While initially greeted with skepticism by many, cryptocurrency is becoming a more widely utilized and accepted form of exchange. Many retailers and service providers have begun to accept bitcoin as a form of payment, including Expedia, Dish Network, Gap and Microsoft, and Yahoo Japan announced that it is preparing to launch a cryptocurrency exchange.
As the use of cryptocurrencies becomes more prevalent, the likelihood that they will form an asset of an insolvent estate increases. Cryptocurrencies provide opportunities, but also challenges, to insolvency professionals.
These include the need to identify crypto-currency as an asset, valuing cryptocurrency as either a commodity or currency, cryptocurrency as collateral, and converting substantial holdings of cryptocurrency without impacting its value.
This commentary provides a brief explanation of cryptocurrency and outlines considerations for insolvency professionals as to each of the above issues.
What is a Cryptocurrency?
For those who are not longtime “hodlers”1 (what people who invest in cryptocurrency call themselves), the following is a brief description of some of the key principles underlying cryptocurrency.
A cryptocurrency is a virtual currency or digital asset that was designed to work as a medium of exchange just like the dollar, yen or euro. Unlike the dollar, yen and euro, however, cryptocurrencies are generally not backed by any government, fiat currency or commodity.
Bitcoin, created in 2009, was the first decentralized cryptocurrency and is the best known. However, there are now over 1,000 cryptocurrencies.
Cryptocurrency is so named because it uses cryptography to secure transactions, control the creation of additional units and verify transfers. Cryptographic digital signatures are used to verify that transactions are valid and to transfer ownership.
The digital signature mechanism generates a “public key” and a “private key” that are mathematically related. The public key identifies the user, and the private key allows the user to transfer the cryptocurrency.
Cryptocurrencies are stored electronically in “digital wallets” and exchanged over the internet through a direct peer-to-peer system. Transferring and verifying exchanges requires a validation process.
Payment transactions are processed by a network of private computers. The operators of the computers who validate transactions are known as “miners,” and the validation process is known as “mining.”
Miners obtain new cryptocurrency as a reward for validating transactions, which decreases transaction fees and creates an incentive to contribute to the processing power of the network.
Cryptocurrency exchanges allow people to exchange cryptocurrencies for other currencies or cryptocurrencies.
Cryptocurrency Must be Disclosed as as Estate Asset
Counsel for debtors should inquire whether a debtor holds cryptocurrency when completing the debtor’s bankruptcy schedules.
Cryptocurrency falls within the broad language of Section 541 of the Bankruptcy Code, which defines “property of the estate” to include “all legal or equitable interests of the debtor in property as of the commencement of the case.” As such, debtors must disclose cryptocurrency as property of the bankruptcy estate.
Because cryptocurrency can be held and traded under a pseudonym, however, it may require extra diligence by insolvency professionals to identify whether a debtor holds cryptocurrency. In addition, debtors may be unaware that cryptocurrency is considered an asset of the estate.
Creditors and the U.S. Trustee will certainly investigate whether a debtor holds cryptocurrency. For example, in the bankruptcy case of In re Jackson, the rapper known as 50 Cent, the U.S. Trustee and certain creditors investigated reports that the debtor held cryptocurrency worth millions of dollars.2
The debtor ultimately filed a declaration explaining that, despite rumor to the contrary, he did not possess cryptocurrency as payment for online record sales or related goods.
The declaration went on to explain that his limited bitcoin transactions were handled by an independently owned and operated third party and the bitcoin transactions were processed and converted contemporaneously to U.S. dollars based on the then-existing exchange rate.
This example illustrates the need for bankruptcy professionals to discuss cryptocurrency holdings before the issue is raised by another party in interest.
Cryptocurrency Valuation Avoidance Actions
One persistent issue involving cryptocurrency is how it should be valued.
Historically, currency had value because it was linked to a commodity such as gold or silver or because the value of the currency was established and maintained by a central government. Because cryptocurrencies are generally not linked to a commodity or fiat currency, determining their value can be challenging.
The nature of cryptocurrency impacts valuation. There are two schools of thought on the nature of cryptocurrencies.
The first is that cryptocurrency should be considered a currency and treated the same way as other currency, and the second is that it is a commodity like gold. How a court answers this question may significantly affect the value that a bankruptcy trustee may obtain for avoidance or preference actions.
