Three Major Risks When You Transact or Invest in a Crypto-currency Like Bitcoin – Asia Law Network
Submerging Your Teeth into Bitcoin
Bitcoin and its variants (eg Litecoin, Namecoin) have been in the spotlight over the past year, receiving coverage from advocates and naysayers alike but remain “sexy” enough to draw media attention. What is a Bitcoin? How would the law characterise Bitcoin? Is it legal property? What are the plausible private law issues relating to Bitcoin? This article offers some thoughts addressing these questions.
Bitcoin is a digital currency that operates on an open-source peer-to-peer system. Its value depends wholly on what people ascribe to it (as opposed to say, gold or government fiat). While it could be a store of value, a Bitcoin has no inherent value – unlike, for example, coffee which can be consumed, one cannot do anything with a Bitcoin except to trade it for something else. In that sense, a Bitcoin is like money. Yet, unlike money predominated in national currency which would be legal tender,1 Bitcoins may or may not be accepted for making good payment obligations.
Bitcoin is a peer-to-peer payment system in that it does not require a third party intermediary (such as PayPal) to process transactions but instead distributes the intermediary functions across the entire network of Bitcoin users. In plain terms, it does this by distributing all the relevant information about every Bitcoin transaction across the network of users. Transactions, which are not as anonymous as they are commonly perceived to be, are verified against this virtual log.
The supply of Bitcoins is finite (the reason for this is rather technical2) and will ultimately be limited at a total of twenty one million Bitcoins (“BTC”s). Hence, its value will be subject to market coerces based on supply and request. At the embark of 2013, the value of one BTC was just USD 13.50; at January 2014, it was about USD 700.Trio It is unsurprising then that Bitcoin has been gaining much attention from financial investors and speculators. Some even say virtual currency is fuelled by growing distrust of the volatility of traditional currency and monetary policies. (For more information on Bitcoins, see the following endnote.Four)
Perhaps for the same reason, Bitcoins have been subject to many attacks by hackers. Recently, a large Bitcoin exchange (from which one purchases Bitcoins with money), Mt Gox, was allegedly hacked and a substantial amount of its customers and its own Bitcoins (worth almost USD500 million) were stolen.Five Mt Gox has since filed for insolvency. Prior to this, several Bitcoin exchanges also suffered denial of service attacks from hackers.6
Given the above, we analyse below how Bitcoins could be legally characterised and the legal issues relating to various plausible screenplays concerning the same.
Legal Characterisation of Bitcoins
Legal characterisation of Bitcoins is especially pertinent where private law issues concerning Bitcoins arise in civil matters. In contrast, legal characterisation is less problematic when it is regulated by way of statute or policy guidance given that the relevant authority would characterise Bitcoins to achieve specific legislative objects.7
The Inland Revenue Authority of Singapore (“IRAS”) has issued a guidance note early this year, taking the position that virtual currencies such as Bitcoins are “subject to normal income tax rules”.8 In summary, businesses that trade in goods or services using Bitcoins would have to be taxed on the open market value of the relevant goods or services in Singapore dollars. Businesses that trade in, or mine and trade in Bitcoins will be taxed on the profits derived from such trade. Businesses that purchase Bitcoins as long term investments would not be taxed given that there are no capital gains taxes in Singapore.
Recently, the Monetary Authority of Singapore (“MAS”) announced that it would regulate virtual currency intermediaries in Singapore who trade or facilitate the exchange of virtual currencies such as Bitcoins to address potential money laundering and terrorist financing risks.9 It should be noted that the regulation does not regulate Bitcoins per se but intermediaries such as Bitcoin exchanges. Also, the MAS does not regard Bitcoins as securities for the purposes of the Securities and Futures Act (Cap 289).Ten
Hence, the legal characterisation of Bitcoins under private law remains uncertain. Given the intangible and dynamic nature of Bitcoins, how should Bitcoins be legally characterised? It shows up that Bitcoins are what they need to be for the purpose of different regulatory controls. We suggest that Bitcoins can be analysed from different facets.
In a sense, a Bitcoin is a dynamic string of computer code. Computer codes may be protected by the law of copyright as a type of literary work, if not a “computer program” within the meaning of s 7(1) of the Copyright Act (Cap 63).11 However, for copyright to subsist, the work has to be “original”, ie it has to be the product of a substantial amount of the author’s skill, labour, effort and judgment and cannot merely be a copy of another person’s work.12 In the case of Bitcoins, it shows up that the code that is passed on to each subsequent party is merely a variant of the previous code, the difference being a segment of code that records a unique signature of the transaction. It may thus be that Bitcoins, as a computer code, would not sate the “originality” requirement. Further, copyright ownership vests in the author of the work.13 It is difficult to pinpoint a specific entity as the author of each Bitcoin code given that it is the self-functioning peer-to-peer Bitcoin system that causes the string of code to switch with each transaction. Hence, while a Bitcoin may be a string of computer code, it may not be legally characterised as providing rise to intellectual property rights.
