Key takeaways

The decision affirms the proprietary nature of cryptocurrencies in Hong Kong. The decision has significant implications for players in the cryptocurrency market:

• The decision offers greater certainty with respect to the legal status of cryptocurrencies and the rights and obligations pertaining thereto under the law.
• For cryptocurrency exchanges and their investors, the terms and conditions of use of the exchange are a key factor in determining whether the cryptocurrencies deposited are held on trust for an investor. Exchange users must carefully examine the terms and conditions.
• In an insolvency context, cryptocurrencies that are held on trust for exchange users will be returned to users if the exchange is wound up. In contrast, cryptocurrencies that are assets of the exchange will be realized to fund the costs of the liquidation and made available for distribution to unsecured creditors of the insolvent exchange.

In more detail

Gatecoin Limited ("Gatecoin") operated a cryptocurrency exchange platform. Customers opened accounts with the platform and deposited cryptocurrencies or fiat currencies ("Currencies") with Gatecoin for trading purposes. In March 2019, Gatecoin was wound up and joint and several liquidators ("Liquidators") were appointed.

The Liquidators took out an application under s.200(3) of the Companies (Winding up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) for directions from the Court on (1) the characterization of the Currencies held by Gatecoin; and (2) the allocation of the Currencies to Gatecoin's customers.

The terms and conditions of Gatecoin

Gatecoin had updated its terms and conditions on a few occasions. The terms and conditions in place prior to the winding up contained no express declaration of trust and expressly disclaimed any fiduciary relationship between Gatecoin and its customers. The terms and conditions further provided that the Currencies may be stored in pooled blockchain assets accounts or omnibus fiat accounts.

In practice, the Currencies deposited by Gatecoin's customers were treated as Gatecoin's assets. Gatecoin was able to use the cryptocurrencies in its wallets as it saw fit, including to carry on trades in its own right. Gatecoin's audited financial statements treated the cryptocurrencies held by Gatecoin as its assets and the "customer deposits" as liabilities.

The court held that Gatecoin held the Currencies in its own right under this latest version of the terms and conditions, and not on trust for its customers.

The practical implication of this decision is that for customers that have accepted the latest terms and conditions, the "customer deposits" held by Gatecoin formed the assets of Gatecoin in the liquidation process. The investors making these deposits will not have a proprietary claim to the Currencies in their accounts and will be treated as unsecured creditors of Gatecoin.

Cryptocurrencies are "property"

The decision is significant in that the court confirmed that cryptocurrencies fall within the definition of "property" and are capable of forming the subject matter of a trust.

Prior to this decision, the court had granted interlocutory proprietary injunctions over cryptocurrencies without any party suggesting that cryptocurrencies were not "property." The decision that cryptocurrency is property also aligns the Hong Kong position with that of other common law jurisdictions, which recognize the proprietary nature of cryptocurrencies.

The way forward

The case highlights the importance of the terms and conditions of cryptocurrency exchanges, which govern the extent to which an exchange is entitled to deal with users' assets and the protection (if any) offered to exchange users in the case of the exchange's insolvency. Notably, cryptocurrencies that are held on trust for investors will be returned to investors in the event the exchange is wound up.

Under the existing and incoming licensing regimes in Hong Kong for centralized virtual asset trading platforms, licensed operators of virtual asset exchanges will be required to hold client money and cryptocurrencies on trust. This will ensure that all user or client assets will at all times be segregated from the assets of the exchange operator itself.

In contrast, similar to Gatecoin, unlicensed exchanges and trading platforms often times hold client assets in their own right, as if the client assets are actually assets of the exchange operator itself. Users should be aware of the risks of depositing assets with unlicensed trading platforms and should consider using trading platforms or other custodial solutions that ensure clear segregation of user assets and recognize the proprietary nature of cryptocurrencies.

1 [2023] HKCFI 914

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