Latif Pelinku
St. John’s University School of Law
American Bankruptcy Institute Law Review Staff
Section 502(c) of title 11 of the United States Code (the “Bankruptcy Code”) gives courts “substantial discretion” to determine the appropriate means to estimate “any contingent or unliquidated claim, the fixing or liquidation of which, as the case may be, would unduly delay the administration of the case.”[1] In In re FTX Trading Ltd., the United States Bankruptcy Court for the District of Delaware considered the novel issue of estimating the value of cryptocurrency.[2] The Court held that the “Blockage Method” was the appropriate method for determining the value of the cryptocurrency assets. In applying the Blockage Method, the Court adjusted the valuation’s “discount for lack of marketability” to quantify reasonable discounts for each cryptocurrency token.[3]
On November 11, 2022 (the “Petition Date”), FTX Trading Ltd. and its affiliates (collectively, the “Debtors”) filed for relief under chapter 11 of the Bankruptcy Code.[4] The Bankruptcy Code requires creditors to file proof of claims asserting a value in U.S. dollars.[5] In order to value the millions of claims asserted by creditors, Debtors filed a motion under section 502 of the Bankruptcy Code to estimate the value of the cryptocurrency asset claims.[6] An initial estimation hearing was held on January 31, 2024, where the Court decided that estimation of the cryptocurrency claims was appropriate and that the Debtors’ proposed “Digital Asset Conversion Table” method for estimating the claims, along with their adjustments of the Petition Date’s market prices, was fair and reasonable.[7] However, prior to the initial estimation hearing the Debtors agreed to defer the objections of three parties: Maps Vault Limited, TMSI SEZC Ltd., and Foundation Serendipity (the “Objectors”), regarding their cryptocurrency asset claims for MAPS, OXY, and SRM tokens.[8]
During an evidentiary hearing in March 2024, the Court encountered complications in assessing the value of the cryptocurrency assets at issue due to their trading restrictions.[9] First, the crypto assets were contractually “locked” and not freely tradable as of the Petition Date.[10] Second, the cryptocurrency tokens were not “transactional tokens,” which are used as a payment method like Bitcoin, but were “utility tokens” which serve specific functions limited to their respective blockchains, such as governance participation and earning rewards.[11] Third, the three tokens at issue fell victim to FTX and its sister company Alameda Research’s deliberate scheme of restricting the free float supply of tradable tokens, in which market prices are derived, by holding nearly the entire supply of tokens to inflate the value of their balance sheets.[12] For example, Debtors held over 99% of the total supply of MAPS, over 97% of the total supply of OXY, and over 95% of the total supply of SRM.[13] Thus, the Court decided that a proper valuation under section 502(c) should consider the entire supply of cryptocurrency assets at issue and the impact of liquidating the Debtors’ holdings, rather than merely valuing the tokens held by each creditor as proposed by the Objectors.[14]
In wading the “largely uncharted territory” of valuing restricted cryptocurrency, the Court heard expert testimony on which method to apply to discount the crypto assets for their lack of marketability and illiquidity after baseline prices were determined.[15] The two proffered approaches were the “KO Model” proposed by the Debtors and the “Blockage Method” proposed by the Objectors.[16] The KO Model quantifies the transaction cost of liquidating a large position in the market to account for the downward pressure the large position inflicts on the asset’s market price.[17] The Blockage Method is a generally accepted method in tax court for valuing large asset holdings where they undergo a phased out liquidation approach where sales are dribbled-out rather than impacting the market with large volume on a single date.[18]
The Court found that the KO Model was an inappropriate method to estimate the discounts because it is not used to value assets, but rather to calculate the transaction costs of selling assets in the market.[19] Further, the KO Model has never been previously used to value assets or calculate discounts, and it is limited to only assessing the impact from illiquidity, rather than all factors of unmarketability, as is typically done by discounts for lack of marketability.[20] The Court held that the Blockage Method was the appropriate method to apply due to the overwhelmingly large supply of crypto assets held by the Debtors in comparison to the assets’ low trading volume and because it solved all the problems identified with the KO Model.[21] However, the Court found flaws in the Objector’s expert’s application.[22]
The chief flaw of the Objector’s expert’s application was his use of certain option pricing models to calculate the discounts for lack of marketability of the crypto assets.[23] The Court found that those specific option pricing models were unreliable for their inability to calculate discounts for long time horizons.[24] The Court thus relied on the Debtors’ expert rebuttal calculations under the Blockage Method with the use of a different option pricing model because it produced reasonable results compared to the other option pricing models.[25] The Court concluded that the reasonable discounts that would be applied to the cryptocurrencies’ market prices to determine their values would be: 100% to MAPS tokens, 99.9% to OXY tokens, and 18.6% to SRM tokens.[26] The Court conceded that the final discounts essentially wiped the value of MAPS and OXY tokens, but reasoned that market prices were not a reliable indicator of their actual value.[27]
Bankruptcy courts maintain discretion to estimate the value of cryptocurrency asset claims. In such cases, the court will scrutinize the reasonableness of financial expert methodology and application and make adjustments as needed to ultimately reach reasonable discounts. Future cryptocurrency valuations in bankruptcy court may follow this Court’s framework when liquidating large holdings of restricted cryptocurrency by applying the Blockage Method and Ghaidarov option pricing model.