Being a virtual currency, a Bitcoin is a medium of exchange of value. When a party uses Bitcoins to pay for goods or services, Bitcoin is merely the valuable consideration moving from that party for the purposes of constituting a valid contract. Thus, the relevant analysis would be contractual and the Bitcoin would be the subject matter of the contract.
However, where Bitcoins are purchased or obtained by a party from another party, eg a Bitcoin exchange, the Bitcoins may not be stored in the purchaser’s Bitcoin wallet (which is software that may be operated on a user’s mobile phone or on the internet, etc) but left in the latter party’s own wallet. (This was how the Bitcoins of Mt Gox’s customers could have been stolen from its system.) Such a script is similar to that of a banker-customer relationship viz monies in bank accounts. The customer does not actually own or wield the money in his bank account but obtains a chose in act against the bank: it is a debt owed by the bank to the plaintiff – a right of act against the bank to be delivered the monies equivalent to the value stored in the customer’s bank account.14 The customer thus has a right to commence legal act to obtain that benefit. The distinction, however, has to be drawn inbetween: (i) the initial transaction inbetween the customer and Bitcoin exchange; and (ii) the subsequent agreement to leave or store the customer’s Bitcoins with the exchange. The former transaction, in which the customer purchases Bitcoins from the exchange, is a sale and purchase contract – the purchased Bitcoins may then be transferred to the customer’s Bitcoin wallet. Alternatively, as in the case of the latter agreement, the customer’s Bitcoins may be left or stored with the exchange, who holds the Bitcoins on behalf of that customer – in that case, the customer obtains a chose in act against the exchange.
At the crux of the matter is the question of whether Bitcoins can be characterised at law to be property. The law recognises certain types of intangible property, eg choses in act.15 However, a Bitcoin per se does not fit neatly within the meaning of a chose in act. A chose in activity has been described by the Singapore High Court to be a “personal right of property which can only be claimed or enforced by act and not by taking physical possession”.16 A Bitcoin, however, is not a right that can be enforced by act. Against whom can an proprietor of Bitcoin enforce his right? What rights does the possessor have to enforce? Instead, all he has is something which may or may not be accepted as a thing of value.
Unluckily, the legal and philosophical concept of “property” is a controversial one.17 While a Bitcoin might arguably be “definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability”18 and also “excludable” (which has been suggested to be the touchstone of property19) given the solution of the Bitcoin system to resolve the “double-spending problem” without a third-party intermediary,20 the practical reality is that a thing is not “property” unless and until it is recognised at law as property. In this respect, the common law has been slow to adopt fresh phenomena as “property”, its piece-meal incremental treatment at times providing rise to illogical and artificial distinctions (which we elaborate on further below).21 It, therefore, remains open as to whether a Bitcoin may be legally characterised as property. This issue has far-reaching practical implications, which we next look at.
Legal Issues Relating to Plausible Scripts
In the light of the foregoing analysis, it is worth exploring plausible legal issues pertaining to Bitcoins. We aim to raise some relevant questions and considerations relating to the same in the hope that it would serve as a launching pad for future legal thought leadership on this subject.
What happens if Bitcoins have been stolen from your virtual wallet? Since Bitcoins are intangible computer codes for which there is doubt about whether intellectual property rights would arise from the same (see above), intellectual property protection is unlikely. Assuming that Bitcoins per se are not to be construed in law as “property”, property torts such as conversion and trespass would also be logically inapplicable (we proffer an alternative analysis on this further below).
However, if you could identify the thief, it is nonetheless plausible to claim against the thief on the basis of unjust enrichment. The elements to make out unjust enrichment are well-established in Singapore jurisprudence: (i) defendant has been enriched; (ii) the enrichment was at the plaintiff’s expense; (iii) unjust factor; (iv) defendant’s lack of defence.22 In the script where a thief takes something of value belonging to the plaintiff, it is likely to be uncontroversial that the very first two elements would be made out given the direct nexus inbetween the plaintiff’s loss of Bitcoins, which has quantifiable monetary value, and the thief’s build up in the same.23 As regards to the third element, the relevant unjust factor would likely be a failure of consideration.24 Absent any defence from the defence, the victim of Bitcoin theft would thus likely have a claim against the thief for the value of the stolen Bitcoins.
