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The wave of liquidation and bankruptcy of encryption industry institutions, US lawyers explain how users can reduce risks

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FTX announced bankruptcy and reorganization, what is Chapter 11?

Original compilation: wzp&Bob, BlockBeats

Related Today, cryptocurrency brokerage Voyager Digital has filed for Chapter 11 bankruptcy protection in the Southern District of New York, documents show. Voyager currently has $1.3 billion worth of encrypted assets, holds more than $350 million in cash in Metropolitan Commercial Bank (Metropolitan Commercial Bank) customer FBO accounts, and Voyager is expected to have more than 100,000 creditors.

Follow Voyager The official released the proposed compensation plan, saying that it will repay user assets through Sanjian repayment, distribution of new stocks and platform Token. And said that the plan may change and need to obtain court approval, Voyager will continue to evaluate all strategic alternatives to maximize value creation for stakeholders.

Market deleveraging is intensifying, and more and more centralized institutions are experiencing liquidity crises, Celsius , Three Arrows Capital, and Voyager Digital have been liquidated and even bankrupted one after another, which has never happened before in the history of cryptocurrencies. Then, what will be the process and results of the bankruptcy and reorganization of centralized institutions in the cryptocurrency industry? Darren Azman and Gregg Steinman, partners of the famous American law firm McDermott Will & A report published today explains this. BlockBeats organizes and translates it as follows:

User property under bankruptcy of cryptocurrency trading platform

As of May 27, no cryptocurrency trading platform in the United States has filed for bankruptcy. However, as the price of cryptocurrencies fell to the lowest level since 2020, people are increasingly concerned about how the customer property of the cryptocurrency trading platform will be handled if the trading platform initiates bankruptcy proceedings, that is, whether the customer's encrypted assets fall within the scope of the platform's bankruptcy estate .

If the answer is yes, then customers will not have the right to demand that the encrypted trading platform return their assets. If not, then all platform users, as well as other unsecured creditors, will share proportionally any assets remaining on the trading platform.

This article discusses this issue and discusses how customers can take proactive steps to protect their assets.

Is the cryptocurrency trading platform a debtor as defined in the Bankruptcy Code?

There is no clear answer as to whether cryptocurrency trading platforms are eligible for Chapter 11 of the U.S. Bankruptcy Code. Entities and exclusions that may be defined as debtors under Section 109 of the Bankruptcy Code include commodity brokers and banking institutions, other than member state banks or corporations that are uninsured under Section 25A of the Federal Reserve Act.

Although cryptocurrency trading platforms do not fall under the traditional regulatory framework of banks, because they are designated as financial institutions under the Bank Secrecy Act, cryptocurrencies can be considered Trading platforms belong to the category of banks. Additionally, certain cryptocurrency trading platforms with fiduciary licenses define themselves as banks under applicable state banking statutes, in accordance with applicable state banking statutes.

Trading platforms may not be classified as commodity brokers, which is defined as an entity engaged in the business of leveraged trading and is subject to Section 19 of the Commodity Exchange Act Supervision. For these reasons, it is not certain that cryptocurrency trading platforms qualify as debtors in bankruptcy. However, for the purposes of this article, we assume that the trading platform can seek bankruptcy relief in the United States.

Does the customer's encrypted assets belong to the platform's bankruptcy estate?

The court emphasized that Section 541 of the Bankruptcy Code defines the scope of the estate as "the All legal and equitable interests in property at the commencement of the case ... wherever located and by whomsoever held."

Section 541(a) is intended to broadly cover all types of property, tangible or intangible. The term "property" is interpreted broadly, and an interest does not fall outside its definition because it is new or accidental, or because enjoyment must be deferred.

Whether a customer’s encrypted assets purchased through a cryptocurrency trading platform constitutes one of the key factors for property ownership One is whether the asset is held by a custodian.

At a high level, custody assets are the assets held for profit. This means that when a customer buys cryptocurrency on an exchange, the amount of cryptocurrency is reflected in the customer's wallet. But in practice all crypto assets are held in a common asset pool, which may include the trading platform's own assets and those of other clients.

