Cryptocurrency and Bankruptcy

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Cryptocurrency and Bankruptcy

More and more frequently, cryptocurrency holdings are showing up in the bankruptcy schedules of Debtors.  A number of issues can arise in this context, including whether cryptocurrency is included within the meaning of property of the estate, how it should be valued, and how it should be categorized for bankruptcy purposes.  These issues are, of course, just the tip of the iceberg.

Issue:  Is cryptocurrency an asset that must be disclosed in bankruptcy?

Very little caselaw exists on the issue of cryptocurrency, but it is clearly an asset that must be disclosed.  All property of a debtor, no matter the value (see more below on value), must be disclosed in a bankruptcy case.

The more practical issue related to disclosure is whether or not cryptocurrency could be discoverable by a trustee if a debtor fails to inform his or her attorney and fails to disclose the cryptocurrency as an asset.  Such non-disclosure could be innocent enough given that cryptocurrency is hardly a common asset, and many people may not understand that it constitutes an asset requiring disclosure.  Of course, intentional failure to disclose could lead to criminal prosecution.

And even when a cryptocurrency asset can be identified, challenges arise in actually gaining control of the cryptocurrency and realizing value for it.  The individual in possession of a “private key” can be regarded as the controller of the cryptocurrency held in a digital wallet.  Therefore, in order to realize any of the cryptoassets held in the digital wallet, a trustee or other insolvency professional will require the cooperation of the debtor in obtaining the private key; otherwise the insolvency professional will not have sufficient control over, or access to, the cryptoassets in order to realize their value.

Issue:  Can cryptocurrency be treated as an exempt asset?

Unfortunately, cryptocurrency does not fit cleanly into any bucket of exempt assets.  What property is exempt in a bankruptcy case varies from state to state.  In some states, debtors can choose between a set of exemptions defined by state law and a set of exemptions defined by federal law.

In Texas, for example, with just a few exceptions, state law provides a generous exemption for a debtor’s homestead.  As long as a debtor did not recently move to the state of Texas, a Debtor has an unlimited homestead exemption under Texas state law.  However, Texas has no exemption for which cryptocurrency would qualify.

Exemptions under Federal law, however, include what is known as a “wildcard” exemption.  The “wildcard” exemption allows a debtor to exempt any property up to a defined value that would not otherwise be exempt.  At the time of this writing, the wildcard exemption applies to property worth up to $1,325.  Additionally, if a debtor does not have a homestead, s/he can use up to $12,575 of the unused homestead exemption as part of the wildcard exemption.  Therefore, a debtor could potentially exempt as much as $13,900.00 in cryptocurrency in certain circumstances.  Of course, the exemption rules apply individually to each debtor, and therefore a married couple could exempt a much as $27,800.00 in cryptocurrency.

Issue:  How is cryptocurrency categorized?

Cryptocurrency carries with it characteristics of various forms of assets.  For starters, cryptocurrency could be classified as cash, as it does share certain characteristics as cash.  It can be exchanged for good or services.  However, there is known country that currently recognizes cryptocurrency as legal tender.

Cryptocurrency also has many characteristics akin to financial securities.  Although cryptocurrency is frequently traded on exchanges, it is not traded on formal stock exchanges and is not recognized as a financial instrument or a negotiable instrument by any government.

Despite the uncertainty, cryptocurrency clearly has potential value that should be disclosed.  At a minimum, such cryptocurrency should be disclosed in a debtor’s asset schedule as an “other asset.”

Issue:  How to determine the value of a cryptocurrency holding

Perhaps the most difficult issue with respect to cryptocurrency is valuation.  Even if a debtor properly lists the asset; even if it is properly categorized – how is it valued? Valuation could determine the ability to exempt all or a portion of the cryptocurrency.  And yet no clear market exists, and values tend to fluctuate wildly.   Any trustee faced with the prospect of evaluating a cryptocurrency would likely need assistance with understanding software for a particular cryptocurrency and access to the exchange on which that particular cryptocurrency is traded.

Issue:  Fraudulent transfers of cryptocurrency

Just like any other asset, transfers of cryptocurrency assets within two years of a bankruptcy filing could constitute a fraudulent if the necessary elements exist.  Such a transfer exists if a debtor voluntarily or involuntarily makes such a transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was indebted.  Such a transfer also exists if a debtor received less than a reasonably equivalent value in exchange for such transfer or obligation and was insolvent at the time of the transfer.  Valuation once again becomes an issue in determining “reasonably equivalent value”.