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In the past year, there have been a few high-profile bankruptcies in the cryptocurrency spaces. Some users may receive less than full value for assets held in these companies when they filed for bankruptcy. But what of the lucky depositors who were able to pull their coins out before it all came crashing down?

You may have heard that in U.S. bankruptcy, there is a 90-day lookback period from the date of a bankruptcy filing. It is true that a bankruptcy trustee can unwind certain transactions that occurred in the 90 days prior to the bankruptcy filing (or longer, in some circumstances). 11 U.S.C. 547. In essence, creditors who were paid right before the house collapsed have to give the money back so that the money can get distributed “fairly.” This rule is meant to prevent a failing company from paying out all of its assets right before a bankruptcy, therefore favoring certain creditors over others. Bankruptcy law gets to pick the favorites—not the debtors. Certain assets are excluded from this rule, however. For example, funds or other assets that never belonged to the debtor.

“Custodial” assets are assets that are held by one party on behalf of another. Think of it like parking your car in a paid parking lot. If the lot goes bankrupt while your car is in there, you still get it back. It never belonged to the lot; they were just holding on to it for you. In fancy legal terms: you’ve created a “bailment.” If the parking garage goes bankrupt, the car does not become an “asset” of the bankruptcy estate. The car remains yours. If you then drive your car off the lot, the bailment ends, and the bankruptcy estate cannot force you to bring it back. This is true even if a sink hole opens up and swallows up cars owned by other customers. The lot still owes that other customer a car—but it can’t use your car to pay them for it.

The same rule applies in traditional banking—sort of. When a bank goes bankrupt, the deposits are not used to pay back creditors. The deposits belong to the customers who placed money in the bank for safekeeping, and those customers are entitled to receive it back. Unlike crypto exchanges, traditional banks are insured by the Federal Deposit Insurance Company (“FDIC”) which pays depositors directly while the bank goes through the insolvency process. When a bank has less money on hand than it owes to its depositors, insurance kicks in to make up the shortfall (within specified limits) and customers do not have to wait for the bank to complete the bankruptcy process—which can take years.

The bankruptcy code and existing U.S. case law offers some guidance[1]—and suggests that cryptocurrency balances held at exchanges may be treated as “custodial” and therefore not part of the bankruptcy estate and therefore cannot not be clawed back. See 11 U.S.C. 541(b)(1) (property of the estate does not include “any power that the debtor may exercise solely for the benefit of an entity other than the debtor”); In re Enron Corp., No. 01-16034 (AJG) (Bankr. S.D.N.Y. Jan. 22, 2003) (contract constituted a bailment even though asset was fungible and comingled with other assets). In the Celsius Network bankruptcy proceeding, a now-insolvent cryptocurrency company that offered cryptocurrency “savings accounts,” the trustee has listed remaining customer deposits as “unsecured creditors,” but made no efforts so far to claw back withdrawals during the 90-day lookback (other than from insiders). Earlier this month, the Bankruptcy court denied the trustee’s motion seeking claw backs from insiders who withdrew their own crypto assets, emphasizing that it had not yet determined whether the assets were property of the bankruptcy estate but that there was no evidence that the withdrawals were fraudulent. [2]

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There are no guarantees that litigants will not try to argue otherwise. For example, in Ponzi schemes bankruptcy trustees have in the past sought to claw back withdrawals from unsuspecting customers that occurred immediately prior to the bankruptcy. See e.g. In re: Woodbridge Group of Companies, LLC et al., 17-12560 JKS (Bankr. D. Del. 2021). In Woodbridge, the trustee sought not only the profits gained on the investment, but also the underlying principal amounts withdrawn within 90 days of the bankruptcy filing. Ponzi scheme cases involve investments, however, which may explain the difference in treatment (think of the difference between giving someone money to hold for you, versus giving them money and asking them to invest it).

Courts may be asked to analyze whether the assets were investments as opposed to custodial assets, but UCC article 8, its proposed revisions, and prior case law involving traditional banks all support the idea that cryptocurrencies held by an exchange are “custodial assets” under U.S. law. In that case those lucky customers who were able to get their assets out would be able to keep them even if it means that other unlucky customers will not receive full value for their deposits. Given the large sums at stake in some of the current bankruptcies, perhaps the issue will be fully litigated, and courts will offer clarity for future cases.


[1] Although FTX is based in the Bahamas, the company filed for bankruptcy protection in Delaware.

[2] Opinion and Order, Celsius Network LLC, et al., No. 22-10964 (MG), Dkt. 1267 (Bankr. S.D.N.Y. Nov. 2, 2022); available at https://cases.stretto.com/public/x191/11749/PLEADINGS/1174911022280000000070.pdf.

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