Bankruptcy Valuation Issues in Respect of Cryptocurrencies

        Value is everything in bankruptcy: finding (or creating) it, preserving it, maximizing it, and ultimately allocating it in accordance with statutory priorities among many (and often competing) constituencies. Value can exist in many forms, including in the form of new technologies that have produced “cryptocurrencies.”[1]

What Are Cryptocurrencies?

       Defining what a cryptocurrency “is” in the regulatory or judicial context is not so simple. A cryptocurrency exists digitally and/or virtually, using cryptography[2] and resting on “blockchain” technology,[3] which purportedly makes it secure and difficult to counterfeit.[4] These attributes also factor into the inherent value of cryptocurrencies, which, unlike legal tender or “fiat” currency, are decentralized and are not issued by a national governmental or similar authority, thus rendering them theoretically immune to government monetary policies.[5] Even by the standards of our rapidly changing, technologically forward-propelled world, the creation and use of cryptocurrencies in commerce[6] is a relatively recent phenomenon. It post-dates the 2007 introduction of the iPhone, for example, but largely pre-dates effective driverless cars.

       Legal issues involving cryptocurrencies can arise in various, but fairly typical, ways. To highlight a few, a cryptodevelopment company can become embroiled in allegations that insiders are engaged in self-dealing;[7] cryptodevelopers can fight over the trade name of, or other intellectual property rights relating to, a cryptocurrency and may seek injunctive relief over allegations of infringement;[8] disagreements can arise as to whether disputes over cryptocurrencies must be arbitrated;[9] and cryptocurrencies can be the subject of criminal forfeiture (not surprisingly, the anonymity attendant to cryptocurrencies occasionally results in their use in criminal transactions or other illicit behavior).[10] Although it does not appear that any substantive cryptocurrency issue has yet been considered by the Supreme Court, at least one Justice has acknowledged the possibility.[11]

       Although the focus of this article is not the technology behind cryptocurrencies (i.e., blockchain, distributed ledgers, “mining,” etc.), at least a superficial understanding of such technology may be helpful for bankruptcy practitioners in cases involving cryptocurrencies as assets or as a medium for pre-bankruptcy transfers. The U.S. District Court for the District of Kansas recently provided an explanation of how bitcoins came to be and how they are mined:

The [B]itcoin network is a peer to-peer payment network created in 2009. It uses digital currency known as “bitcoin[s].” The [B]itcoin network is decentralized; no authority oversees its operation, and it uses open-source encryption software for transactions. The network uses cryptography to create and control the currency. Bitcoins are created by “mining,” a process where “miners” receive transaction fees and newly minted bitcoins in return for verifying and recording payments in a public ledger. By design, mining is a computationally intensive process that becomes more difficult over time. Further, the faster one is able to mine bitcoins, the more money one may make. As the difficulty of bitcoin mining has increased, the computer hardware required to profitably mine [B]itcoin has advanced....[12]

Cryptocurrencies in Bankruptcy

       However obtained, it seems clear enough that a cryptocurrency would be included among a debtor’s property interests under § 541 of the Code, to the extent of the debtor’s interest therein.[13] But what kind of property? [14] There is an ongoing debate among regulatory agencies in the blogosphere and in the case law as to, among other things, whether Bitcoin and other forms of cryptocurrencies are commodities, currency, cash, or possibly even goods or securities.[15] None of these terms, other than securities (the definition of which is broad), are defined by the Code.[16]

       The definitive answer to this question has not yet crystallized but may very well impact issues — including valuation issues — that bankruptcy practitioners will have to address. For example, the Code contains “special” nondebtor-friendly provisions relating to cash-like instruments, including swap agreements,[17] and to commodities and forward contracts,[18] which can affect value considerations in bankruptcy with respect to such matters and property interests of a debtor.

       These issues will become more prevalent. Inevitably, debtors, and those who deal with debtors, increasingly will include cryptocurrency among their assets, use cryptocurrency to do business, or otherwise have a relationship based in part on the use of, or holdings in, cryptocurrencies.[19] At present, there are only a handful of decisions that touch on these issues, and the guidance that has been provided is anything but clear.

