A Global Guide for In-House Counsel: Doing business in a rapidly changing world


Insolvency – Crypto

How is cryptocurrency treated as an asset in a bankruptcy proceeding in your jurisdiction?

In the United States, cryptocurrency is considered an asset in bankruptcy and must be disclosed when filing for bankruptcy. Failure to disclose a cryptocurrency may constitute an offence under the Bankruptcy Act, like failure to disclose shares, cash in your bank, etc. Cryptocurrency is valued in bankruptcy on the dollar equivalent at the time of filing for bankruptcy.

Unlike traditional bank accounts or brokerage accounts, crypto-assets are not backstopped or guaranteed by any governmental or other agency, like the FDIC or SIPC. If Coinbase or another similar platform were to file for bankruptcy, and assets held in custodial accounts were deemed to be the property of the bankruptcy estate, customers could make claims as unsecured creditors to try to recover the value of their assets, but they would not have the protections afforded more traditional investment accounts, and their unsecured claims may be paid at just pennies on the dollar, if at all.

Holders of crypto can mitigate these risks by carefully deciding how their crypto will be held, carefully reviewing any third-party custodial agreement and applicable state law, and consulting legal advisors to help navigate these complex issues.

Are there legal tools in your jurisdiction that can be used against exchanges to recover stolen cryptocurrency?

Where the stolen cryptocurrency can be traced to another exchange, there are several steps parties can take to recover those assets or seek the identity of the holder. Most major exchanges own and control the wallets holding the cryptocurrency on deposit. Where that is the case, a party could seek injunctive relief against the exchange, requesting that the exchange freeze the account linked to the stolen cryptocurrency. It is also possible to compel exchanges to turn over the

identities of account holders through “John Doe” proceedings. In this type of proceeding, the plaintiff sues an unknown John Doe defendant and then issues third party subpoenas to an exchange or other source to obtain discovery of the John Doe’s real identity. That information can facilitate litigation or collection against the ultimately identified individual. It bears noting that most major cryptocurrency exchanges have adopted “know your customer” rules that require users to provide proof of identity before being allowed to trade. Therefore, customer identifying information is available from these exchanges.

Depending on the circumstances, and particularly in cases involving fraud or criminal activity, it may also be possible to obtain an informal injunction by putting the exchange on notice that a particular wallet or transaction is tainted. As cryptocurrency exchanges come under increasing regulatory scrutiny, they are highly sensitive to being seen as facilitators of illegal activity. If a creditor can convince an exchange to halt further transactions from an account pending resolution of a dispute, that will effectively achieve the same result as a formal injunction or restraining order.

Where stolen cryptocurrency cannot be traced to an exchange, recovery can be much more difficult because the blockchain will not allow the transfer of cryptocurrency ownership without the private key. By analogy, although physical assets may be traced to an unbreakable safe, that knowledge is useless without the key or the ability to compel the person with the key to open the safe.

In these cases, creative and resourceful litigation is necessary to both link the cryptocurrency assets to a physical person or entity or obtain access to the private keys. Where the holder of the stolen cryptocurrency can be identified and is subject to the jurisdiction of a court of competent jurisdiction, an option would be to seek a court order requiring the holder to turn over the private keys or the cryptocurrency itself, or face contempt of court. In some cases, especially where sanctions for civil contempt include imprisonment, these types of orders may be effective.

Another possible path to recovery is identifying any point of contact the cryptocurrency assets have with the traditional financial system. There are still relatively limited opportunities to exchange cryptocurrency for goods or services of significant value. As a result, cryptocurrency is typically converted to cash before it can be usefully spent. If a creditor can obtain information showing a link between cryptocurrency and a bank account, it may be possible to direct enforcement efforts at that bank account rather than the cryptocurrency itself.

Sanli Pastore & Hill is not a legal firm. The information provided in this article is not, and is not intended to be, legal advice. Please seek legal advice from an appropriate attorney.

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Given the recent downturn in the cryptocurrency markets and the bankruptcy filings emanating from this downturn, the use of chapter 15 for cryptocurrency related companies instituting foreign insolvency proceedings remains a useful tool to protect assets within the United States.

Chapter 15 authorises the representative of a foreign insolvency estate to commence an ancillary bankruptcy case in the US. Chapter 15 provides the foreign representative with several beneficial tools in preserving and maximising value for creditors, including customers of an insolvent exchange.

A cryptocurrency exchange in insolvency proceedings abroad may hold cryptocurrency or other assets in the US and may also be subject to litigation in the US. In addition, where the insolvency proceedings arise from the theft or embezzlement of cryptocurrency, those who participated in the wrongdoing may be in the US and the stolen cryptocurrency may be traceable to US exchanges. In each of those circumstances, Chapter 15 may aid the foreign representative.