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Vulnerability of Customers’ Crypto in Bankruptcy; Is Help on the Way?

The major cryptocurrencies have experienced significant declines in 2022; with the crypto market shedding $2 trillion of its peak $3 trillion market capitalization in November 2021. Amid this “crypto winter,” Terra Luna and its algorithmic stablecoin collapsed, triggering a domino effect of losses and illiquidity throughout the crypto industry. The hedge fund Three Arrows Capital was the first big domino to fall, defaulting on $1 billion in loans including $650 million owed to Voyager Digital (“Voyager”). To avoid the proverbial “run on the bank,” many crypto exchanges halted trading and froze customer accounts, and some have filed for chapter 11 bankruptcy protection, like Voyager and Celsius Network (“Celsius”).

The Voyager and Celsius chapter 11 filings have enabled these crypto exchanges to use the breathing-spell of bankruptcy (e.g., the automatic stay) [1] to hopefully ride out the “crypto winter” and attempt to reorganize or pursue some other strategy to maximize recoveries for all stakeholders, perhaps at the expense of their customers.

The Voyager and Celsius bankruptcies raise a critical question: are customers’ custodially-held crypto assets property of the bankruptcy estate (which can be used to facilitate a reorganization and satisfy debts of other creditors)? [2] If so, the customers will be left with a general unsecured claim and stand to lose most, if not all, of the value of their crypto assets. If not, the customers should be entitled to relief from the automatic stay and reclaim their crypto assets. While the Voyager and Celsius bankruptcy courts have yet to weigh in on this question; their rulings will likely turn on the following factors: (i) the parties’ intent, evidenced by the agreements between the crypto exchange and the customer, (ii) whether a customer’s crypto assets are commingled or can be readily traced and (iii) who controls the crypto assets.

Voyager customers have reason to be concerned. Voyager’s customer agreement provides that Voyager does not hold custodially-held crypto assets in segregated accounts and can freely use these assets for its own account; only promising to make like-kind crypto available to its custodial customers when they seek to trade or withdraw.

Celsius customers have reason to be concerned as well, though their situation is not quite as bad. Under pressure from regulatory authorities, earlier this year, Celsius changed its customer agreement to provide that customers retain title to custodially-held assets; however, the agreement provides that custodially-held crypto assets are commingled with assets of other customers and the custodial arrangement may not be respected in bankruptcy. Why? It is virtually impossible to trace fungible crypto; so, customers cannot make a claim to their crypto. Will the bankruptcy court provide some type of equitable relief; can it find a basis for imposing a constructive trust over the commingled account for the benefit of custodial customers? In any case, pending a ruling by the bankruptcy court, custodially-held crypto remains with the exchange, inaccessible to customers and subject to the crypto market volatility.

While too late to help Voyager and Celsius customers, efforts are underway, at the state and federal level, to address the uncertainty surrounding crypto custodial arrangements.

The Uniform Law Commission and the American Law Institute have recently approved and recommended for enactment in all states amendments to the Uniform Commercial Code (the “UCC”) to address emerging technologies. The proposed amendments include amendments to Article 8 which provide that, as with traditional securities, if a “securities intermediary”—which would include a crypto exchange—agrees with a customer to treat the customer’s fungible crypto assets as “financial assets,” it holds those assets as custodian, and the customer retains its property interests even if the exchange holds the assets outside of an account for the customer’s benefit and are commingled. If an intermediary commingles a customer’s crypto assets, the customer will have a pro-rata property interest in the commingled crypto assets. It bears emphasizing that the proposed amendments to Article 8, if adopted by the states, will only be helpful if the exchanges adopt the protocols and agree with customers to treat custodial crypto as “financial assets.” Notably, under SEC guidelines for publicly traded crypto exchanges, Coinbase recently updated its agreement for retail customers to indicate that it is a “securities intermediary” under the UCC and has agreed that customers’ crypto are “financial assets.”

At the federal level, there are dozens of bills which have been introduced in Congress to regulate the crypto industry which would attempt to reign in the crypto industry’s cowboy ways and provide protection to customers. Two of the more prominent bills, the Responsible Financial Innovation Act (“RFIA”) and the Digital Commodities Consumer Protection Act (the “DCCPA”), provide for fungible crypto assets to be treated as commodities and confer authority on the Commodity Futures Trading Commission to regulate the industry. They would require crypto exchanges to treat and deal with all crypto assets of any customer as belonging to the customer and prohibit commingling (though a customer can opt out of the commingling protections). The RFIA and DCCPA would also amend the definition of “commodity broker” in the Commodities Exchange Act and the Bankruptcy Code to include crypto exchanges, [3] which would be subject to specialized liquidation provisions for commodity brokers in which customers’ crypto assets would effectively be excluded from the bankruptcy estate.

It remains to be seen whether the RFIA or DCCPA (or like legislation) will become law, but there is growing consensus among lawmakers that there is a need for meaningful federal regulation of the crypto industry which includes protection of custodial accounts. Stay tuned.


[1] The automatic stay provides for a broad stay of litigation and other actions, judicial or otherwise that are attempts to enforce or collect pre-bankruptcy claims. It also stays a wide range of actions that would affect or interfere with property of the bankruptcy estate or property in the custody of the bankruptcy estate which, for example, includes customers’ crypto assets being held by Voyager and Celsius.

[2] Here, it is important to distinguish a custodial arrangement from other arrangements a customer could have with an exchange, such as Voyager’s “Rewards” account or Celsius’ “Earn” account in which a customer lends its crypto assets to the exchange for a yield (typically in the form of like-kind crypto) and transfers ownership to the exchange which, in turn, lends the crypto assets to a third party.

[3] RFIA, Section 4.07 and DCCPA, Section 5(i).