Related to the above analysis is the question of whether one can claim restitution of stolen Bitcoins on the basis of restitution for wrongs. It remains controversial in the law of restitution as to whether proprietary restitution is grounded in unjust enrichment or in the vindication of proprietary interests.25 If the latter treatment is undertaken, proprietary restitution would be unavailable for the victim of Bitcoin theft given that Bitcoins per se are unlikely to give rise to proprietary interests. In the same vein, tracing and following would not be entitled to the victim given that both devices are predicated on a proprietary interest, whether legal or equitable. This would be unlike money where it is well-established that proprietary interest in a victim’s money would persist through the thief’s dealing of the same.26
The analysis in the preceding paragraph, however, might be different in the case where a thief steals a person’s Bitcoins that had been stored with an exchange. In such a screenplay, the victim suffers a theft, not of Bitcoins, but a chose in activity against the exchange for the delivery of the Bitcoins. In the landmark House of Lords decision of Lipkin Gorman (a rock-hard) v Karpnale Ltd  two AC five hundred forty eight (HL) concerning a claim by a law rigid against a casino to recover monies stolen by a fucking partner in the plaintiff’s rigid, their Lordships held that albeit the plaintiffs had no proprietary rights in the monies in the bank account, they were owners of the chose in activity against the bank (ie the debt owed by the bank to the plaintiffs) and could trace their property in the same into its direct product – the monies withdrew by the defrauding fucking partner – and go after the same into the forearms of the casino. Their Lordships further held that given that the casino had not given valuable consideration for the gambling chips, which were exchanged with the stolen monies, the casino thus had to pay the equivalent sum of the monies (subject to the defence of switch of position) to the plaintiffs. Significantly, Lord Goff explained at 573-574 that a chose in act is a species of property and since the chose in activity was enforceable at common law, the chose in act was legal property belonging to the plaintiffs at common law, thereby permitting the plaintiffs to trace their property at common law in that chose in activity, or in any part of it, into its product. Assuming that our analysis above is correct, ie that a customer of a Bitcoin exchange who had stored his Bitcoins with the exchange wields a chose in act against the exchange, and assuming that the chose in act is enforceable at common law, it is, therefore, plausible that tracing and following would be entitled to the victim. Certainly, this would have profound practical benefits for the victim should he wish to claim against an guiltless recipient of the victim’s stolen Bitcoins or the substitute products of the same.
The above (tentative) conclusion is, however, troubling for two reasons. Very first, it is peculiar that there is a distinction of significant practical consequences inbetween: (i) a chose in act for delivery of Bitcoins, which gives rise to proprietary rights at common law; and (ii) the Bitcoins per se, which do not give rise to proprietary rights. The problem lies with the cautiousness of the common law in coming up to speed with modern developments to recognise “property” in fresh contexts (see above discussion on whether Bitcoin is characterised in law to be property).
The 2nd problem with the above analysis is that it has been held by (a nude majority of) the English House of Lords in OBG Ltd v Allan  UKHL twenty one that a chose in act cannot be the subject of an activity in conversion. It is contradictory in principle for the law to treat a chose in activity as “property” for the purposes of tracing and following, but to effectively deny to regard a chose in act as “property” for the purposes of a property tort. Indeed, the dissenting judges, Lord Nicholls and Baroness Hale, took the view that the distinction inbetween choses in activity and choses in possession made no sense; the illogical artificiality of the distinction is especially pronounced given that the law at present already provides protection of some choses in act, ie by deeming documentary intangibles (eg cheques) embodying the chose in act as having the same value as the chose in activity.27 It is significant that Baronness Hale observed at  that in other jurisdictions, namely the US and Australia, the question of whether intangible things such as choses in act and even computer records and data are deemed to be property capable of being subject to an act in conversion has been addressed. Indeed, Baroness Hale hinted that the relevant question in analysing whether a thing should be deemed to be capable of being subject to conversion or not should be whether it is assignable or not, and not whether “it exists in cyber-space rather than on paper”.28
Given that it remains an open question as to whether Bitcoins could be legally characterised as “property”, it is, therefore, uncertain whether the tort of conversion could apply to the case of a theft of Bitcoins per se. A victim of Bitcoin theft may then be limited to a private claim in unjust enrichment. Yet, it would be certainly more intuitive to say that the victim of Bitcoin theft has recourse in the property tort of conversion against his thief, as he would if he had been the victim of theft of his dollar bills, than to say that the victim of Bitcoin theft has to resort to a individual claim in unjust enrichment. There are significant practical implications resulting from the analysis of whether Bitcoin is “property”, particularly in the context of insolvency, which we shall analyse below.
