Crypto-currencies and Blockchain - An overview for Lawyers

Red Flags

There are a number of red flags associated with cryptocurrency, including:

• Volatility
• Cyber crime
• Unregulated
• High risk
• Lack of transparency
• Scams

On 8 October 2023, the marketing of cryptocurrencies became regulated, but other aspects remain unregulated and therefore those investing in cryptocurrencies remain largely unprotected; the Financial Conduct Authority has warned that scammers are active around crypto markets.

In a report published in January 2024 covering the year 2023, crypto and fintech groups were fined $5.8bn for shortcomings in client due diligence and anti-money laundering controls.

What is cryptocurrency?

Cryptocurrency is a digital form of currency that uses cryptography for security purposes; it is decentralised, which means it is not controlled by any central bank or government.

“Crypto” means ‘hidden’ or ‘secret’ reflecting the secure technology used to record who owns what, and for making payments between users. “Currency” is a type of electronic cash.

Cryptocurrencies operate using blockchain technology, which is supposed to make it difficult to alter or manipulate a transaction history, ensuring transparency and security. However, billions of pounds have been stolen via remote access and social engineering scams where criminals have been able to obtain the crypto keys that allowed access into wallets (accounts).

High profile hacking losses include:

• $530m from Coincheck in 2018
• $250m from Kucoin in 2020
• $3.2billion from exchanges/decentralized finance apps in 2021

Cryptocurrencies can be used as a medium of exchange for goods and services, just like normal currencies. They can also be used for investment purposes, as their value can fluctuate significantly. Some cryptocurrencies have specific uses within their respective networks, such as Ethereum which enables the creation and execution of cryptocurrency smart contracts.

What are the pros and cons of cryptocurrency for law firms? 

Pros

• Security
• Decentralisation
• Accessibility
• Potential for high returns
• Borderless transactions

Cons

• Volatility
• Lack of regulation
• Limited acceptance
• Environmental impact
• Potential for illegal activities

What is Blockchain and how can law firms use Blockchain?

Blockchain is a distributed ledger technology (DLT) that provides a secure and transparent way of recording and verifying transactions. It works by creating a chain of blocks, each containing a list of transactions that are linked together using cryptography. Law enforcement agencies have been able to crack some cases by being able to follow the blockchain to the criminals; so it is not totally obscure!

DLT is used in the legal sector in a number of ways, including, digital signatures, smart contracts, and non-fungible tokens (NFT), which are related to digital artworks, etc. NFT thefts were over $100m in 2021/22.

Law firms can benefit from using DLT by potentially improving the speed, flexibility and traceability of many transactions, while at the same time reducing costs. The high potential for cost and time savings from the use of smart contracts will mean a likely growth in demand for their use.

Criminals are attracted to DLT for a variety of reasons, including:

• The perceived anonymity of blockchain technology
  
  
• The ease of defrauding many consumers through crypto scams, in particular, through ransomware attacks

There was $14bn worth of crypto-currency crime in 2021, nearly double that in 2020.

Binance failed to report more than 100,000 suspicious transactions and acted for criminals, terrorists and child abusers and was fined $4.3bn.

Crypto assets are a relatively new development and keeping up with the pace of change is challenging, particularly for those not engaged on the topic. It can also be hard to understand the varying reputations of certain crypto assets or related service providers as things change so quickly.

Money Laundering

There have been criminals who have used cryptocurrencies to launder and/or attempt to launder money and there are tools which help to make crypto ownership/ transfers even more opaque.

Can law firms accept cryptocurrency?

Despite the risks associated with them, due to increased prevalence and awareness of crypto assets, it is now much more common to encounter clients that have gained money from investment in crypto. Crypto investments can be a valid source of legitimate funds, but you should check:

• The source of funds for their original crypto investment, particularly where it was a substantial amount in relation to their income/salary.
  
  
• Claimed profits, given what you know about their initial investment and the changes in price over time.
  
  
• Transactions using publicly available records. Bitcoin and many other crypto assets can allow you to simply use google to track down transactions involving specific assets or between specific wallets. You will need details of the client’s wallet or the assets held in order to be able to check them against publicly available transaction databases eg blockchain.com.
  
  
• Have profits made from crypto-currencies been declared to HMRC for CGT purposes (checking if CGT has been paid on crypto-investments is not tax advice – SRA)?

If looking to take payments in cryptocurrency you should consider:

• The client account rules that require money held on account to be held in a bank or building society in England and Wales; there are no current compliant client accounts for crypto-assets offered by banks or building societies, payment in crypto-assets will only be possible after the services have been provided or as a fixed fee.
  
  
• The importance to meet the price transparency requirements, bearing in mind the high fluctuation in value of crypto-currencies.

The future of cryptocurrencies

The reputation of the global cryptocurrency market remains badly damaged in the wake of the  collapse of the FTX crypto exchange and other big players with crypto prices, volumes and venture capital investment well below their 2021 peaks; it is likely to take many years for the crypto market to repair its reputation, if it ever does!

Polls

During the webinar we ran two polls looking at the use of cryptocurrency and smart contracts, and here are the results:

1. Does your firm accept funds generated from cryptocurrency investments in relation to client matters?
   13. Yes – 13.51%
   14. No, and never will – 27.03%
   15. No, but may do in the future – 45.95%
   16. Unsure – 13.51%
       
       
2. Does your firm act in client matters that involve ‘smart’ contracts?
   2. Yes – 2.7%
   3. No – 81.08%
   4. Unsure – 16.22%