Cryptocurrency and Bankruptcy
- Is Cryptocurrency an Asset that Must Be Disclosed in Bankruptcy?
- Can Cryptocurrency Be Treated as an Exempt Asset?
- How Is Cryptocurrency Categorized?
- How Is the Value of Cryptocurrency Determined?
- When Is a Transfer of Cryptocurrency Deemed Fraudulent?
Cryptocurrency holdings are showing up in the bankruptcy schedules of debtors with increasing frequency. 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.
Even though there is still very little case law on the issue of cryptocurrency, it is clearly an asset that must be disclosed. In a bankruptcy case, all property of the debtor, no matter the value (see more below on value), must be disclosed.
However, the more practical issue related to disclosure is whether cryptocurrency can be discoverable by a trustee if a debtor fails to list it as an asset. Because cryptocurrency can hardly be considered a common asset, such nondisclosure could be innocent enough.. Many people still do not understand that cryptocurrency is an asset requiring disclosure. This misperception must be addressed because the intentional failure to disclose could lead to criminal prosecution.
Even if cryptocurrency is properly identified as an asset on the debtor’s bankruptcy schedule, challenges may arise in actually gaining control of the cryptocurrency and realizing its value. In fact, the individual in possession of the “private key” is effectively the controller of the cryptocurrency held in the digital wallet. For this reason, if a trustee or insolvency professional wants to realize the value of cryptocurrency in the debtor’s digital wallet, the trustee or professional will need the cooperation of the debtor to obtain the private key. Otherwise, the trustee or professional will not have sufficient control over, or access to, the cryptocurrency in order to realize its value.
Unfortunately, cryptocurrency does not fit neatly into any bucket of exempt assets. Furthermore, the property that is exempt in a bankruptcy case varies from state to state. In some states, debtors may choose among those exemptions defined by state law and those exemptions defined by federal law.
In Texas, for example, state law generally provides a generous exemption for a debtor’s homestead. In fact, the debtor is qualified for an unlimited homestead exemption under Texas state law, as long as the debtor did not recently move to the state. However, Texas state law provides no exemption for which cryptocurrency might qualify.
Exemptions under federal law, however, include what is known as a “wildcard” exemption. The wildcard exemption allows a debtor to exempt any property that would not otherwise be exempt up to a defined value. At the time of this writing, the defined value was $1,325. Additionally, if a debtor does not have a homestead, the debtor can use up to $12,575 of the unused homestead exemption in Texas as part of the wildcard exemption as well. Therefore, a debtor could potentially be exempt as much as $13,900 in cryptocurrency under certain circumstances. Since exemption rules apply separately to each debtor, a married couple could exempt as much as $27,800 in cryptocurrency under certain circumstances.
Cryptocurrency possesses the characteristics of various forms of assets. For starters, cryptocurrency has many characteristics akin to cash. For example, they can both be exchanged for goods or services, although there is no known country that currently recognizes cryptocurrency as legal tender.
Cryptocurrency also has many characteristics akin to financial securities in that it is frequently traded on exchanges. However, it is not traded on formal stock exchanges and is not recognized as a financial instrument or a negotiable instrument by any government.
Regardless of its classification, cryptocurrency clearly has a potential value that should be disclosed. At a minimum, such cryptocurrency should be disclosed in a debtor’s asset schedule as an “other asset.”
Perhaps the most difficult issue with respect to cryptocurrency is valuation. Even if a debtor properly lists the asset and even if it is properly categorized, the question remains as to how it should be valued. Valuation is crucial in determining how much of the cryptocurrency may be exempted., Yet, no clear market exists, and values tend to fluctuate wildly. Furthermore, any trustee faced with the prospect of evaluating cryptocurrency would likely need assistance to understand the software used by that particular cryptocurrency and to access the exchange on which it is traded.
Like the transfer of any other asset, transfers of cryptocurrency within two years of a bankruptcy filing could be deemed fraudulent if the elements of fraud are satisfied. More specifically, a transfer is deemed fraudulent if a debtor voluntarily or involuntarily makes a transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was indebted. Similarly, a transfer is also deemed fraudulent if a debtor received less than a reasonably equivalent value in exchange for such transfer or obligation and was also insolvent at the time of the transfer. For these reasons, valuation is an important issue in determining the “reasonably equivalent value” of cryptocurrency.
Freeman Law represents virtual currency clients in the United States and Internationally. Contact us now or Schedule a consultation or call (214) 984-3410 to discuss your cryptocurrency and blockchain technology concerns.