Section 550 of the Bankruptcy Code, 11 U.S.C.A. § 550(a), states that “the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property.”
When the item transferred is currency, the trustee would be entitled to only the historical value at the time of the transfer. When property is transferred, however, the trustee would be entitled to receive the value of the property at the transfer date or time of recovery, whichever is greater, allowing a trustee to capture the value of appreciation.
Accordingly, whether a trustee is entitled to recover the face value of transferred cryptocurrency or any appreciation since its transfer depends on whether cryptocurrency is classified as a currency or a commodity.
Given the extreme volatility of cryptocurrencies, the answer to this question can lead to significantly different recoveries for a trustee. Unfortunately, this issue remains unresolved.
The U.S. Bankruptcy Court for the Northern District of California was confronted with this issue in In re Hashfast Technologies LLC.3
In Hashfast, a liquidating trustee sought to avoid and recover an alleged fraudulent transfer of 3,000 bitcoins. At the time of the transfer, the bitcoins were worth about $363,000. Since the transfer, however, the bitcoins had appreciated to over $1 million.
The liquidating trustee argued in a motion for partial summary judgment that he was entitled to the bitcoins or their present value because they were a commodity and not currency.
The Bankruptcy Court declined to determine whether bitcoins are currency or commodities for purposes of the fraudulent-transfer provisions of the Bankruptcy Code.
It left the determination of whether the trustee could recover the property transferred or the value and date of the valuation for a later time. It never reached a decision as to the valuation because the adversary proceeding settled.
Other courts and government agencies have come down on either side of this divide. For example, the U.S. District Court for the Eastern District of Texas determined that bitcoins are a currency or a form of money.4
However, the Commodity Futures Trading Commission has determined that cryptocurrencies are not a currency but are a different type of commodity.5 As discussed below, this decision means the buying and selling of cryptocurrency are subject to the retail commodity provisions of the Commodity Exchange Act, or CEA.6
It is important that professionals remain sensitive to this issue as courts and regulators continue to provide guidance as to the nature of cryptocurrency.
Cryptocurrency as Collateral
When a debtor enters bankruptcy, an important consideration for a creditor is the universe of assets to which it may look for repayment. Properly perfected security interests in specific collateral provide creditors with certainty and protections regarding repayment from identified collateral.
As cryptocurrencies have continued to garner more and more attention, the demand for financing secured by cryptocurrencies has also increased.
Lenders securing financing with cryptocurrencies need to take appropriate steps to ensure they can realize on the collateral if their borrower does not repay the loan and must structure the financing in a way that complies with applicable laws and regulations.
A creditor taking a security interest in cryptocurrency must perfect that security interest under applicable state law. The method of perfecting a security interest in cryptocurrency depends on its nature, which, as discussed above, is still unsettled.
Article 9 of the Uniform Commercial Code governs security interests in personal property, both tangible and intangible. If cryptocurrency is viewed as a currency or money, the only means of perfecting a security interest would be through possession of the virtual currency, which raises a multitude of issues.
Some commentators have argued that cryptocurrency does not meet the UCC’s definition of money.7 They say it should be viewed as a commodity or security account and that a lender perfects its interest through control of the account. In the context of cryptocurrency this would require control over a digital wallet and the private key to the cryptocurrency.
Other commentators believe that cryptocurrency is appropriately considered a “general intangible” under the UCC, which is perfected by filing a UCC-1 financing statement in the proper filing office.
Anecdotally, it appears that lenders are currently seeking to secure cryptocurrency through control. However, this may lead to regulatory violations.
In addition to properly securing an interest in cryptocurrency, lenders need to ensure that they are complying with existing laws and regulations in structuring the financing.
Regulation of cryptocurrencies is still being worked out, and overlapping regulations may exist at the state and federal level and across federal agencies, creating some legal uncertainty.8
A comprehensive discussion of the possible regulations and areas of legal uncertainty is beyond the scope of this article, but is an important consideration for insolvency professionals and estate fiduciaries alike as the changing regulatory landscape may increase costs associated with cryptocurrency.
