In 2018, Quadriga Fintech Solutions Corp. (“Quadriga”), throughits wholly-owned subsidiaries, was one of Canada’s largest onlinecryptocurrency exchanges. Quadriga survived the first boomand bust cycle of cryptocurrencies when the value of Bitcoinskyrocketed to C$25,000 and fell back down to C$4,200 all withinone year, but it did not survive the death of its co-founder and CEO,Gerald Cotten.
After graduating from university inNovember 2013, Cotten, together withMichael Patryn, co-founded Quadriga,an online exchange that allowedusers to store, buy and sell variouscryptocurrencies, upon depositing cashor cryptocurrency with the exchange.Quadriga made money by charging itsusers a fee for each transaction on theplatform. In 2014, only C$7.4m worthof bitcoin was traded on the exchange.
In 2016, following the resignation ofall other directors, Cotten became thesole director of Quadriga, which had nooffices or employees, and engaged onlya few general contractors.1The companywas run from Cotten’s encrypted laptopat his home in Fall River, Nova Scotia.
As the cryptocurrency markets soaredin 2017, so did the trade volume onQuadriga with about C$1.2bn worthof bitcoin exchanged on the platform.While the spike in volume increasedcommissions, it also caused cashflow problems due to the exchange’sreliance on external payment processorsas Quadriga did not have its ownCanadian bank account that couldhandle these transactions. Increasedtrading volumes also exposed theweakness of Quadriga’s accountingsystem. These were the primary causesof Quadriga’s eventual downfall. In June2017, Quadriga announced that theylost ethereum currency worth C$14mdue to a smart contract error, whichbridled the confidence of Quadriga’susers in its ability to effectivelymanage the exchange.2Following thecrash of the cryptomarkets, Quadrigacustomers reported delays whenattempting to withdraw fiat currencyfrom the exchange and critical paymentprocessing issues emerged. The oneman operation of Quadriga had grownso quickly that it wasn’t able to build outit* infrastructure to service its growth.
On top of these payment processingand accounting concerns, on December9, 2018, Cotten passed away at theyoung age of 30 during a trip toIndia. Cotten’s death was publiclyannounced by Quadriga on January14, 2019. Without Cotten to managethe exchange and without a centralizedcash management system and due tofrequent issues with withdrawal offunds and payment processing, themarket panicked, losing confidencein the viability of the cryptocurrencyexchange. Worse yet, Quadriga storedmost of its cryptocurrency depositsin digital “cold wallets” on the harddrive of Cotten’s encrypted laptop,which were inaccessible after his deathor, if accessible, contained minimalcryptocurrency units. The missingcryptocurrency was estimated to beworth C$190m at the time. In January2019, C$25.7m in cash held byCustodian Inc., a Quadriga paymentprocessor, was frozen by the CanadianImperial Bank of Commerce, as the bankcould not determine the ownership ofthe money and could not contact theexchange following Cotton’s death. Themoney was later paid into court, whichsubsequently distributed the funds to Custodian; however, as a result of thetemporary loss in liquidity in additionto the missing cryptocurrency, coupledwith massive deposit withdrawaldemands, Quadriga was unable to satisfyits obligations to its users. On January28, 2019, the Quadriga website andexchange platform was shut down as aresult of liquidity constraints. Quadrigahas not carried on business as acryptocurrency exchange since that date.As a result of the platform shut down, allof Quadriga’s independent contractors,except for three individuals, wereterminated effective February 28, 2019.
On February 5, 2019 Quadriga andcertain of its affiliates filed for creditorprotection under the Companies’Creditors Arrangement Act (the “CCAA”)to manage Quadriga’s liquidity crisis.According to public filings, Quadrigahad 363,000 registered users andowed in excess of C$260m in cash andcryptocurrency balances to 92,000affected users. The claims ranged fromvery small amounts up to very largebalances of up to C$70m.
Pursuant to an initial order, the NovaScotia Supreme Court, amongstother things, issued a general stayof proceedings and appointed Ernst& Young Inc. as the monitor (the“Monitor”) in the CCAA proceedings ofQuadriga. Following the CCAA filing,the Monitor started investigating theassets and business of Quadriga andalso tried to monetize the tradingplatform and recover the missingC$190m of cryptocurrency. The Monitorwas able to recover all identified cashin the amount of C$25.2m held byvarious third-party payment processingcompanies, which were used byQuadriga to operate its business.
