U.S. court weighs novel issue of crypto ownership in bankruptcy

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WILMINGTON, Del., Dec 7 (Reuters) — A U.S. judge this week is con­sid­er­ing for the first time the ques­tion of who owns bit­coin and oth­er tokens in frozen accounts at a bank­rupt dig­i­tal asset exchange in a case that could shape cus­tomer pro­tec­tions in the cryp­tocur­ren­cy industry.

U.S. Bank­rupt­cy Judge Mar­tin Glenn in New York City will sort through who owns cryp­tocur­ren­cies held in accounts at the Cel­sius Net­work LLC exchange, which sus­pend­ed with­drawals and then fell into Chap­ter 11 dur­ing this year’s cryp­to crash.

Glen­n’s even­tu­al rul­ings will help shape the treat­ment of cryp­to in accounts that have been frozen at oth­er failed firms such as FTX, Voy­ager Dig­i­tal Ltd and Block­Fi, which do not have enough funds to repay every­one in full.

If Cel­sius deposits are deter­mined to belong to cus­tomers, users are far more like­ly to get their assets returned. If the account hold­ings belong to Cel­sius, those cus­tomers will be at the back of the line for repay­ment, col­lect­ing pen­nies on the dollar.

Unlike bank deposits or bro­ker­age accounts, which are backed by the U.S. gov­ern­ment up to $250,000 and $500,000 respec­tive­ly, cryp­to deposits are not insured and dig­i­tal asset com­pa­nies are light­ly reg­u­lat­ed and often oper­ate offshore.

Cryp­to com­pa­nies typ­i­cal­ly offer a vari­ety of accounts and they will like­ly be treat­ed dif­fer­ent­ly in bankruptcy.

Cel­sius, for one, has argued that its “earn” accounts, which offer inter­est to cus­tomers, should be treat­ed dif­fer­ent­ly than its “cus­tody” accounts, which pro­vide a place to store cryp­tocur­ren­cy with­out gen­er­at­ing inter­est. Block­Fi, which is at the begin­ning of its own bank­rupt­cy case, also offers both inter­est-bear­ing and cus­tody accounts.

“It can get com­pli­cat­ed,” Glenn said dur­ing Wednes­day’s hear­ing. “I’m try­ing as expe­di­tious­ly as pos­si­ble to get through as many issues as I can.”

‘WORSE THAN BANKS’

Courts will also have to look beyond the user agree­ments and exam­ine how cryp­to com­pa­nies actu­al­ly han­dled the deposits, accord­ing to bank­rupt­cy specialists.

“That’s going to be a real­ly thorny issue for the court, because there’s the rep­re­sen­ta­tion of what should have been hap­pen­ing ver­sus what is actu­al­ly hap­pen­ing on the ground,” said Yesha Yadav, an asso­ciate dean and law pro­fes­sor at Van­der­bilt University.

FTX cus­tomers have sought com­fort in the fact that their terms of ser­vice say they own the cryp­to in their account. FTX founder Sam Bankman-Fried pushed back on that idea when asked about it last week dur­ing a New York Times Deal­Book inter­view.

“So there is that piece from the terms of ser­vice,” Bankman-Fried said when asked if the agree­ment pre­vent­ed FTX from trans­fer­ring cus­tomers’ funds to its trad­ing unit Alame­da Research. “But there were a num­ber of oth­er parts of the terms of ser­vice, a num­ber of oth­er parts of the plat­form on top of that.”

If a com­pa­ny was using the deposit­ed cryp­to to make loans or comin­gled it with oth­er clients’ hold­ings, as was the case with Cel­sius’ high-yield accounts, it would be evi­dence the firm owned the cryp­to the same way a tra­di­tion­al bank owns its deposits.

Cel­sius wants Glenn to declare the cryp­to in “cus­tody” accounts as client prop­er­ty and on Wednes­day the judge said a sub­set of those accounts could be dis­trib­uted to customers.

The com­pa­ny also wants the judge to find the hold­ings in the high-yield “earn” accounts are prop­er­ty of Cel­sius, which plans to use some tokens to pay for the lawyers and advis­ers to plot a way out of Chap­ter 11 bankruptcy.

“I felt like I was stabbed in the back, because numer­ous times (Cel­sius founder Alex) Mashin­sky said, ‘banks are not your friends,’ ” Daniel Frish­berg, an “earn” cus­tomer, told Reuters before Wednes­day’s hear­ing. “In fact, they were much worse than the banks.”

A rul­ing on cryp­to own­er­ship may not be the end of the road for cus­tomers, how­ev­er. Even if the cus­tomers clear­ly own the assets, bank­rupt cryp­to com­pa­nies won’t have enough funds to pay every­one back, and deter­min­ing who gets paid in what amounts may take months or years.

“The bank­rupt­cy courts are now the van­guard of rule­mak­ing in rela­tion to cryp­to, because it’s going to be decid­ing fun­da­men­tal issues in rela­tion to asset allo­ca­tion and client cus­tody,” Yadav said. “This is going to have enor­mous influ­ence on cryp­to com­pa­nies and cryp­to cus­tomer behavior.”

Report­ing by Tom Hals in Wilm­ing­ton, Del., and Diet­rich Knauth in New York
Edit­ing by Amy Stevens, Noeleen Walder, Matthew Lewis and Ros­al­ba O’Brien

Our Stan­dards: The Thom­son Reuters Trust Principles.

Tom Hals

Thom­son Reuters

Award-win­ning reporter with more than two decades of expe­ri­ence in inter­na­tion­al news, focus­ing on high-stakes legal bat­tles over every­thing from gov­ern­ment pol­i­cy to cor­po­rate dealmaking.

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