UK: Cryptocurrencies - A Quandary For Quadriga

Last Updated: 14 February 2019
Article by Karen Boto
Most Read Contributor in UK, March 2019

Over its relatively short 10 year life span, the cryptocurrency sector has been plagued by a number of high profile exchange scandals, heists and data breaches.  The viability and future of the sector has recently been questioned, once again, upon one of Canada's largest cryptocurrency exchanges, Quadriga CX, seeking urgent creditor protection. 

The facts

Quadriga launched in December 2013. It was founded by Mr Gerald Cotten, who was the sole officer and director of the company.  Quadriga allowed users to deposit cash or cryptocurrency through its online trading platform, storing the digital assets on blockchain ledgers accessible only by an immutable alphanumeric code. Cotten ran the exchange from his home using an encrypted laptop. 

Last month, Quadriga announced that it may have lost access to millions of dollars' worth of bitcoin and other cryptocurrencies after Cotten died very suddenly on 9 December 2018, taking various private keys and passwords with him.

As a result, bitcoin and other cryptocurrencies valued at just under C$200 million are said to be locked in "cold wallets", where the digital assets were being held in order to protect them from a hacking incident. A sensible decision, one might think, especially in light of the number of major exchange attacks that occurred last year. However, due to Cotten seemingly having sole control and knowledge of Quadriga's cold storage, investors and users of the exchange have now been left unable to access their funds. 

This latest revelation has hit investors hard.  For several months,  Quadriga has reportedly been experiencing problems with users withdrawing their funds, following a long legal battle (which has now been resolved) with one of its banking partners, Canadian Imperial Bank of Commerce, who last year allegedly froze a significant portion of assets held by Quadriga. 

Unsurprisingly, since the passing of Cotten, disgruntled users and investors have threatened to bring legal action against the exchange. Indeed, a number of affected users are said to have created an informal committee, which has already retained leading Canadian law firms to represent it.  

After announcing the death of Cotton (several weeks after his passing), Quadriga sought creditor protection to stay any lawsuits, whilst it attempts to sort out its finances.  

On 5 February 2019, the Nova Scotia Supreme Court was told that the newly appointed board of directors are taking all steps possible, including enlisting industry specialists, in an attempt to access the funds.  Searches are being undertaken for a physical record of the passwords and attempts are being made to "hack" Cotten's laptop.  Quadriga is apparently also considering selling its platform to cover its debts. 

In light of the unusual circumstances of this case, the Canadian Court granted Quadriga a 30-day stay to stop any lawsuits from proceeding against it. It was also granted the protection from creditors that it sought. Ernst & Young have been appointed to monitor and to help manage Quadriga's finances during this process. 

The temporary reprieve from legal action will be welcomed by Quadriga; however, it may not be a long term solution if the cold wallets cannot be accessed.   

Typically, when people die unexpectedly, survivors may be required to search for safety deposit keys. If they cannot be found a bank can normally drill open the lock.   No similar solution, however, applies in the crypto space.  If it is simply not possible to access the cold wallets, investors' funds could be lost forever.  

Was this a fraud?

Regrettably, as is often the case in the crypto sector, this latest incident has led to speculation that Quadriga was a "sham" business.   

Some cryptocurrency analysts have already allegedly reviewed publicly available transaction histories and claim to have found no evidence that Quadriga controlled wallets that held funds anything like those which the company claims. The largest wallet which has allegedly been identified is a "hot wallet" (i.e. one connected to the internet/a network) which it is suggested Quadriga appears to have used to satisfy immediate withdrawal requests, using new investments. 

This has also led to some users of the exchange, and others in the cryptocurrency space to question, without any evidence, whether Cotten is even deceased. Online speculation suggests that Quadriga's funds have been moving since Cotten's passing, which is clearly contrary to the firm assertion being maintained by Quadriga that the funds are currently inaccessible. 

Clearly further investigation is required into this case. However, there is a real risk that Quadriga will be left to solve the difficult quandary of how to reimburse more than 100,000 of its users.  

Could insurance assist?

It is not known if Quadriga is insured. We suspect it is not as there has been no mention of insurance in the court filings. 

