipient’s address) is generated from the public key. With the private key, the recipient can use the Bitcoin received by the Bitcoin address generated by the corresponding public key.
Since the dispute was about understanding the distinction between using a “cold” wallet, i.e. the hardware, and a “hot” wallet, the court explained that the digital keys are stored in a “wallet”, which can be “hot”. which is connected to the internet, or “cold”, which is not. Trezor was a hardware device where a cold wallet can be created. A wallet does not actually “store” Bitcoin. The purpose of the wallet is to generate and store the private keys associated with the “wallet” and provide an interface to perform cryptocurrency transactions. When a wallet is initialized, a 24-word recovery seed is created for recovery purposes, and the Bitcoin associated with the private keys stored in the wallet will also exist in the wallet.
Proprietary injunction granted in favor of plaintiff
The defendant ended up having control over the wallet to which the plaintiff transferred the private keys associated with her Bitcoin, and he had the ability to access those Bitcoin. The court concluded that the circumstances in which the state of affairs arose allowed for a serious and thorough assessment during the trial.
The plaintiff sought both a Mareva injunction to freeze the defendant’s assets and a proprietary injunction with respect to the Bitcoin transferred to the wallet that the defendant retained. The court was not convinced that a good arguable case had been established to grant a Mareva injunction, as it believed that the plaintiff faced problems with forensic evidence about the authenticity of messages relating to the existence of the swap agreement, which remained a serious issue to be tried . However, the court agreed that plaintiff had established a triable triable issue, which is the lower threshold for granting the proprietary injunction.
Comment
With the growing population of crypto users and the excitement created by the metaverse and NFTs, more people are getting familiar with concepts in the fintech world. This case shows that the terminology and concepts used in the crypto world are gradually and inevitably becoming a part of society that our courts must familiarize themselves with, especially as there is likely to be an increasing number of disputes about cryptocurrencies and fintech products and -services. The granting of a proprietary injunction in this case again demonstrates that Bitcoin and other cryptocurrencies can be protected as property under Hong Kong law.
This case shows that it will greatly assist the court in assessing the parties’ arguments if the parties in cryptocurrency disputes can clearly explain the relevant terms and terminology and provide expert evidence as needed. It also provides useful guidance for assessing the amount of fortification required to support a proprietary cryptocurrency mandate. The court had difficulty with this task, given Bitcoin’s volatility and consideration of the risk of losing business to the defendant (who was a businessman in the blockchain industry) as a result of the injunction. The court considered the defendant’s investment pattern and ordered the plaintiff to pay garnishment to cover the cost of the defendant borrowing 50% of the value of Bitcoin for two years, which was rounded up to HK$5.5 million.