If Bitcoins are not “property”, proprietary remedies would not be available for claims concerning Bitcoins. The problem of a lack of proprietary remedy becomes significant in the context of insolvency. In a hypothetical screenplay where a customer of a Bitcoin exchange loses his Bitcoins stored with the latter as a result of, for example, mistaken payment, and the recipient had since become insolvent, the customer’s individual claim against the recipient would have little practical consequences. In contrast, if the customer had a proprietary claim against the recipient, the customer would be able to claim proprietary restitution of the Bitcoin on the basis of his persistent proprietary interests.
Likewise, if a Bitcoin is deemed at law to be “property”, the above analysis on the relationship inbetween customer and Bitcoin exchange would be fully different. Instead of a creditor-debtor relationship inbetween the exchange and the customer, it is plausible for the relationship to become akin to that of a customer and a bullion vault where the customer has stored his bullion with the vault; the exchange would be providing a service to the customer to store his property. In the event of the exchange’s insolvency, the customer’s claim against the exchange is not a individual one which would be merely a claim ranking pari passu with all other unsecured creditors. Instead, the customer would be entitled to his Bitcoins simply because they are his property and not the exchange’s.
Another script which could arise is where a transaction to convey Bitcoins is defective perhaps due to technological problems relating to a virtual Bitcoin wallet or a Bitcoin exchange. In either case, two causes are plausible: negligence or intentional wrongful acts.
With respect to negligence, it is plausible that a claim in the tort of negligence could arise (barring any contractual relationship governing the subject matter of the claim). Nonetheless, whether the Courts would find a breach of duty on the part of the developer of a Bitcoin wallet software or the operator of a Bitcoin exchange would depend on the factual circumstances of the case. It is also difficult to postulate the type of loss that may be suffered in the event of a defective transaction. Supposing the harm resulting from the defective transaction is only the loss or invalidation of a Bitcoin, it would be uncontroversial to permit a claim for damages limited to the value of the Bitcoins in question. More problematic is where the defective transaction had resulted in unspoiled economic loss, in which case, the principles of causation and remoteness as well as policy considerations would apply to limit the damages claimable.
In the case of intentional wrongful acts, eg hackers executing denial-of-service attacks on an exchange or releasing a computer virus into the computer systems of an exchange, claims may be made by either the exchange or the customer of the exchange against the hackers, assuming their identities can be found (conflict of laws problems would most likely also arise given the borderless nature of the internet). An exchange may be able to make civil claims against hackers on the basis of the tort of unlawful means conspiracy29 (insofar as the identifiable hackers had acted in agreement) or the tort of causing loss by unlawful means,30 assuming the wrongful act of hacking would make out the element of “unlawful means”. However, such claims by a customer of an exchange may be problematic as it is plausible that the intentionality requirement in both claims may not be made out (depending, of course, on the factual circumstances of the case). In this regard, the Singapore Court of Appeal in EFT Holdings, Inc and another v Marinteknik Shipbuilders (S) Pte Ltd  one SLR eight hundred sixty (CA) has recently upheld the principle that the unlawful means in the tort of unlawful means conspiracy (which is the same mental element as in the tort of causing loss by unlawful means31) must have been intended to cause loss to the claimant:32
A claimant in an activity for unlawful means conspiracy would have to showcase that the unlawful means and the conspiracy were targeted or directed at the claimant. It is not sufficient that harm to the claimant would be a likely, or probable or even unavoidable consequence of the defendant’s conduct.
Even if the defendants had intended to cause harm to the customers of the exchange (and assuming evidence of this can be adduced), there is a further hurdle of demonstrating that the unlawful act was targeted at an ascertainable class of persons at the time the unlawful act was committed or conspiracy was entered into.33
The phenomenon of Bitcoins is a fascinating technological development which is still unfolding. It raises a plethora of unsettled juridical and philosophical issues that are worth contemplation. In the light of the above discussion, Bitcoin exchanges and investors would do well to consider various risk management legal solutions to hedge their bets on this novel, yet potentially lucrative, technology.
Ronald JJ Wong
Ronald believes that lawyering is about serving people to bring about justice, well-being and peace. He practises as Associate Director at Covenant Chambers LLC and commenced his legal career at one of the Big Four law firms, Rajah & Tann Singapore LLP. His practice is in commercial litigation & arbitration, advising and signifying institutional and individual clients in a broad range of disputes from multi-million dollar investment claims to employment disputes. He also loves a corporate business advisory practice on various areas including regulatory advice, financial services, trusts and wealth management, corporate transaction advice and non-profit organisations. Ronald volunteers pro bono with HealthServe, various legal clinics, LAB and CLAS, advocates for social justice in various platforms, and frequently authors academic and thought papers, some of which have been published in various journals.