       In Hashfast Technologies,[20] a liquidating trustee sought to avoid the debtor’s pre-bankruptcy transfer of Bitcoin to a third party. Whether the Bitcoin was a commodity or a currency, or whether that currency was U.S. dollars, was important in the litigation and for the purposes of valuation, because the Bitcoin traded at one value at the time of the transfer and at a higher value later. The trustee’s position was that if he prevailed on avoidance, the remedy to which the estate would be entitled, under § 550 of the Code (which allows for the recovery of “the property transferred, or, if the court so orders, the value of such property”), should be the higher value at the time of avoidance rather than the lower value at the time of transfer (in effect, that the estate should obtain the post-transfer appreciation in value of the Bitcoin). The defendant argued otherwise. On summary judgment, the bankruptcy court did not decide what it presumably may have perceived as the thornier commodity vs. currency issue. Instead, it decided simply that if it were currency, Bitcoin clearly was not U.S. dollars:

The court does not need to decide whether bitcoin[s] are currency or commodities for purposes of the fraudulent transfer provisions of the [B]ankruptcy [C]ode. Rather, it is sufficient to determine that, despite defendant’s arguments to the contrary, bitcoin[s] are not United States dollars. If and when the Liquidating Trustee prevails and avoids the subject transfer of [B]itcoin to defendant, the court will decide whether, under 11 U.S.C. § 550(a), he may recover the bitcoin[s] (property) transferred or their value, and if the latter, valued as of what date.[21]

       Although at first blush it might seem logical and inviting to conclude that a cryptocurrency is a currency (as it can be used as a medium of exchange, just like U.S. dollars), some nonbankruptcy courts have concluded instead that it may be a commodity.[22] In My Big Coin Pay, the Massachusetts District Court ruled that the “virtual currency” called “My Big Coin,” allegedly marketed by the defendant in a fraudulent manner, was a commodity within the purview of the Commodity Exchange Act (CEA), and the defendant thus was subject to being sued for fraud by the Commodity Futures Trading Commission. The CEA defines “commodity” as specifically inclusive of many agricultural products such as wheat, cotton, rice, corn, oats, barley and frozen concentrated orange juice,[23] as well as “all other goods and articles, … in which contracts for future delivery are presently or in the future dealt in.”[24]

       The Eastern District of New York reached the same conclusion in Commodity Futures Trading Commission v. McDonnell.[25] The McDonnell court, while noting that “virtual currency” can be, and is, tendered for payment of debts, it is not legal tender that must be accepted in the United States. The court further noted that a “commodity” “encompasses virtual currency both in economic function and in the language of [the CEA].”[26]

       It seems, however, that whether cryptocurrency is a commodity or a currency misses the mark in a fraudulent-transfer action. Whether a currency or a commodity, it has a value in U.S. dollars, which can be determined at various points in time. In a bankruptcy case, specifically in a fraudulent-transfer action, a bankruptcy court could determine the value of Bitcoin transferred as of the various possible points in time (e.g., as of the date of transfer, as of the date of avoidance). The best interests of the estate as perceived by the court might be a critical factor in that determination.

       The “what is it” debate and the inherent volatility of cryptocurrencies in the marketplace also may have consequences in other settings including, without limitation:

*          cash-collateral disputes under Code §§ 361 and 364, such as what may constitute the “indubitable equivalent” of a cryptocurrency;

*          disputes regarding whether a purported security interest in a cryptocurrency is properly perfected;

*          questions of how a claim secured by cryptocurrency must be dealt with for cramdown purposes under § 1129;

*          valuation of cryptocurrency assets in filing bankruptcy petitions and in schedules of assets; and

*          whether, in a sale of assets, a secured creditor is under- or oversecured.

       Although there are no reported decisions of which this author is aware that address specifically the valuation of a specific cryptocurrency in a bankruptcy case, it seems clear that the valuation of cryptocurrencies, in light of the extreme volatility in their trading value, will give rise to interesting issues, and likely litigation, that could be meaningful from the very beginning to the very end of a bankruptcy case.