Bitcoins. Litecoins. Dogecoins. Even, at one point, “Coinye West.” Like it or not, it’s hard to deny that bitcoin and cryptocurrencies like it have been quite the talk of the financial world recently. Between Feb. 1, 2013, and Feb. 1, 2014, bitcoin prices have risen from about $20 per coin to a high of more than $1,200 and then fallen back down into the $500 to $600 range.
However, although they have seen increasing acceptance by retailers, cryptocurrencies function differently from dollars, pounds and euros, and we would be remiss to ignore these important differences. As we have already seen, one important difference is the sheer price volatility of cryptocurrencies in the present market. Another difference is that while conventional currencies are generally stored in bank or investment accounts, cryptocurrencies are typically stored in digital wallets, which are accessible through public-key cryptography.
Due to the high volatility of bitcoin prices, it may be more helpful to think of bitcoins as a commodity that is easily liquidated, rather than as dollars and cents. This is important to keep in mind when preparing a debtor’s schedules and statements. Rather than declaring “five bitcoins” or “$5,000 in bitcoins,” it is more helpful to provide detailed information, such as “five bitcoins, valued at $5,000 by Mt. Gox on Feb. 1, 2014.” If you provide a date and a source of the valuation on the debtor’s schedules and statements, that can provide you with something comfortable to fall back on when the price changes later. Unlike many other assets, obtaining these valuations does not require an appraiser or any special expertise; visit an online bitcoin exchange like Mt. Gox (similar to a stock exchange, but much less regulated), and find out the current rates on that exchange, or check out one of many websites that specialize in reporting cryptocurrency prices, like bitcoincharts.com.
Without delving too heavily into the details, public-key encryption is a widely-used encryption technique involving a separate public and private key. The public key encrypts the data, preventing people from accessing it without the private key. The public key cannot be used to generate the private key. The important fact for our purposes is that cryptocurrency stored in a digital wallet typically cannot be accessed without the private key. If the owner loses the private key, that is the end and the currency is no longer accessible. Even for online bitcoin wallet services, the wallet service itself cannot access the individual wallets without the private key. Thus, while you can garnish a bank account, garnishing a bitcoin wallet would likely prove fruitless. The site where the wallet is “stored” would simply tell you that even they cannot access the wallet. Thus, trustees of individual debtors who have bitcoins among their assets would be wise to compel the debtor to hand over their private key or transfer the bitcoins to a separate wallet for the estate.
However, unlike banks, bitcoin exchanges and wallet services are not insured by the Federal Deposit Insurance Corp. (FDIC). Ultimately, unlike with a bank account, if your bitcoins are hacked, there is no guarantee of reimbursement. Account hacks have affected both legal and illegal websites sites, and hit online marketplaces, as well as bitcoin wallets. Problems have gotten so bad that as of Feb. 19, 2014, Mr. Gox, one of the world’s largest bitcoin exchanges is currently halting all withdrawals from the exchange due to concerns regarding a flaw in bitcoin wallet software. Although some speculate that Mt. Gox may declare bankruptcy, the future is far from clear. [Editor's Note: Mt. Gox filed for bankruptcy protection in Japan in February, and in March, Mt. Gox Co., Ltd. filed a chapter 15 proceeding in the U.S. Bankruptcy Court for the Northern District of Texas, Case No. 14-31229.]
The moral of the story: Don’t get bit by bitcoin. Whether you are a trustee representing a debtor with assets locked up in cryptocurrency, or represent a significant unsecured creditor of an estate with holdings in cryptocurrency, it is important to understand that bitcoin and other cryptocurrencies should not be treated like dollars and cents, but instead handled with care.