How to freeze crypto assets

Note: none of this is legal advice

An interesting question is whether it is possible for the courts to force crypto custodians/digital vaults/digital wallet service providers (crypto custodians from hereon) to comply with orders to freeze assets, or whether it is possible to draft an order that effectively allows for the freezing of crypto assets.

https://www.sec.gov/news/press-release/2018-8
https://www.coindesk.com/us-court-freezes-bitconnect-assets-as-lawsuits-mount/?utm_content=buffer8e1b0&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

Unlike a bank or traditional financial custodian, crypto custodians typically hold the private keys (a string of numbers and letters which allows anyone with knowledge of it to control or transfer the crypto assets) and do not ‘hold’ or record legal ownership of crypto assets.[1]

Beyond the problem of defining the “asset” subject to court order, there is the problem of actual enforcement. Courts could order crypto custodians not to allow for a defendant’s crypto assets to be transferred, however that may be pointless if the defendant also holds the private key and is willing to accept the legal consequences of effectuating a post-freeze transfer. Three possible (not mutually exclusive) solutions are:

  1. If the defendant also held the private key, crypto custodians could be directed to transfer the crypto assets out of the wallet, and into a court controlled wallet.
  2. Crypto custodians could also facilitate multi-sig storage and give one of the keys to the courts, thereby preventing any transfers without the court’s consent.
  3. Perhaps going forward, certain crypto custodians could be required to establish exclusive ownership of the private keys, and thus, exclusive control of the crypto assets — not only as an added security measure (because the risk of crypto theft increases with the number of people holding the private key) but to allow for compliance with court orders.

Given that many crypto assets such as bitcoin were created to be censorship resistant, a government controlled crypto custodian would introduce another centralized third party intermediary into the ecosystem and may seem unattractive to most (unless you manage an investment fund and need to comply with SEC regs).

There is nothing stopping the defendants from memorizing their private key or managing the storage of their crypto assets using cold storage/hardware wallets. However, as the value of crypto assets and the risk of loss rises (e.g., a UK crypto trader was robbed of his bitcoin at gunpoint and a Canadian crypto exchange was hit by armed robbers last week), there could also be an increase in demand for secure custodian services, even at the price of those services operating subject to the reach of courts/regulators.

https://xkcd.com/538/

[1] Another question is — how do you define legal ownership of bitcoin? It is generally accepted that possession of private keys = ownership of bitcoin. But how do we reconcile concepts of property law with the fact that ownership of bitcoin is such a fragile and subjective concept?

For e.g. Alice holds private keys to 100 bitcoin. If Alice shares the private key with Bob, do they become joint owners of the bitcoin? How do we know that Alice is the rightful owner? Will the answer change if Bob accidentally/purposely saw her private keys on her phone when she left it on the table? What if Alice publishes her private keys on the internet — does the bitcoin become a public good, belonging to anyone who had access to it, up until the moment an opportunistic person transfers the bitcoin to their own wallet? Is that considered stealing or did Alice effectively give away her bitcoin? Where does the intent of the private key holder come in, or is it even relevant at all?


About me: I am an Australian lawyer living in New York with experience at the Australian Securities and Investments Commission (ASIC). I am interested in the legal questions on whether emerging tech fits under existing laws, policy questions as to what should be regulated, and technical questions as to how uses of tech can be regulated (where necessary).

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