In this second part of our blog exploring the various issues courts need to address in applying the Bankruptcy Code to cryptocurrency, we expand upon our roadmap. In part one, we addressed whether cryptocurrency constitutes property of the estate, the impacts of cryptocurrency’s fluctuating valuation, issues of perfection, and the effects of cryptocurrency on debtor-in-possession financing. In this part two, we explore preferential transfers of cryptocurrency, whether self-executing smart contracts would violate the automatic stay, and how confusing regulatory guidelines negatively impact bankruptcy proceedings, including plan feasibility.
Pursuant to section 547(a) of the Bankruptcy Code, a debtor-in-possession (or trustee) can avoid a transfer of the debtor’s property to a creditor made in the 90-days before filing the petition if, among other things, the creditor received more than it would have in a Chapter 7 liquidation proceeding. Notably, such a transfer can only be avoided if the thing transferred was the debtor’s property. When cryptocurrency is valued and whether cryptocurrency is considered to be property of the estate can impact preference liability.
Perhaps the first question to arise in cryptocurrency preference litigation is whether the transferred cryptocurrency is property of the estate. If, as in the Chapter 11 bankruptcy case of Celsius Network LLC and its affiliates, the cryptocurrency withdrawn by the accountholder during the ninety days prior to the bankruptcy is determined to be property of the estate, and not the accountholder’s property, a preferential transfer claim could be asserted. If, however, the cryptocurrency was property of the accountholder, for instance if it was held in a wallet to which only the accountholder had exclusive rights, no preference liability would attach to the withdrawal of the cryptocurrency.
Assuming that a preferential transfer claim lies, the court must decide how to value the preferential transfer. Section 550 of the Bankruptcy Code allows a debtor-in-possession to recover “the property transferred, or, if the court so orders, the value of such property.” This gives the debtor-in-possession wide latitude in asserting a preference claim. For instance, the debtor-in-possession could take the position that the cryptocurrency is a commodity, in which case a claim could be asserted to recover the cryptocurrency itself, which, by the end of the case, may be worth a much more than it was at the time of the transfer, with any gain accruing to the estate’s benefit. In contrast, the party receiving the transferred cryptocurrency would likely take the position that the cryptocurrency is currency, in which case a claim would be limited to the value of the cryptocurrency at the time of the transfer.
The proper valuation methodology has not to date been definitively addressed by the courts. Perhaps the closest a court has come to deciding that issue was in Hashfast Techs. LLC v. Lowe, where the trustee claimed that a payment of 3,000 bitcoins to a supplier was a preferential transfer. The bitcoin was worth approximately $360,000 at the time of the transfer but was worth approximately $1.2 million when the trustee asserted the preferential transfer claim. The trustee argued that the payment to the supplier was intended to be a transfer of bitcoins and not a payment of $360,000, and that the supplier was required to pay 3,000 bitcoins to the estate, notwithstanding the substantial increase in value (and the resulting windfall to the estate). Ultimately, the court refused to decide whether bitcoin is either currency or commodities and held that “[i]f and when the [trustee] prevails and avoids the subject transfer of bitcoin to defendant, the court will decide whether, under 11 U.S.C. § 550(a), he may recover the bitcoin (property) transferred or their value, and if the latter, valued as of what date.”
The changing value of cryptocurrency will also impact the question of whether the creditor received more than it would have in a Chapter 7 liquidation proceeding. While the value of preferential transfers are determined at the time of the transfer, the analysis of whether such transfer made the creditor better off than in a Chapter 7 liquidation is determined at the time of a hypothetical distribution, which means, practically, at the time of the petition. Therefore, if a customer withdraws cryptocurrency from a platform during the 90-day preference period, and the cryptocurrency experiences a decrease in value during those 90 days, that customer could arguably be liable for a preferential transfer because the withdrawn cryptocurrency was worth more at the time of the transfer than at the time of the petition.
Presently unanswered is whether the safe-harbor provisions provided for in section 546(e) of the Bankruptcy Code shield cryptocurrency transfers from preferential transfer attack. Pursuant to section 546(e), a debtor-in-possession cannot avoid as a preference a margin payment or settlement payment made to “financial participant . . . in connection with a securities contract . . . commodity contract . . . [or] forward contract . . . that is made before the commencement of the case.” If the court determines that cryptocurrency is a security or commodity, and that the transfers were made in connection with forward or commodities contracts, then section 546(e) may shield those transfers from attack as preferential.
