You’ve been airdropped: New York court order clears the way to serve lawsuit defendants via NFT

At the start of this year, Liechtenstein-based exchange LCX was hacked for about $8 million worth of crypto. Now, with the help of law firm Holland & Knight and a court order from a New York Supreme Court justice, it’s come up with a blockchain-based way to serve the anonymous hacker with a lawsuit.

When a plaintiff sues someone, the legal process includes serving the defendant with the complaint and any related orders or documents. In the US and many other jurisdictions, the legal system requires defendants to be given fair notice and the opportunity to respond to claims against them. 

But what happens when a defendant’s identity isn’t yet known? The court order LCX has from New York’s Supreme Court contends that you can serve them a non-fungible token (NFT).

Tracking the attacker

In January of this year, someone stole funds from one of LCX’s hot wallets. Though confidential customer data wasn’t affected, nearly $8 million in crypto evaporated. Since then, the exchange has been working with law enforcement and blockchain tracing specialists to recover the funds.

For now, the identity of the attacker isn’t known, but LCX is pretty sure it’s found their Ethereum wallet. Specialists tracked the stolen funds through Tornado Cash — a mixer protocol that hides the trail of Ethereum transactions by breaking the link between the source and destination addresses — and then identified the wallet in question. 

As it turns out, whoever controls the wallet recently deposited some of the funds on Coinbase and also swapped some of the money from ETH to USDC, the stablecoin issued by Circle. 

Even if the identity of the hacker is never found out, it’s possible to hold an anonymous person accountable if there’s a way to exert authority over their property, explained Holland & Knight’s Andrew Balthazor. 

“Here, the defendant possesses virtual assets whose underlying protocol — the assets’ programming rules embedded in a smart contract — is governed by a third party,” he said. “In our case, we are able to take advantage of this particular protocols’ features to exert some control over the assets — via court orders to the third-party controlling the protocol — and potentially provide our client LCX with a remedy for their stolen funds.”

Freezing funds

Recovering funds often requires a court order since many places, including the US, have laws against unreasonable search and seizure. As Balthazor noted, courts have recognized different procedures to provide defendants notice so they have a fair chance to tell their side of the story. 

“Courts are rightfully reluctant to take another’s property without giving the person who owns that property this opportunity; in legal terms, we call this ‘due process,’” he said.

Still, there are also legal remedies to freeze funds to prevent further harm until the case plays out. In this case, LCX worked with law enforcement to obtain a Lichtenstein court order to have Coinbase Europe freeze the funds on its platform. 

Navigating how to freeze the USDC led the Lichtenstein-based LCX all the way to New York. 

Though USDC is issued by Circle, the technology and ability to blacklist wallets or freeze tokens is handled by the Centre Consortium, which is headquartered in New York. LCX obtained a temporary restraining order from New York Supreme Court Justice Andrea Masley that gave Centre the legal authority to blacklist the wallet, freeze the funds and bar the defendant from moving the funds in any way.

You’ve been airdropped

But in order to execute the requirements of the order, Holland & Knight had to somehow serve the defendant so they know they’ve been implicated in a legal battle and are prohibited from moving the funds. The firm proposed a blockchain-based solution to a blockchain-based problem: it would airdrop a token to the address with a hyperlink to a webpage containing all the necessary documents. 

Attorney Joe Dewey happened to be a solidity programmer, so Holland & Knight kept the process in-house. Dewey learned the necessary skills to create and deploy the contract. The firm deployed the NFT earlier this week. Like everything else on the blockchain, the transaction and documents are public.

Though the legal team can’t know for sure if the address holder has seen it, it can see how many times the link has been visited.

“The theory is that because the defendant is using this address and has the funds into it, taking funds out of it, the court determined that this was a fair way of serving them with this notice, because we know that the defendant has an interest in this address and has access to it,” said Balthazor. 

If somehow LCX’s analytics didn’t lead them to the right address, the idea is that the address holder would come forward and clear their name, letting LCX know they should retrace the funds.

According to LCX CEO and co-founder Monty Metzger, the link provided in the NFT has been clicked many times.

If no one responds to the lawsuit by the deadline, which is about a month from now, the case will progress. The court will have to decide whether to maintain the asset freeze. Holland & Knight would also request the court to enter a default judgment against the defendant, which treats a defendant as though they have admitted to the allegations. 

A new frontier

This is a first for the US legal system. It’s not clear if similar arguments would work in other jurisdictions. Still, Metzger said it also demonstrates a level of transparency in crypto that hasn’t been seen in traditional finance. Crypto’s traceability opens the door to avenues of legal recourse that have not been available, he said.

The “service NFT” could be a “key tool for the future of regulation or regulation that is enforced on chain,” Metzger said.

In this case, it also helped to have a progressive judge, according to Metzger. Indeed, Balthazor said Justice Masley had previously educated herself on blockchain-related law and understood the technical concepts required.

“I think the judge understood exactly why this was appropriate,” he said. “We didn't have to do a lot of arguments on why this just made sense here.”

Balthazor said the firm is now looking into other ways crypto technologies may be able to help navigate legal roadblocks. 

“I think this is an exciting first step in trying to use these innovative technologies in a way to benefit people who've been sometimes harmed by them,” he said. “And we're going to continue looking at ways to improve this and make it a successful mechanism for serving defendants who can't otherwise be served by conventional means.”