Keep calm and carry on - unpicking crypto relationships in any insolvency
Few will have missed the recent developments in the crypto market – the total collapse of more than one coin (including stablecoins), the plunge in market value of almost every cryptocurrency, solvency concerns surrounding Celsius Network and now also Three Arrows Capital - not to mention the expansive jobs cuts at Coinbase. Is this the so-called ‘winter of discontent’ or just part of the usual cyclical trading pattern that is seen in most markets? Either way, it is little surprise that cryptocurrencies and crypto assets are becoming a common discussion point in the insolvency market.
Insolvency practitioners are undoubtedly alive to the risks of ignoring or mis-handling crypto assets and the threats of misfeasance or unfair harm claims that could follow. In this, the first in a series of articles on the subject, the message is simple – the technical details might appear arcane but provided you take specialist advice, a crypto asset is no different from any other asset you come across – keep calm and carry on.
So what is a crypto asset?
A crypto asset is, at a technical level, a digital unit (generated by software) that is accepted by others as having a value of some sort. A digital ledger (known as a blockchain) stores the transaction information showing the transfers of a crypto asset from one ‘public address’ to another. Reflecting the root of the prefix ‘crypto’ (i.e. ‘cryptography’), all crypto assets are based on public key cryptography where a key pair controls the ability to transfer a crypto asset from its current public address to another. These keys are known as a ‘private key’ and ‘public key’ Each key is a unique alphanumeric string – the most important of which is the private key.
It is not possible to authorise a transfer from a public address without having the private key for that public address – if one tried to do this then the transfer request would be rejected. The private key is therefore paramount. It is this private key that enables the transfer of a crypto asset currently allocated to one public address from that address to another public address.
The Courts have shown a great degree of flexibility with considering crypto-related issues, most recently when considering whether they are able to grant proprietary injunctions. As a result, we now know that cryptocurrency is ‘property’, which is a helpful starting point.
How do insolvency practitioners (and their advisors) work out who owns the crypto assets? Are they part of the company’s estate or are they held on trust (and if so, for whom and under what regime)?
When identifying the owner of the crypto asset, the starting point would usually be to look to the blockchain or ledger for the public address used to hold the crypto asset. The person with the private key corresponding to that public address would (most likely) be the owner of the crypto asset. This is another helpful ‘rule of thumb’ (although how they obtained ownership is another matter). It may sometimes be necessary to seek to trace the ownership chains back through the blockchain and/or to trace the person ‘behind’ the public address. This can take a little longer but is by no means impossible.
Now that we have a grasp of the technical side, insolvency practitioners should not lose sight of the fact that crypto assets (be it cryptocurrency, NFTs or any other type of token – ‘utility’, ‘security’, ‘exchange’, or others) are just that: assets. In that sense, the steps required to identify the owner of the asset are no different when analysing any other asset class. Identifying the owner will depend on the facts of each case, and the individual terms of conditions that relate to that asset. For crypto assets, once you have identified who holds the private key, it is worth considering how they obtained that key: on what terms? And what has happened since that date?
Whilst there are currently no English insolvency cases in this area, the New Zealand courts applied the above analysis in the Cryptopia case. Cryptopia held the private keys for the crypto assets on its exchange. It noted in its terms and conditions that any trades were for “its own account”. However, this was not sufficient for the Court to hold that the assets were company property. The Court held the assets were held on trust for the individual investors and considered that in practice Cryptopia acted as if it were a trustee, trading crypto assets on behalf of the investors. The ruling in Cryptopia is analogous to recent peer to peer cases of Lendy and Funding Secure in that the Courts will consider not only the terms and conditions of the individual contract but also the wider factual matrix.
However, that is not to say all crypto exchanges and peer to peer lenders will be trustees. If crypto exchanges do hold, and trade, crypto assets for their own account then any trades passing through it are more likely to be classed as a series of individual and separate sales. An investor sells to the platform who then sells them on to another third party. This is the approach the Court took in the late 2021 case of Wang v Darby where it concluded that the contract in that case was a sale and repurchase agreement. When considering insolvent exchanges, the analysis will therefore require a review of both the written terms and conditions as well as the day-to-day business practice. If the exchange says that assets are held for its own account, was this carried through into practice?
The end result is that, when faced with unpicking a legal relationship based on crypto assets, the usual interpretation rules apply – start with the terms and conditions unique to that relationship and build out from there. Insolvency practitioners (and their legal advisors) have been doing this for years. Whilst crypto is the ‘new asset on the block’, the analysis required is no different. However, in order to avoid any allegations of unfair harm when dealing with this specific asset class, it is important that insolvency practitioners understand the technology, terminology and fundamentals in order to apply the analysis. To end on an analogy, Les Dawson could only play the piano in the way he did because he was an excellent piano player.
Other crypto developments
In the next article, we will discuss recent HM Treasury consultations, other global developments and no doubt reflect on market movements given there are firms currently restructuring or seeking additional financing.
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