Crypto bankruptcy plunges the industry into uncharted territory

Celsius and Voyager Digital’s bankruptcies could force courts to weigh difficult questions about how to prioritize customers and value digital assets.

Kolin Burges, a Mt. Gox customer, holds a placard in front of a building housing the company operating the Mt. Gox Bitcoin exchange in Tokyo, Japan, on Thursday, Feb. 27, 2014. The Bitcoin Foundation, an advocacy group for the nascent digital currency, provided information to federal prosecutors this week that aided a probe into Mt. Gox, a shuttered exchange in Tokyo. Photographer: Tomohiro Ohsumi/Bloomberg via Getty Images

Mt. Gox's collapse led to crypto's most infamous bankruptcy, but the proceedings mostly played out outside U.S. court and started when the industry was much smaller.

Photo: Tomohiro Ohsumi/Bloomberg via Getty Images

The first day in bankruptcy court for crypto lender Voyager Digital came with a warning, from the company's own attorney, that this could get tricky.

“I think for many of us, this is unchartered territory,” said Joshua Sussberg, an attorney with Kirkland & Ellis. “There will be many potential legal issues of first impression.”

The U.S. bankruptcy courts have never dealt with an insolvency proceeding of a crypto company on the scale of Voyager Digital or Celsius. Both companies, which operate lending businesses, are entering Chapter 11 bankruptcy with billions in both assets and liabilities. The filings came just a week apart: Voyager on July 6 and Celsius on July 13.

The uncharted nature of the proceedings means they will be watched closely by policymakers and within the industry, and especially by customers seeking their crypto back.

Many questions, few answers

There are established rules and insurance for customer funds if a broker-dealer or bank goes under that have not been established for crypto. And that type of bankruptcy is relatively rare, said Nizan Geslevich Packin, a professor of law at the Baruch College Zicklin School of Business.

“We don't really have any precedent for crypto firms in the U.S.,” Packin said. “We have an international case from almost a decade ago. But that was early on: a different continent, different rules, with the size of the market significantly smaller."

Packin was referring to Mt. Gox, the most infamous crypto bankruptcy. Mt. Gox customers, along with those who purchased creditor claims, are just now preparing to get some of their crypto back, eight years after the exchange collapsed into bankruptcy and lost 850,000 bitcoins total, valued at $500 million at the time. While the bitcoin that customers receive back will be worth significantly more than when it was stolen, creditors are receiving only a fraction of their initial claims.

Both Voyager and Celsius have offered plans to restart their businesses and are not in "free fall," as Voyager's filing described it. Still, bankruptcies can be years-long proceedings, said Packin, who specialized in Chapter 11 cases at Skadden, Arps, Slate, Meagher & Flom.

One major question, Packin said, is the priority of the creditors: who gets paid back, how much and in what order.

Voyager, for instance, has promised to pay back customers with a combination of their crypto, Voyager’s token, stock in the company and proceeds from its efforts to recover a loan to the bankrupt hedge fund Three Arrows Capital. But that plan would require court approval.

Coinbase sent a scare into the crypto world in May by warning in an SEC filing that customers could be considered unsecured creditors if the exchange went bankrupt. That would mean customer funds are considered part of the bankruptcy estate and those customers are the lowest priority as far as getting paid back.

CEO Brian Armstrong quickly assured customers that Coinbase was not at risk of bankruptcy and the company was only following new federal guidance with the disclosure. But he acknowledged that a court could pool customers' funds as part of the bankruptcy estate, whereas customer accounts have to be kept separate in a stockbroker bankruptcy.

In a smaller-scale crypto bankruptcy case, the lending platform Cred classified its customers as unsecured creditors in its November 2020 Chapter 11 filing, where it reported liabilities in excess of $160 million. The court approved a liquidation plan for the company that started last year amid allegations of fraud and mismanagement. Rick Hyman, a partner with Crowell & Moring, told Protocol that the small size of the company meant the case did not garner nearly the attention of the Coinbase disclosure, but nonetheless offered a cautionary tale.