But, recovering the lost cryptocurrencywas more complicated. To provide sometechnical background, cryptocurrencyis generally stored in digital wallets. Awallet is a virtual address that storesa cryptocurrency trader’s private andpublic keys, which allows the traderto send and receive cryptocurrency.There are so called “hot wallets”,which are stored online, through adigital currency exchange, and “coldwallets”, which are stored offline ona hard drive or a removable devicesuch as an encrypted USB. Whiletransactional activity and balances inany wallet are publicly available with a wallet address, the ability to transferthe cryptocurrency within the walletis restricted to individuals holdingthe required passwords or credentialsand, in the case of cold wallets,physical custody of the device that theprivate key of the wallet is stored on.When a user opened an account withQuadriga, as is customary with othercryptocurrency exchanges, the user wasprovided with a hot wallet address (the“User Wallet”) to which the user couldsend cryptocurrency to be received bythe exchange. The User Wallet addressis typically (although not always) anaddress set up uniquely for a singleuser. The user’s access only allows fortransfers to that address. Followingdepositing cryptocurrencyin the User Wallet, the user does nothave direct control over the balanceand the exchange has custody of thedeposited cryptocurrency.
As is typical for cryptocurrencyexchanges, upon receivingcryptocurrency in a User Wallet,Quadriga credited the user’sexchange platform account withthe corresponding quantity ofcryptocurrency. Quadriga thencontrolled the cryptocurrency in theUser Wallet, typically pooling thecryptocurrency deposited by users andmoving the cryptocurrency to wallets,both hot and cold, under the exchange’scontrol. Users with account balancescan place orders for either othercryptocurrency or traditional currency.When a user ultimately wanted to makea withdrawal of cryptocurrency fromits account with the exchange, theuser provided instructions to Quadrigato send cryptocurrency to a specifiedwallet outside the exchange’s control.Quadriga accessed its cryptocurrencypooled reserves to fulfill the transaction.Similarly, if a user wanted to withdrawfiat currency, the user would providebank account or address information tothe exchange.
During the course of the investigation,the Monitor was able to recoverC$902,743 worth of cryptocurrencyfrom Quadriga’s hot wallets. Accordingto public filings, Cotten generallytransferred the pooled cryptocurrencydeposits from the platform’s hotwallets into cold wallets on devices inCotton’s control to protect the assetsfrom possible hacking. Of course,after Cotten’s death and without theappropriate passwords, Quadriga’s coldwallets were inaccessible. To the extentthat it was possible for the Monitor togain access to Quadriga’s cold wallets onCotten’s computer and USB drives, theMonitor found only nominal amountsof cryptocurrency in Quadriga’s coldwallets. Without the wallet passwordsthat were only known by Cotten, theMonitor has been unable to gain accessto Quadriga’s full cryptocurrencyinventory possibly stored on Quadriga’scold wallets.
The Monitor also became aware ofoccurrences where the corporateand personal boundaries betweenQuadriga and Cotten were not formallymaintained, and it appeared to theMonitor that Quadriga funds may havebeen used to acquire assets held outsidethe corporate entity. The Monitorobtained an asset preservation order,which prohibited Cotten’s wife, theCotten estate, and other related entitiesfrom selling or otherwise disposing oftheir assets. The appraised value of theassets subject to the asset preservationorder is C$12m, which could formallybecome part of Quadriga’s estate onfurther order by the Court. As of April12, 2019, Quadriga had C$28.6m ofknown assets and around C$216mowing to its creditors, out whichC$214.6m was owed to 76,319unsecured creditors represented byrepresentative counsel.
In its fourth report to the Court, theMonitor concluded that the possibilitythat Quadriga would restructureand emerge from CCAA protectionwas remote. Subsequently, on April11, 2019, the CCAA proceeding wasterminated and the proceeding wasconverted into bankruptcy proceedingsunder the Bankruptcy and InsolvencyAct (the “BIA”). The Monitor stated thatas trustee under the BIA, it would havebroader investigative powers to movealong the investigation into Quadriga’smissing assets and maximize valuefor Quadriga’s creditors. The Monitor,now acting as trustee in Quadriga’sbankruptcy proceeding, is still lookingto sell Quadriga’s trading platform.
According to a statement on thewebsite of the United States FederalBureau of Investigation (the “FBI”)on June 3, 2019, the FBI, the InternalRevenue Service Criminal Investigationdivision, the US Attorney’s Officefor the District of Columbia and theDepartment of Justice’s Computer Crimeand Intellectual Property Section areconducting an investigation into themissing assets of Quadriga.
The Quadriga case has many of the samecomplications as past cryptocurrencyinsolvencies in other jurisdictionsrelating to proper characterization andvaluation of creditor claims, divisionof distributable assets among claimholders, and dissipation of assets.However, the Quadriga case also addsa layer of complexity that arises whenno party remains available to unlockpotentially very significant asset value. This will be a significant issue for futurecases to ensure that all potential assetvalue can be preserved and distributedto creditors and other claim holders.