A recent example of the dangers of running afoul of regulations in securing financing with cryptocurrency can be seen in the CFTC’s order in an action involving the company Bitfinex.9
Bitfinex provided a platform that matched lenders to purchasers of bitcoin. The bitcoin served as collateral for the loan and was held in an account for which Bitfinex retained control of the private key, thereby ensuring that the bitcoin was not transferred by the borrower.
The CFTC found that this arrangement violated a CEA provision regulating financed retail commodity transactions. The CEA requires financed retail commodity transactions to be conducted on a designated contract market unless an exception applies. A designated contract market is a board of trade or exchange regulated by the CFTC.
The CFTC further determined that an exception to the CEA for a contract of sale that results in actual delivery of the commodity within 28 days did not apply. Noting that Bitfinex retained control of the private key, the commission reasoned that the borrower did not receive “actual delivery” of the bitcoin because there was no transfer of possession and control.
Ultimately, Bitfinex settled the matter and was fined and enjoined from continuing to provide the financing services that violated the CEA.
Lenders seeking to secure financing with cryptocurrency are well advised to keep current on how cryptocurrency is being categorized for purposes of Article 9 of the Uniform Commercial Code as well as the regulations and laws that govern such financing.
Maximizing the Value of Cryptocurrency
A bankruptcy trustee’s primary duty is to maximize the value of the estate for the benefit of creditors. But maximizing the value of cryptocurrency can be difficult because, somewhat like a security, the nature of its value is based on supply and demand.
Some analysts and bitcoin investors have argued that a large selloff of cryptocurrency through an exchange would drastically decrease its value.
The potential impact of mass sales of a cryptocurrency may need to be structured so that the sales capture the value of high prices without devaluing the currency and potentially diminishing the value of the estate. Certain future exchanges now offer bitcoin futures products that may assist trustees in exploring bitcoin valuation.
Bankruptcy trustees should plan carefully and look for reliable sources of valuation, such as developing future exchanges, in seeking to maximize the value of cryptocurrency while converting it to funds from which distributions may be made.
結論
The meteoric rise in the value of cryptocurrencies, and the increasing acceptance of cryptocurrencies as a medium of exchange, portend increasing ubiquity of virtual currencies and their inclusion as bankruptcy assets.
Therefore, estate fiduciaries and professionals should become familiar with cryptocurrency and the challenges it can raise within bankruptcy.
Similarly, lenders seeking to secure financing with cryptocurrencies should carefully review developments in securing cryptocurrency and laws and regulations that may affect such a security interest.
注記
1 “Hodl” is derived from a misspelling in a Reddit discussion regarding cryptocurrency. For a thorough discussion of the origins of the term “hodl,” see Leah Stella Stephens, What’s the Backstory on the Word, Hodl?, Medium (Apr. 30, 2017), https://medium.com/dash-for-newbies/whats-the-backstory-on-the-word-hodl-27756392b698
2 See In re Jackson, Case No. 15-21233, Docket No. 879-3 (Bankr. D. Conn. Feb. 23, 2018).
3 Kasolas v. Lowe (In re Hashfast Techs. LLC), Adv. No. 15-3011 (Bankr. N.D. Cal.).
4 SEC v. Shavers, Case No. 13-cv-416, Docket No. 23 (E.D. Tex. Aug. 6, 2013) (determining that investments in bitcoin constituted an investment of money).
5 See In re Coinflip Inc., CFTC No. 15-29 (Sept. 17, 2015) (“Section 1a(9) of the act defines ‘commodity’ to include, among other things, ‘all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.’ … Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities.”).
6 The CEA has a different framework for regulating retail currency transactions.
7 See Jeanne L. Schroeder, Bitcoin and the Uniform Commercial Code, 24 U. of Miami L. Rev. 1, 22 (2016) (arguing that whether or not a government adopts bitcoin as currency, the Uniform Commercial Code limits classification of “money” to physical currency).
8 See Commodity Futures Trading Comm’n v. McDonnell, 287 F. Supp. 3d 213 (E.D.N.Y. 2018) (“Until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency.”).
9 In re BFXNA Inc., No. 16-19, 2016 WL 3137612 (C.F.T.C. June 2, 2016).
This article first appeared in the May 17, 2018, edition of Westlaw Journal Bankruptcy.