"I would expect that many of the customers dealing with Cred probably didn't recognize that they will be entitled to nothing more than a general unsecured claim [in bankruptcy],” Hyman said.

Volatile valuations

There is also the question of valuing volatile digital assets. Bankruptcy proceedings take time, and crypto prices change quickly.

In 2016, nearly two years into the bankruptcy of crypto miner HashFast, a trustee sought to claw back payments to a promoter of about 3,000 bitcoin, paid three years earlier. The value of bitcoin had climbed from about $360,000 to more than $1 million in that time. This caused a dispute: The promoter said the courts should consider bitcoin a currency, which would leave HashFast on the hook for only the value of the bitcoin at the time of the transaction. The trustee, meanwhile, contended that bitcoin is a commodity and therefore must be returned at its current market value, according to bankruptcy laws. Ultimately, the case was settled before the court came down in either direction.

The same questions of classification for crypto could come up in the Voyager or Celsius cases. Robert Honeywell, a restructuring partner at K&L Gates, questioned in an interview with Axios whether crypto customers could claim to be securities holders to improve the priority of their claims.

"The real question is even if they filed as a Chapter 11, will customers who have yield-bearing accounts with Voyager say, 'I’m not just a normal unsecured creditor, I’m a securities holder,' even though no regulator has said they are that," Honeywell said, acknowledging that it is an untested proposition.

Regulation coming

The crypto regulation bill from Sens. Cynthia Lummis and Kirsten Gillibrand includes a section that aims to safeguard customer assets in the case of a crypto bankruptcy and treat digital assets similar to commodities in proceedings. But it remains to be seen whether that legislation can garner the support to become law.

In the meantime, the bankruptcies are just the latest fallout from crypto's crash, one that experts say is prompting even greater urgency for regulation. SEC Chair Gary Gensler indicated on Thursday in an interview with Yahoo Finance that the agency has authority to tailor parts of securities law to help bring crypto companies into compliance, potentially increasing investor protections in the process.

Gensler, who has been accused by some in the industry of regulating only by enforcement, said he has said to “the industry, to the lending platforms, to the trading platforms: ‘Come in, talk to us.’”

The current crash should leave more crypto companies open to accepting stronger oversight and regulation, said Diogo Mónica, co-founder and president of Anchorage Digital, the first federally chartered crypto bank.

"People are going to remember this: What happens if the company fails? How are you running risk management?" Mónica said. "All of a sudden those questions are being asked again that, to some extent, get forgotten during bull markets.”


Judge Zia Faruqui is trying to teach you crypto, one ‘SNL’ reference at a time

His decisions on major cryptocurrency cases have quoted "The Big Lebowski," "SNL," and "Dr. Strangelove." That’s because he wants you — yes, you — to read them.

The ways Zia Faruqui (right) has weighed on cases that have come before him can give lawyers clues as to what legal frameworks will pass muster.

Photo: Carolyn Van Houten/The Washington Post via Getty Images

“Cryptocurrency and related software analytics tools are ‘The wave of the future, Dude. One hundred percent electronic.’”

That’s not a quote from "The Big Lebowski" — at least, not directly. It’s a quote from a Washington, D.C., district court memorandum opinion on the role cryptocurrency analytics tools can play in government investigations. The author is Magistrate Judge Zia Faruqui.

Keep ReadingShow less
Veronica Irwin

Veronica Irwin (@vronirwin) is a San Francisco-based reporter at Protocol covering fintech. Previously she was at the San Francisco Examiner, covering tech from a hyper-local angle. Before that, her byline was featured in SF Weekly, The Nation, Techworker, Ms. Magazine and The Frisc.

The financial technology transformation is driving competition, creating consumer choice, and shaping the future of finance. Hear from seven fintech leaders who are reshaping the future of finance, and join the inaugural Financial Technology Association Fintech Summit to learn more.

