Many authorities and commentators have considered cryptocurrencies, and the blockchains that undergird them, as a potentially disruptive force in the financial industry. Now, that disruption has made its way to a different side of finance—bankruptcy, and during the past year, the United States bankruptcy courts have had to confront many unexpected challenges involved in dealing with cryptocurrency.
The Bankruptcy Code is a tool to create order out of chaos. However, when it comes to bankruptcy law, cryptocurrency appears to be an oddly shaped peg without a hole. This multi-party blog post aims to give a roadmap of the issues that the courts will need to address, and the challenges that parties will face, in the inevitable clash of cryptocurrency and bankruptcy. In this first post, we address whether cryptocurrency is property of the bankruptcy estate, perfection of security interests in cryptocurrency and how the fluctuating value of cryptocurrency can impact a bankruptcy case.
Key Concepts Underlying Cryptocurrency
Cryptocurrencies rely heavily on a technology called blockchain, which is a system for keeping a chronology of transactions without the need for third-party oversight. Contracts can be programmed onto the blockchain, allowing for two parties to create self-executing deals; these contracts are called smart contracts. Smart contracts allow for decentralized finance loans, commonly referred to as DeFi loans. DeFi loans make use of smart contracts and blockchains to allow for financial transactions without the need for a bank or some other middleman. A crypto “wallet” is a form of digital storage by which the cryptocurrency assets can be accessed. A stablecoin is a type of cryptocurrency designed to be tied or pegged to another currency, commodity, or financial instrument.
Is Cryptocurrency Property of the Estate?
Whether cryptocurrency held on debtor platforms is property of the bankruptcy estate is a key issue that has arisen when cryptocurrency exchanges have filed bankruptcy. The most recent court to face this issue is the Bankruptcy Court for the Southern District of New York (see our coverage here).
Celsius Network LLC and affiliates (collectively, “Celsius”) ran a cryptocurrency finance platform. Faced with extreme turbulence in the cryptocurrency markets, Celsius filed Chapter 11 petitions on July 13, 2022. As part of their regular business, Celsius had allowed customers to both deposit cryptocurrency digital assets on their platform and earn a percentage yield, as well as take out loans by pledging their cryptocurrencies as security. One specific program offered by Celsius was the “Earn” program, under which customers could transfer certain cryptocurrencies to Celsius and earn “rewards” in the form of payment of in-kind interest or tokens. On the petition date, the Earn program accounts (the “Earn Accounts”) held cryptocurrency assets with a market value of approximately $4.2 billion. Included within the Earn Accounts were stablecoins valued at approximately $23 million in September 2022.
Perfection of Security Interests in Cryptocurrency
Questions of perfection of security interests in collateral can be front and center in many bankruptcy cases. These questions become more difficult if the collateral in question is cryptocurrency since there is a lack of consensus on how to perfect security interests in cryptocurrency. This uncertainty is driven in large part by the lack of consensus on how to categorize cryptocurrency.
For instance, if cryptocurrency is considered to fall under the category of “general intangibles,” a security interest in the cryptocurrency would be perfected under Article 9 of the UCC by filing a UCC-1 financing statement. Alternatively, cryptocurrency could be considered a “financial asset,” and the account that the cryptocurrency is being held in a “securities account.” In such case, the security interest in the cryptocurrency would be perfected under Article 8 of the UCC by the lender having control of the securities account. Some lenders in the cryptocurrency space have taken both approaches simultaneously, filing an Article 9 UCC-1 financing statement and taking control over the securities account.
A new Article 12 to the UCC, which was approved by the Uniform Law Commission and the American Law Institute in July 2022 and is currently being considered by 17 state legislatures and has been adopted by 11, is designed to provide clarity on these perfection issues. In the new Article 12, “general intangibles” includes the term, “controllable electronic records” (or “CERs”). CERs are records stored in an electronic medium which can be subject to control. “Control” exists under Article 12 when a holder is able to derive “substantially all the benefit” from the CERs; has “exclusive power” to “prevent others from availing themselves of substantially all the benefit” from the CERs; and the CERs allow the holder “readily to identify itself in any way, including by . . . cryptographic key,” as having these powers. Pursuant to Article 12, a security interest in CERs may be perfected either by control or by filing a UCC-1 financing statement, with the proviso that a party that takes “control” of CERs “for value, in good faith, and without notice of a claim of a property right in the controllable electronic record” is considered a “qualifying purchaser” whose rights trump any other security interests in the asset, even those interests perfected through the filing of a UCC-1 financing statement. Market participants must therefore follow closely their jurisdiction’s progress in the adoption of Article 12, and should, upon adoption, be sure that they obtain control of any CERs to ensure that they obtain a first-priority lien.
The Fluctuating Value of Cryptocurrency
The wild fluctuation in cryptocurrency prices creates unique issues in bankruptcy proceedings. Bankruptcy cases can remain pending for a long time before reaching a resolution, and the value of cryptocurrency can dramatically fluctuate during the life of the case, raising the question of how and when to value a cryptocurrency claim.