[1] In re FTX Trading Ltd., No. 22-11068 (JTD), 2024 WL 3191668, at *5 (Bankr. D. Del. June 26, 2024) (quoting In re Specialty Prod. Holding Corp., No. BR 10-11780-PJW, 2014 WL 545780, at *1 (D. Del. Feb. 7, 2014) (citing Bittner v. Borne Chem. Co., 691 F.2d 134, 135 (3d Cir. 1982)); 11 U.S.C. 502(c)).
[2] See id. at *1.
[3] See id. at *9, *12; id. at *8 (“[Discounts for lack of marketability] generally account for all of the reasons why an asset may not be marketable, including illiquidity.”).
[4] See id. at *2.
[5] See 11 U.S.C. 502(b).
[6] See In re FTX Trading Ltd., 2024 WL 3191668, at *2; 11 U.S.C. 502(c).
[7] In re FTX Trading Ltd., 2024 WL 3191668, at *2 (“[The Digital Asset Conversion Table] provided a means for converting each of the Digital Assets into U.S. Dollars . . . adjustments [] needed to be made to Debtors’ Spot Prices due to the fact that some of the Digital Assets were: (1) extremely illiquid; and/or (2) subject to restrictions that precluded their sale until a certain date.”).
[8] See id.
[9] See id. at *3.
[10] Id. at *1, *3 (discussing the general challenges in estimating the value of cryptocurrency assets, such as trading solely on sentiment, sparse regulation, questions about how to value locked tokens, and Debtors’ ownership of the vast majority of supply); Id. at *1 (citing 11 U.S.C. § 502(b) (“As with any estimation, the value of the claims must be determined as of the petition date as if the bankruptcy had never occurred.”).
[11] See id. at *3.
[12] See id. at *12.
[13] See id.
[14] See id. at *5–6 (reasoning that any action taken with the Debtors’ holdings of above 95% of the existing supply would have an immediate effect on the market, given the unusually low daily trading volume, and ignoring that fact would lack a reasonable basis in contradiction to the requirements of the Bankruptcy Code).
[15] Id. at *6 (“[T]he valuation of cryptocurrency assets is largely uncharted territory and, as such, there is little basis to state with any degree of certainty what approach is the correct approach.”); id at *3 (“[Kevin Lu, Director of Data Science and Product at Coin Metrics] determined the baseline prices by first selecting what he believed to be trusted exchanges and generating high quality constituent markets for each Digital Asset. Following his selection of trustworthy markets, Mr. Lu calculated the price of each digital asset using a weighted-median approach, with weights derived from the 60-minutes immediately preceding the petition time.”).
[16] Id. at *4 (The “KO Model” was proposed by the Debtors’ expert Professor Sabrina T. Howell, Professor of Finance at NYU Stern School of Business, who assisted the Debtors in determining the value of the 1,321 digital assets and fiat currencies at issue, and Objector TMSI’s expert Ioannis Gkatzimas, Principal at The Brattle Group. The “Blockage Method” was proposed by Objectors Maps Vault’s and Fondation’s expert Fotios Konstantinidis, Managing Director of Digital and Data Analytics at Stout Risius Ross, LLC.).
