Crypto custody case shows DeFi becoming mainstream
Updated
Cryptocurrency proponents are monitoring a Canadian court ruling that granted interim custody of $16m (£12.12m) in allegedly stolen digital assets to a third party to see how it could affect decentralised finance (DeFi) in the future.
An Ontario court awarded an Anton Piller order, or civil search warrant, to law firm Cicada 137 and assigned the company the missing digital assets and their litigation and recovery rights.
Cicada 137 is seeking several court orders against Andean Medjedovic, a 19-year-old Hamilton, Ontario, resident who allegedly stole the assets in October 2021 from the Indexed Finance System, which runs on the Ethereum blockchain.
Indexed provides a way of buying and holding several crypto assets through one cryptocurrency.
“DeFi and digital assets are becoming increasingly more mainstream,” Jason Beitchman, a Toronto-based civil litigation lawyer with Rayman Beitchman, told Capital.com. “As regulation in the sector grows, and institutional investors onboard, there is an increase in stability but also a move away from what may have been the original intentions of a decentralised economy. Growth requires change.”
The case is a very typical battle over an alleged conversion of assets, he added. The plaintiff is arguing that assets were taken unlawfully and the defendant is asserting a right to those assets.
Courts addressing digital assets
“The case is also one of a half dozen or so early examples in the last couple of years regarding how the courts are demonstrating a willingness and ability to address digital assets as a legal concept of value,” Beitchman said.
He said it’s remarkable that legal concepts dating back a century or more are sufficiently flexible and adaptable to apply to something new like digital assets, wallets, private keys and crypto exchanges. This decision, he added, will lead to more clarity in the law and regulation of cryptocurrency.
“A framework for the regulation of crypto is evolving, and, in my view, is part of the reason for crypto’s explosion in market value and market share,” he said. “There is a balance between regulating so much that it will choke out the purpose and benefits of crypto, but we are a long way from that, and the evolution will continue.”
Cicado also obtained a court order that prevents Medjedovic from distributing assets until the case is resolved.
Arrest warrant issued
A judge issued an order for Medjedovic’s arrest in December 2021 after he refused to transfer funds to Cicada or appear in court.
According to Canadian Lawyer, an Anton Piller order allows a party to enter a property, investigate, seize assets, require records and have property detained under the control of an independent third party. This form of civil search warrant is designed to preserve certain materials when they are on jeopardy of being destroyed.
Such orders are often used in intellectual property cases.
Benjamin Bathgate, a lawyer with McMillan who is representing Cicada, said the case is the first in Canada, and among the first in the world, concerning attacks against blockchain smart contracts and interactions between users on DeFi trading platforms, Canadian Lawyer reported.
First crypto-related Anton Piller order
This marks the first time that an Anton Piller order was used in a cryptocurrency case, according to Bathgate, Canadian Lawyer also reported.
In a statement to Capital.com, Bathgate said Cicada has financed the civil litigation and is seeking justice on its and other victims’s behalf. Cicada provided the evidence and brought the case that resulted in the orders against Medjedovic and the arrest warrant, and those efforts pose the best chance of holding him accountable and recovering the allegedly stolen cryptocurrency.
“Despite Mr. Medjedovic’s claims that he wants his day in court – to defend his actions and assert code is law – he has refused the court’s calls to participate in its process,” Bathgate said.
“Rather, he thumbs his nose at court orders, and continues to transact in the victims’s cryptocurrency tokens, with no apparent appreciation that he will be no exception. His unlawful conduct will invariably be held to account by the same rules of law that govern all our interactions. His disappearance will only serve to delay that endgame, not avoid it.”
The lawyer’s team includes associates Reuben Rothstein and Joseph Osborne, and law student Madeline Klimek.
Bathgate told Canadian Lawyer that the case will be the first legal test of the code-is-law, also known as codeslaw, theory, a popular belief among computer programmers on how law applies to the digital world.
Novel concept
Beitchman said the code-is-law concept is “novel,” and “We may see how that develops in this case.”
University of Toronto finance professor Andreas Park told Capital.com that the code-of-law defence is “interesting.” He explained that DeFi generally operates on two components – a piece of code that operates on a blockchain, usually Ethereum.
The creator of a protocol deploys the code that anybody can access through a related website.
“Essentially what the plaintiffs here alleged is that the attacker or the exploiter, that kid, stole funds,” Park said. “That's an allegation. So what he was able to do was to use protocols in such a way that he could extract funds from this protocol. …That's basically what happened. So, essentially, the plaintiffs argued that the attacker used the protocol in a manner which was not intended by them.”
Legal certainty of protocols
Park said the case raises questions about the legal certainty of the DeFi protocols, notably whether the creator controls the protocol even though the blockchain operates it.
“Obviously, there is an implied answer here, which is that the law still applies,” he said. “But, again, I think this is very tricky. Keep in mind one thing: In principle, DeFi is borderless. In principle, the ethos is, there’s no jurisdiction for it. So Canadian laws may very well differ from laws in the US and in Europe. Who is the ultimate judge going forward?”
He said it’s entirely possible that the court rules in favour of the defendant.
“If they rule against the accused, then I think the interpretation is: Digital assets do not live in the Wild West. There's still a set of rules that applies, codeslaw law is not (legal) code, if you want.”
But US lawyer Jason Gottlieb of New York-based Morrison Cohen, who specialises in cryptocurrency, told Capital.com that while some people insist DeFi is unregulated, all forms of finance are regulated.
“In the United States, the CFTC has broad anti-fraud and anti-manipulation authority over all commodities with futures markets, and – as two US district court judges have ruled – that includes anti-fraud authority over all cryptocurrency,” Gottlieb said.
Assets are just assets
Assets are just assets, he added.
“It may be new, it may be complicated, it may be abstract – but ultimately, people shouldn’t be allowed to just take your stuff, whether it’s digital or physical,” Gottlieb said. “The case against (Medjedovic) just says: Manipulating markets to take other people’s stuff is wrong. It’s illegal. And we shouldn’t countenance it.”
Gottlieb dismissed the code-is-law defence.
“Code is not law,” he said. “Law is law.”
Gottlieb was asked if the case could lead to more laws and regulators covering crypto in Canada, the US and other countries. He said regulators should focus on frauds and manipulators in the crypto space because fraudsters make it look bad. But he contended that more anti-fraud laws are not necessary because regulators already have broad anti-fraud authority.
“They just need to focus more energies on fighting the actual wrongdoing in the space, and less resources chasing responsible projects for failing to register” – when the regulators have not provided a path to registering these products or companies,’ Gottlieb said.
The US Securities and Exchange Commission has taken legal action against some crypto companies that it alleges are selling unregistered securities.
“I hope that regulators partner more co-operatively with the responsible players in the crypto space to fight the real wrongdoing, such as the market manipulation and theft that (allegedly) happened here,” Gottlieb said. “Time will tell.”
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