If the terms of service or user agreement of the cryptocurrency trading platform are in effect, such documents can serve as a reference as to whether the assets are held by the custodian. Generally, these terms include: Statement that the assets are held for the benefit of the client, but that the assets are not segregated from other client assets or assets of the trading platform (the trading platform is under no obligation to segregate).

Additional terms regarding custody assets may include: The exchange maintains control over the private keys associated with wallet addresses. While the terms may state that legal title to the assets remains with the client, if the assets are not segregated they may constitute custodial assets.

For example, the terms of service of the cryptocurrency trading platform FTX stipulate that customers have ownership of the assets in the accounts, but the assets in these accounts are not segregated, but kept In a shared address or account. The user agreement of the cryptocurrency trading platform Gemini stipulates that client assets in deposit accounts are concentrated in one or more of Gemini's digital asset wallets.

Though these trading platforms acknowledge that clients have ownership and some form of control over the assets in their accounts, the trading platforms themselves have title to the assets, And have the right to move, pool and even use assets according to the terms agreed by customers.

In fact, most trading platforms are likely to keep client assets in hybrid wallets during their operations and rely on internal accounting ledgers to reconcile client assets. For these reasons, courts may consider that client assets held in escrow may fall within the broad spectrum of platform bankruptcy estates.

Assets in non-custodial wallets

Trading platforms make buying cryptocurrencies easy Simple and efficient, this has led many retail clients to enter the field. It is important for these clients to understand the terms of service they agree to and the various plans offered by the trading platform.

Specifically, many exchanges offer non-custodial wallet options. Assets in non-custodial wallets are isolated, and only customers have permission to access the wallet and control the assets. In addition, customers can freely transfer assets from custodial wallets to non-custodial wallets outside the trading platform, including: (1) hot wallets, which are wallets connected to the Internet, such as MetaMask and MyEtherWallet Inc.; (2) cold wallets, which are Offline storage; (3) Warm wallet, that is, a downloadable software wallet that provides an additional layer of security.

As a matter of threshold, if customers are really the only ones with access to non-custodial wallets in the exchange's ecosystem -- not the exchange -- Then the analysis should stop there. But if, for any reason, the trading platform could assert control of the assets, the client might have an obvious claim that those assets are not property like real estate because the trading platform holds the assets in trust.

Generally speaking, assets held by the debtor on trust for third parties do not constitute estate property. That doesn't mean these customers are free and clear. It is the client's responsibility to ascertain the existence of a trust and the source of law supporting it - whether statutory or common law.

Clients also need to track assets, which seems straightforward unless the assets are Commingle already. Blending is a serious hurdle to overcome.

If the trading platform has access to the client's assets and at any time mixes these assets with other assets - whether correct or not - assert trust Clients of the relationship must track assets in order to recover them. Because most cryptocurrencies are fungible and do not contain unique characteristics, once a cryptocurrency is mixed with other cryptocurrencies of the same type, it becomes very difficult to track. — but not impossible to track. [8] This situation is not unique to cryptocurrencies.

For example, funds in a bank account held by the debtor on trust for the creditor. If the debtor wires additional funds into the account, it is impossible to determine which dollars. There are trust resources or additional wire funds in the account. To address these situations, the court applies Lowest Intermediate Balance Rule.

In the minimum intermediate balance rule, if the commingled collateral in the account has fallen below the initial transfer level, but has not been depleted, the claimant is entitled to Get the lowest intermediate balance in the account. Therefore, even if a customer establishes a trust relationship and traces their assets to a specific account, the customer's ability to recover the assets in full will depend on the application of the minimum intermediate balance rule.

Conclusion

Since no cryptocurrency trading platform has pursued bankruptcy filings in the United States, it is unclear how the bankruptcy court will describe client assets.

However, applying long-standing insolvency principles to the terms of service disclosed by trading platforms suggests that following a bankruptcy filing, a cryptocurrency trading platform's bankruptcy assets may contain user assets. Despite this possibility, customers can take proactive steps to reduce risk by ensuring assets are held in non-custodial wallets.

< blockquote> Note: The views expressed in this article are those of the author and do not reflect the position of his company, clients, or Portfolio Media Inc., or any of their respective affiliates. The information is provided for informational purposes only and is not intended and should not be construed as legal advice.