[17] See id. at *4 (“The KO model accounts for this downward pressure of [liquidating a large position into the market] by calculating the ‘price impact cost’ and ‘bid-ask spread cost’ of the liquidation, which together represent what KO refer to as a ‘transaction cost’ or what Professor Howell referred to as the ALD [Asset Liquidation Discount].”).
[18] See id. at *9 (“You need to follow a phased liquidation approach, what we call in valuation theory a dribble-out method. So, everything is sold gradually for the certain period of time and then you go back on the petition date and apply the discount.”).
[19]See id. at *8–9 (“But as Professor Howell concedes, the purpose of the KO Model is not necessarily to value an asset. Rather, it is to calculate the transaction costs from a decision to take a position in a market of a certain size. Transaction costs describe a market. They don't describe an asset. Valuational discount is asset-specific. Additionally, as Mr. Konstantinidis testified, the KO Model has not previously been used for the purpose it is being used for here . . . the evidence suggests that the KO Model is not well-suited to quantify that impact as a discount to the market price. In several respects, the KO Model outputs themselves lead to this conclusion. For example, for several of the Digital Assets, the model concludes that the appropriate discount is one far in excess of 100% . . . the KO Model is limited in that it only assesses the impact on an asset due to illiquidity. It does not account for other reasons that an asset might not be marketable, such as the fact that it is subject to restrictions regarding its sale (i.e. it is ‘locked’). DLOMs generally account for all of the reasons why an asset may not be marketable, including illiquidity. The fact that the KO Model requires two discounts further supports the conclusion that it is not the correct methodology here.”) (emphasis in original).
[20] See id.
[21] See id. at *9, *12 (“The simple fact that the Debtors held nearly all of the supply of the Tokens at issue had the effect of keeping trading volume low and, quite possibly, keeping prices artificially high.”).
[22] See id. at *9–11 (“First, Mr. Konstantinidis only valued the Tokens held by his clients. He did not consider how the Debtors’ holdings would impact the price of the Tokens at all. The second problem with Mr. Konstantinidis’ application of the Blockage Method here is his assumptions regarding trading volume growth . . . are much higher than is reasonable in light of the facts of this case. The third problem is that the discount models he uses are unnecessarily limiting . . . [where] Mr. Konstantinidis’ model in effect implies that assets that cannot be sold for 30 years are more valuable than assets that are only not marketable for 5 years.”).
[23] Id. at *10.
[24] See id. (“[T]he DLOMs produced by the Finnerty model arbitrarily cannot go above approximately 32 percent, no matter the length of the non-marketability period or the characteristics of the asset at hand. Perhaps even more problematically, at long time horizons the Chaffe model implies that DLOMs decrease as the length of the non-marketability period increases, a clearly nonsensical result. Once combined into an average by Mr. Konstantinidis, these DLOM models result in DLOMs that decrease in the non-marketability period beyond an approximately five-year horizon. Therefore, Mr. Konstantinidis’ model in effect implies that assets that cannot be sold for 30 years are more valuable than assets that are only not marketable for 5 years.”).
[25] See id. at *11–12 (“[I]n her rebuttal report, Professor Howell performed several sensitivity analyses to Mr. Konstantinidis’ model, in which she applied the Blockage Method but corrected the problems identified above by changing three of the inputs. First, Professor Howell changes the total liquidated assets for each Token to include the Debtors’ holdings and not just the holdings of the Objectors. Second, she changes the volume growth so that instead of projecting an increase in trading volume growth after the Petition Date, volume remains constant at the initial level. Last, Professor Howell uses the Ghaidarov Model as the discount model instead of averaging the results of the Chaffe and Finnerty models. Given all the evidence before me, I am persuaded that the discounts contained in Professor Howell's sensitivity analyses are reasonable.”).
[26] See id. at *13.
[27] See id. at *12 (“I am cognizant of the Objectors’ argument that such a valuation is in tension with the fact that the Tokens had a positive trading price on the Petition Date. [However,] the evidence suggests that the market prices for these Tokens may not be a reliable indicator of their actual value.”).
