Deciphering the Cryptic World of Cryptocurrency in Bankruptcy

Robert Loughran
Jul 17 2019

While initially perceived by most as a novelty, cryptocurrencies are becoming more widely purchased and accepted. The chances that a cryptocurrency will be an asset in a bankruptcy estate are ever growing. Cryptocurrencies provide attorneys with a couple of challenges; including; (1) identifying the existence of cryptocurrencies in the debtor's estate, and (2) should cryptocurrencies be treated as a currency or commodity.

For those who are unfamiliar with cryptocurrencies, a cryptocurrency is a virtual currency or digital asset that operates like the dollar or yen; however, unlike the dollar or yen, cryptocurrency is not backed by any government. While Bitcoin is the most well-known cryptocurrency, there are now over 1,000 including Facebook’s new Libra coin. As these digital coins grow in popularity, it becomes more important for those working with creditors and debtors to understand how cryptocurrency can impact a bankruptcy estate.

Identifying Cryptocurrency

Attorneys for debtors should inquire whether their clients hold any cryptocurrencies when completing the debtor’s schedules. Section 541 of the Bankruptcy Code defines “property of the estate” as “all legal or equitable interests of the debtor in property as of the commencement of the case.” Cryptocurrency clearly falls into this broad language.

Because of the nature of cryptocurrency, two issues can emerge for the debtor: (1) the debtor can be unaware that the cryptocurrency is considered an asset of the estate and (2) an unscrupulous debtor could attempt to hold and trade the cryptocurrency under a pseudonym. Thus, creditors and trustees may have to investigate whether the debtor holds a cryptocurrency. A famous example of this was the bankruptcy of the rapper 50 Cent. See In re Jackson, Case No. 15-21233 (Bankr. D. Conn. Feb. 23, 2018). Jackson accepted Bitcoin for his record, thus many of his creditors thought Jackson has millions in Bitcoin. After an investigation, the creditors were satisfied that the Bitcoin had been converted to dollars. However, this case illustrates the need for a thorough investigation.

Currency or Commodity

Is cryptocurrency a currency such as the dollar or a commodity such as gold? The answer to this affects the value the bankruptcy trustee may extract from the cryptocurrency in liquidation and avoidance actions - preference or fraudulent transfer litigation. In Section 550(a) of the Bankruptcy Code “the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property.” If the cryptocurrency is currency, a trustee would be entitled to the historic value at the time of the transfer. However, if it is a commodity, the trustee is entitled to recover the value of the property at the time of the transfer date or the time of the recovery, whichever is a greater value to the estate.

The valuation determination, given the extreme volatility of cryptocurrencies, can lead to significant differences in recovery for the bankruptcy estate. Yet, this question has not been answered. In In re Hashfast Technologies LLC, the trustee sought to recover the fraudulent transfer of 3,000 Bitcoin. At the time of the transfer, the value of the Bitcoin was $363,000, yet at the time of recovery, the value of the Bitcoins was over $1,000,000. The Court did not reach a determination because the case settled. In SEC v. Shavers, in the Eastern District of Texas, the Court determined that cryptocurrencies should be treated as currency. However, the Court in In re Coinflip determined that cryptocurrencies should be treated as a commodity.

As acquisition and usage of digital currency becomes more popular and their value continues to fluctuate wildly, the decision of Courts on this issue are going to begin to greatly impact, debtors, creditors, and the value of the bankruptcy estate.