If the exchange had secured insurance cover, then Quadriga may have had means of compensating its users, without having to consider selling its platform.  

Had insurance been in place, it might have been triggered to negate the losses being suffered by Quadriga's users, allowing Quadriga to take further steps to try and access its "locked" funds.  It may have also helped to legitimise the exchange to prevent conspiracy theories being launched, seemingly without any hard evidence at present. 

Whether insurance coverage would be provided to a cryptocurrency exchange for an event like this would, of course, turn on the exact terms of any insurance policies in place.  

As highlighted in our recent article: Cryptocurrencies: To insure or not to insure? (read more here), whilst some insurers are underwriting crypto businesses, the terms upon which they are doing so are not readily known and vary widely from insurer to insurer, and across crypto risks.  

However, if Quadriga had secured access to a professional services/civil liability policy, it might have responded to the third party claims which have been threatened by its users/investors for a failure to provide services (i.e. allowing users to access and withdraw their funds). 

Similarly, if directors' and officers' protection was secured, this might have proven to be a vital asset to the deceased's estate and/or the newly appointed board who could now possibly face lawsuits (including class actions) as a result of this incident.  Even if such claims are unfounded, the costs of defending them will be significant. 

Of course, whether such policies would respond to similar events, in practice, will ultimately depend on how the third party claims are framed and the specific terms of the insurance cover on offer. 

If, on the other hand, it does transpire that something more untoward occurred, a typical crime policy, which covers employee dishonesty, might have also responded covering Quadriga for any first party loss sustained as a direct result of any fraudulent or dishonest acts of an employee, subject again to the policy's terms and conditions.  Additional first party loss, such as the costs being incurred by industry specialists trying to locate the data needed to unlock the funds, might have also attracted cover under a cyber or other civil liability insurance policy.  

Whilst an insurance pay out might, therefore, have provided a solution for Quadriga to its immediate predicament, this episode does, of course, highlight a further security risk attached to crypto exchanges, which may be considered by underwriters as another good reason why they should not insure the crypto space.  

Are exchanges a risky business?

Whilst, on the face of it, this latest incident might understandably serve to increase nervousness around the risks associated with the cryptocurrency market, this situation may have been fairly easily avoided if: (i) there had been more than one director and signatory to the cold storage facility; and (ii) strict procedures had been in place to ensure that sensitive passwords were not retained by just one person. It should not, therefore, necessarily act to dissuade insurers from underwriting this class of business.  

As discussed in our previous article, insurers choosing to offer protection in this emerging market are treading with extreme caution and they are performing a considerable level of due diligence.  Sometimes, to such a thorough extent that the prospective insureds are walking away from the process.

We understand that, as part of this process, underwriters will heavily scrutinise the prospective insured's security and storage procedures, including the level of technical security, reliability of key storage, password strength and integrity and the protection of users' personal data.  Underwriters are also assessing the full scale of their operations through to the integrity of the people involved in the business.   

If confronted with an exchange like Quadriga, insurers could have perhaps insisted on more than one officer/employee being appointed to the company, and for some kind of dual control security procedures to be in place, or at the very least, for information, such as private keys, not to be held by just one individual.  Had the exchange refused to comply with such requests, it may have needed to forgo any insurance coverage.  

The future for cryptocurrencies

Whilst insurers could seek to impose stringent terms on their prospective insureds, like those outlined above, and attempt to set standards of good practice,  what this incident really highlights is the increasing need for regulation in this space.  

The lack of any uniform standards may have allowed this situation to occur; where one person has been able to independently run a business which holds millions of dollars of cryptocurrencies. 

There is increasing pressure on governments around the world to regulate bitcoin and crypto businesses in the same fashion as the traditional financial services industry, which would require them to adequately protect their customers from potential losses in the first instance.  

Episodes like this may well lead to an increase in the demand for insurance, if for no other reason but to build trust in the industry.  Of course, if the sector is regulated it may also make exchanges and other crypto businesses a more attractive insurance proposition and give underwriters some comfort as to the nature of the risks they are insuring.  

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Karen Boto
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions