Old Fashioned Interpleader: A Solution to Cryptocurrency Disputes
A law school professor once said that if any question starts with “Can a federal judge….,” the answer was always “yes.” Originally thought to only reference authoritarian powers in a courtroom given the lifetime tenure, the scope of that professor’s one-liner was more “omnibus.”
Recently demonstrated by the United States District Court for the Western District of Virginia, federal judges and (undoubtedly) their string of young, top-notch law clerks, are also able to comprehend the minutia of cyber issues – even from the technical side (when willing).
A recent decision by Judge Elizabeth K. Dillon in Notestein v. Bittrex, Inc. (Civil Action No. 7:20-cv-00342) thoughtfully applied complex bitcoin details to simple and equitable legal concepts. Now, Bitcoin wallets enjoy legal precedent that ownership disputes over cryptocurrencies are resolved (from the wallet’s perspective) by simply depositing the contested funds into the registry of a federal court, referred to as “interpleader.” And provided that the wallet’s prior actions were reasonable and cautious preceding the interpleader, it can retire from the entire ordeal; simple, smart, and equitable.
In Notestein, two cryptocurrencies, namely Steem and Steem-Backed Dollars (SBD), traded on a cryptocurrency exchange hosted by Bittrex, Inc. The court noted that Bittrex was security focused, verifying user identities and using controlled deposits, multi-factor authentication procedures, and strict IP address blocking protocols. Third-party defendant Steemit, Inc., owns a blockchain-based blogging and social media platform that rewards users with Steem and SBD cryptocurrency for publishing content.
In early 2020, the TRON foundation acquired control over Steemit’s social media and blogging platform. The transaction created a “hard fork” regarding SBD cryptocurrency, potentially invalidating previous transactions and blockchains and requiring all validators to upgrade to a newer version of the currency. Given the contentious nature of the “hard forks,” Steem transferred it cryptocurrencies into a Steem account called “community321.”
On May 20, 2020, and unidentified “white knight hacker” transferred 23,627,501 Steem and 427 Steem-Backed Dollars from the "community321" account into Bittrex's Steem wallet for holding, akin to an escrow. The hacker advised Bittrex to return the cryptocurrency to its original owners but did not identify the Bittrex accounts. The potential criminality of the hacker’s actions was not examined.
Plaintiffs, who are corporate and individual cryptocurrency holders of SBD and Steem funds asked Bittrex to return the disputed currencies to them directly. Steem suspected the plaintiffs as being or retaining the “white hat hacker” and asked Bittrex to refund the currencies to the “community321” wallet instead.
Bittrex intelligently refused to move the cryptocurrencies to either the plaintiffs or back to the “community321” wallet, as it could not confirm that the funds were actually stolen. Instead, Bittrex insisted on either a court order or an executed settlement agreement between the parties consenting to the future deposits of the cryptocurrencies.
When no settlement was reached, Bittrex intelligently sought court approval to place a bond equal to the value of the cryptocurrency in the registry of the court and let the parties claiming ownership fight it out in litigation absent Bittrex’s participation.
Referred to as “interpleader,” this mechanism effectively sticks the funds in a legal piñata, in which the court is the tree from which it hangs. The contested funds are deposited into a court registry and the court decides its ownership based on evidence of ownership. The interpleader practice is often used with the sale of real estate with complicated titles, estates with unknown heirs, and other proceedings in which a party inadvertently controls funds or assets with contested ownership and seeks to avoid costly litigation.
In addition to depositing a bond with the court, Bittrex also sought an injunction preventing any party from suing or prosecuting Bittrex directly in any state or federal court relating to, or concerning the cryptocurrency and to be refunded its attorneys' fees and court cost. The Western District wholly agreed with Bittrex, stating that “the stakeholder should not be compelled to run the risk of guessing which claimant should be the beneficiary of a contested fund…” as “Interpleader should be a ‘simple, speedy, efficient, and economical remedy.’"
Bittrex demonstrated a "real and reasonable fear of exposure to double liability or the vexation of conflicting claims” and a desire to award the funds to the correct owner. The court called this complex bitcoin situation “the situation for which discharge of an interpleader plaintiff is warranted.”
While the Plaintiffs did not object to the interpleader, they argue that Bittrex ignored their requests for the return of their property, claiming criminality. However, the Court held that such a position “directly contradict[ed] plaintiffs' concession about the appropriateness of interpleader” and granted Bittrex a discharge from liability and an injunction against further adverse proceedings.
According to the Western District, the bitcoin wallet could not be “liable for retaining funds and not picking a winner when there is a disputed claim.”