Understanding the Legal Challenges of Crypto Bankruptcies

The spate of crypto bankruptcies of major platforms like Celsius, FTX, and BlockFi have brought doubts in the crypto community on the legal uncertainties and financial turmoil coexisting within this highly volatile space.

The sudden changes in legal rights and responsibilities during these crypto bankruptcies have created unpredictable results that some experts are comparing it to stepping into a bizarre alternate reality.

One of the most pressing concerns is that the Bankruptcy Code lacks specific guidance on how and when to value digital assets. This has left stakeholders grappling with a multitude of possibilities, where the value of their crypto holdings could fluctuate dramatically depending on the courtroom they find themselves in.

Ideally, in bankruptcies, creditors receive a percentage recovery after their claims are processed. However, crypto customers of bankrupt platforms have been classified as “general unsecured creditors,” meaning their claims are tied to the volatile value of digital assets.

Moreover, under Section 502(b) of the Bankruptcy Code, the valuation of claims should be based on U.S. dollars as of the bankruptcy filing date. This has given rise to two distinct approaches: the petition-date approach and the distribution-date approach.

The bankruptcies of Celsius, FTX, and BlockFi followed the petition-date approach, where claims were based on the asset value at the time of filing. Unfortunately, this coincided with the “crypto winter,” when asset prices plummeted, leaving claimants with significantly less as the market rebounded.

Conversely, the distribution-date approach, applied in the Genesis bankruptcy, emphasized the time of distribution to creditors. While this approach maximizes in-kind distributions, it has faced criticism for potentially overcompensating creditors.

Further complicating matters is that courts may adopt different valuation approaches for various purposes, as seen in the Genesis bankruptcy. The treatment of preference claims under Section 547 of the Bankruptcy Code also raises concerns about the value of digital asset transfers.

With each court ruling, the crypto bankruptcy saga unfolds like a suspense thriller, keeping investors on edge. As the legal battles continue, one thing is clear: navigating the crypto multiverse requires more than just legal expertise—it demands a significant amount of luck and patience.