An example of this is the now-infamous Mt. Gox bankruptcy case. There, a highly trafficked cryptocurrency exchange filed for bankruptcy in Tokyo in 2014. Included among the cryptocurrency on the exchange was a substantial number of bitcoin which were valued at $483 (US) on the filing date. The value of bitcoin increased dramatically while the case was pending, and the creditors argued that their claims should be based on the newer, and higher, valuation. In response, the trustee argued that the claims should be valued using the original $483 value. The court accepted the trustee’s position, limiting the creditors’ claims to the value of their cryptocurrency as of the filing date. One of the strange, and perhaps disturbing, ramifications of the court’s ruling is that any surplus remaining after payment to the creditors using the lower valuation would be paid to equity, and in particular the former Mt. Gox CEO whom many blamed for the exchange’s failure.
Of course, Mt. Gox has no precedential value in the United States. However, the Celsius bankruptcy case demonstrates how cryptocurrency valuation can affect US bankruptcy proceedings. In Celsius, the debtors enumerated the accountholders’ claims in cryptocurrency. A group of equity holders filed a motion requesting that the court require the debtors to amend their bankruptcy schedules to list the accountholders’ claims only in dollars. The debtors argued that the equity holders filed the motion simply to lock in the accountholders’ claims at a lower value so that the equity holders could reap the benefits of any increase in cryptocurrency during the pendency of the case. Ultimately, the parties settled the dispute.
Cryptocurrency’s ability to rapidly change in value causes other issues as well. On June 7, 2023, the bankruptcy court overseeing the Bittrex bankruptcy cases approved the first ever debtor-in-possession financing solely in bitcoin. In order to protect itself from increases in the value of bitcoin, Bittrex’s debtor-in-possession financing agreement provided that Bittrex is only required to pay the lender back up to 110% of the value of the borrowed bitcoin as was priced on the petition date. (We previously analyzed the implications of this financing agreement).
As more and more entities file for bankruptcy, expect the unique nature of digital assets to create complex situations for courts and parties to confront and resolve—perhaps leading to more novel and interesting results.
 See 11 U.S.C. § 541(a) (the commencement of a bankruptcy case creates an estate that includes all property in which the debtor has an interest, including tangible and intangible assets).
 In re Celsius Network, LLC, 647 B.R. 631 (Bankr. S.D.N.Y. 2023).
 Id. at 651.
 See, e.g., In re Motors Liquidation Co., 777 F.3d 100, 104-105 (2d Cir. 2014) (holding that a secured lender lost its security interest in 42 General Motors facilities when it had mistakenly authorized the filing of a UCC-3 termination statement); 1st Source Bank v. Wilson Bank & Trust, 735 F.3d 500, 503 (6th Cir. 2013) (holding that a secured lender did not have a security interest in accounts receivable when the financing statement did not adequately describe the collateral in question); In re Softalk pub. Co., Inc., 856 F.2d 1328, 1331 (9th Cir. 1988) (holding that a secured lender did not have a perfected security interest when the financing statement contained no description of collateral).
 Uniform Law Commission, https://www.uniformlaws.org/committees/community-home?communitykey=1457c422-ddb7-40b0-8c76-39a1991651ac#:~:text=Description,-Description&text=The%202022%20amendments%20to%20the,intelligence%2C%20and%20other%20technological%20development (last visited October 5 2023).
 Andrew Norry, The History of the Mt Gox Hack: Bitcoin’s Biggest Heist, BLOCKONOMI (June 7, 2019), https://blockonomi.com/mt-gox-hack.
 Ultimately, Mt. Gox entered into a process called civil rehabilitation, which will allow account holders to receive assets instead of the value of their bitcoin as determined by the court through a sale. Id.
 See Series B Holders’ Rule 1009 Motion, In re Celsius, et al., No. 22-10964 (Bankr. S.D.N.Y. Oct. 25, 2022) [ECF No. 1019].
 See Debtors’ Objection to Rule 1009 Motion, In re Celsius, et al., No. 22-10964(Bankr. S.D.N.Y. Nov. 8, 2022) [ECF No. 1304].
 See Order on Rule 1009 Motion, In re Celsius, et al., No. 22-10964(Bankr. S.D.N.Y. Nov. 17, 2022) (directing in part that a conversion table be filed “that reflects the Debtors’ view of the rate of conversion of all cryptocurrency listed in the Debtors’ Schedules to the lawful currency of the United States … as of the Petition Date”) [ECF No. 1387].
 See Final Order: (A) Authorizing the Debtors to Incur Post-Petition Debt, (B) Granting Super-Priority Administrative Expense Claims, and (C) Granting Related Relief, In re Desolation Holdings LLC, et al., No. 23-10597 (Bankr. D. Del. June 7, 2023) [ECF No. 101].
 Id. at ¶10.