Keep ReadingShow less
The Financial Technology Association (FTA) represents industry leaders shaping the future of finance. We champion the power of technology-centered financial services and advocate for the modernization of financial regulation to support inclusion and responsible innovation.

AWS CEO: The cloud isn’t just about technology

As AWS preps for its annual re:Invent conference, Adam Selipsky talks product strategy, support for hybrid environments, and the value of the cloud in uncertain economic times.

Photo: Noah Berger/Getty Images for Amazon Web Services

AWS is gearing up for re:Invent, its annual cloud computing conference where announcements this year are expected to focus on its end-to-end data strategy and delivering new industry-specific services.

It will be the second re:Invent with CEO Adam Selipsky as leader of the industry’s largest cloud provider after his return last year to AWS from data visualization company Tableau Software.

Keep ReadingShow less
Donna Goodison

Donna Goodison (@dgoodison) is Protocol's senior reporter focusing on enterprise infrastructure technology, from the 'Big 3' cloud computing providers to data centers. She previously covered the public cloud at CRN after 15 years as a business reporter for the Boston Herald. Based in Massachusetts, she also has worked as a Boston Globe freelancer, business reporter at the Boston Business Journal and real estate reporter at Banker & Tradesman after toiling at weekly newspapers.

Image: Protocol

We launched Protocol in February 2020 to cover the evolving power center of tech. It is with deep sadness that just under three years later, we are winding down the publication.

As of today, we will not publish any more stories. All of our newsletters, apart from our flagship, Source Code, will no longer be sent. Source Code will be published and sent for the next few weeks, but it will also close down in December.

Keep ReadingShow less
Bennett Richardson

Bennett Richardson ( @bennettrich) is the president of Protocol. Prior to joining Protocol in 2019, Bennett was executive director of global strategic partnerships at POLITICO, where he led strategic growth efforts including POLITICO's European expansion in Brussels and POLITICO's creative agency POLITICO Focus during his six years with the company. Prior to POLITICO, Bennett was co-founder and CMO of Hinge, the mobile dating company recently acquired by Match Group. Bennett began his career in digital and social brand marketing working with major brands across tech, energy, and health care at leading marketing and communications agencies including Edelman and GMMB. Bennett is originally from Portland, Maine, and received his bachelor's degree from Colgate University.


Why large enterprises struggle to find suitable platforms for MLops

As companies expand their use of AI beyond running just a few machine learning models, and as larger enterprises go from deploying hundreds of models to thousands and even millions of models, ML practitioners say that they have yet to find what they need from prepackaged MLops systems.

As companies expand their use of AI beyond running just a few machine learning models, ML practitioners say that they have yet to find what they need from prepackaged MLops systems.

Photo: artpartner-images via Getty Images

On any given day, Lily AI runs hundreds of machine learning models using computer vision and natural language processing that are customized for its retail and ecommerce clients to make website product recommendations, forecast demand, and plan merchandising. But this spring when the company was in the market for a machine learning operations platform to manage its expanding model roster, it wasn’t easy to find a suitable off-the-shelf system that could handle such a large number of models in deployment while also meeting other criteria.

Some MLops platforms are not well-suited for maintaining even more than 10 machine learning models when it comes to keeping track of data, navigating their user interfaces, or reporting capabilities, Matthew Nokleby, machine learning manager for Lily AI’s product intelligence team, told Protocol earlier this year. “The duct tape starts to show,” he said.

Keep ReadingShow less
Kate Kaye

Kate Kaye is an award-winning multimedia reporter digging deep and telling print, digital and audio stories. She covers AI and data for Protocol. Her reporting on AI and tech ethics issues has been published in OneZero, Fast Company, MIT Technology Review, CityLab, Ad Age and Digiday and heard on NPR. Kate is the creator of and is the author of "Campaign '08: A Turning Point for Digital Media," a book about how the 2008 presidential campaigns used digital media and data.

Latest Stories