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The cryptocurrency ecosystem requires balance between enabling legitimate fraud recovery and protecting innocent parties. Parties can address fraud involving crypto effectively by providing courts with clear, accurate information about how blockchain technology works.
Cryptocurrency is being embraced by major financial institutions and is recognized as a legitimate asset class. But as with any technology, a small subset of bad actors has exploited its features.
This includes scammers who convince victims to invest in crypto fraud schemes or otherwise demand payment in cryptocurrency. Unable to identify the actual wrongdoers, victims may direct claims at cryptocurrency exchanges and users whose accounts plaintiffs allege—often without adequate proof—received some portion of the stolen funds.
This creates a challenging situation for courts, which are being asked to issue sweeping asset freezes based on technical assumptions that often don’t reflect how crypto works. One of the most complex issues involves blockchain tracing—the process of analyzing data from the blockchain to determine the source and destination of cryptocurrency funds.
While tracing can be powerful early in a fraud investigation, its reliability becomes difficult to assess once funds reach centralized services. Many platforms operate pooled address architectures—similar to how traditional banks pool customer deposits rather than maintaining separate accounts for each customer—making it challenging to attribute transaction flows to specific users.
Scale of Problem
In 2024, cryptocurrency scams accounted for at least $9.9 billion in stolen funds. Crypto scams have grown an average of 24% annually since 2020, and an entire marketplace has developed supplying the infrastructure needed to perpetuate scams at scale.
Pig butchering scams exemplify this sophistication. In such instances, scammers build trust with victims over weeks or months through dating apps or social media. Once trust is established, they introduce fraudulent investment opportunities, encouraging victims to transfer funds, often in crypto, to a wallet address on the promise of fictitious returns. When victims attempt to withdraw their crypto from the scam wallet, they discover they can’t, often losing their life savings.
Many scammers exploit cryptocurrency for the same reasons legitimate users value it: Transactions are final, cross-border transfers are efficient, and users can maintain privacy—features that also complicate recovery efforts.
As victims seek recourse, courts grapple with increasingly complex technical issues, increasing risks for users who find their funds frozen or accounts swept into litigation because plaintiffs are applying traditional asset-recovery instincts that don’t translate effectively.
Where Tracing Fails
While cryptocurrency transactions are documented on the blockchain, the identities of participants and their locations aren’t. This creates a cascade of problems for traditional legal remedies, including damages, restitution, constructive trusts, and attachment orders—all of which require identifying the wrongdoer and tracing the stolen funds.
Identifying the scammers is often impossible. And tracing is complicated. Cryptocurrency can be transferred to multiple wallets quickly. Scam proceeds may be split into smaller amounts and sent to different destinations, making the stolen funds difficult to track through numerous wallet hops. Once funds are transferred to a service—like crypto exchanges or, more concerningly, “unlabeled” services such as mixers that commingle cryptocurrency funds from multiple users thereby further obscuring traceability—the public loses visibility. It can be difficult if not impossible to verify that the cryptocurrency routed through a service’s address is the same cryptocurrency that comes out.
Even proper tracing can be problematic. Tracing focuses on fund flow rather than account owners, meaning it may implicate innocent account holders who are scam victims themselves (and thus receiving small incentive payments from the scammers).
Exchanges as Targets
Cryptocurrency exchanges and innocent users have been pulled into litigation in two scenarios:
- asset recovery, where a victim seeks compensation and pulls in exchanges or users not responsible for the underlying scam
- information gathering, where a victim seeks information related to an alleged scam
In both scenarios, exchanges may find themselves sympathetic to fraud victims while also being responsible for protecting their own users from wrongful account freezes.
The consequences of flawed tracing have materialized in several cases. In last year’s Steinhardt v. albertAI.click, the plaintiff obtained a preliminary injunction requiring exchanges to freeze accounts associated with identified wallets. The tracing analysis was over-inclusive—it included the plaintiff’s own wallet, which was temporarily frozen.
In Cohn v. Popescu, a case from 2024, an alleged scam victim obtained a preliminary injunction freezing certain accounts without evidence tying the account owners to the alleged scam. Innocent account holders were forced to prove their innocence to regain access to funds, effectively shifting the burden of proof onto parties with no culpability for the underlying fraud.
These cases and others like them illustrate a pattern. When presented with blockchain tracing, courts have found the evidence sufficient to secure preliminary injunctive relief. This may include situations where the proffered tracing falls short of industry standards—particularly when the tracing isn’t challenged as is often the case. Moreover, these proceedings typically focus on the plaintiff’s alleged harm, with less attention given to the potential impact on innocent users and exchanges who may be swept into the litigation.
Reputable exchanges, which work to comply with valid legal process while protecting user privacy, are also pulled into litigation through third-party subpoenas seeking account information. But exchanges that comply produce user information and potentially put both themselves and their users in the crosshairs when plaintiffs realize there’s nothing to recover from the actual wrongdoers.
A Path Forward
Courts need to thoroughly analyze any purported blockchain tracing before assets and users disconnected from alleged scams have their rights affected. When exchange platforms are involved, several steps can help.
First, insisting on a valid court order before freezing assets protects exchanges and users from improper requests. Second, seeking early discovery or an informal information exchange focused on plaintiff’s tracing analysis helps ensure the court has accurate information. Third, involving an expert to perform independent tracing analysis can be valuable, as plaintiffs may be unfamiliar with common tracing pitfalls.
Exchanges may also seek to educate courts about their platforms to help resolve issues and avoid unnecessary disputes. Technology tutorials are instrumental in patent matters and may be similarly helpful in blockchain tracing cases.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.
Author Information
William K. Pao is a partner at Cooley whose practice focuses on advising global companies leading technological and financial innovation.
Alix Mayhugh is a partner at Cooley who helps clients navigate complex legal disputes, often involving innovative and disruptive products and technologies.
Monica Daegele is an associate at Cooley who represents clients facing commercial and intellectual property disputes related to complex technologies.
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