Violations of the Automatic Stay and Smart Contracts
The self-executing nature of smart contracts may raise automatic stay concerns. The automatic stay arises upon the filing of a bankruptcy petition, and in general, prevents creditors and other parties from continuing their collection efforts against the debtor. Of relevance to smart contracts, section 362(a)(3) of the Bankruptcy Code states that the stay applies to “any act” to obtain possession of or control of property of the estate. Very recently, in Chicago v. Fulton, the United Stated Supreme Court held that section 362(a)(3) prevented any “affirmative act that would alter the status quo at the time of the bankruptcy petition.”
Prior to Fulton, a bankruptcy court in Arkansas examined an analogous issue in Hampton v. Yam’s Choice Plus Autos, Inc. (In re Hampton). In Hampton, the court adjudicated whether a device that automatically locked the debtor out of her car violated the automatic stay when it disabled function of the car’s engine postpetition. The device relied on a code—if the debtor paid, the creditor sent her a code, which she would then input, and this prevented the device from automatically disabling the car’s starter. In this instance, the court found a violation of the automatic stay.
Based on current case law, it remains unclear whether a smart contract, operating automatically, would violate the automatic stay. For example, if a smart contract is based on a DeFi loan, and it automatically executes postpetition to transfer to the lender assets of the estate, a court may find a violation of the automatic stay.
Hampton would suggest that such actions would be a violation—but two issues caution against relying on Hampton as a clear bellwether. First, Hampton was decided pre-Fulton and it remains unclear whether, and to what extent, the Supreme Court’s holding in Fulton would change the outcome of Hampton. Second, a potentially key factual distinction exists: the device in Hampton required the creditor to give the debtor a code to prevent the disabling of the car, but smart contracts can be programmed to automatically execute postpetition without any further action by the parties. If a smart contract is found to violate the automatic stay, the next question is whether such a violation is willful, meaning that a court can impose monetary penalties, including potentially punitive damages.
Note that even if a smart contract is found not to violate the automatic stay, it does not mean that a creditor can retain the property. Section 542 of the Bankruptcy Code requires those in possession of estate property to turnover the property to the estate. The estate is created at the time of the filing of the petition, and therefore, any smart contract that executes postpetition would theoretically concern estate property and be subject to turnover. Unfortunately, ambiguities arise even in this statute, as section 542 contains a good-faith exemption to the turnover mandate if the recipient is not aware of bankruptcy filing and transfers the assets. Thus, the turnover mandate may be difficult to apply to non-debtor parties to smart contracts who program the contract ahead of time with the knowledge that such a contract may execute after a bankruptcy petition but with no actual knowledge of such petition having been filed.
The regulatory world has no uniform approach to cryptocurrency. Both the Securities and Exchange Commission (SEC) and the Commodities Future Trading Commission (CFTC), perhaps in part spurred by executive pressure, recently advanced heavier regulatory oversight of cryptocurrency. The two agencies also share jurisdiction; one agency asserting authority to regulate cryptocurrency does not preclude the other from doing so. Other agencies, such as the Department of the Treasury’s Office of Foreign Assets Control (OFAC) and Financial Crimes Enforcement Network (FinCen), have also asserted the jurisdiction to regulate cryptocurrency. The result is regulatory confusion for market participants, both because of the sheer number of agencies asserting jurisdiction and the fact that individual agencies can sometimes issue confusing and ill-defined guidelines.
For instance, the SEC applies the Howey test, developed in the 1940s, to determine whether a specific cryptocurrency is a security. Unfortunately, the SEC has stated that whether a specific cryptocurrency is a security can change overtime, and recently announced even more cryptocurrencies that they believe meet Howey’s definition of a security via their lawsuits with crypto exchanges Binance.US and Coinbase.
The regulatory confusion clouding cryptocurrency has directly impacted bankruptcy proceedings. One recent case study offers a glimpse into that disconcerting influence. In 2022, crypto exchange Voyager Digital Holdings Ltd. filed for Chapter 11 bankruptcy. Another major crypto exchange, Binance.US, entered into an agreement with Voyager to acquire its assets—valued at around $1 billion. The SEC, the New York Department of Financial Services (NYDFS), and the New York Attorney General all filed sale objections in Voyager’s bankruptcy proceedings, arguing that if Voyager’s crypto assets constitute securities, then Binance.US’s rebalancing and redistribution of these assets to its account holders would be an “unregistered offer, sale or delivery after sale of securities” in violation of Section 5 of the Securities Act. The NYDFS also alleged that the agreement “unfairly discriminates” against New York citizens by subordinating their recovery of diminished assets in favor of Voyager’s creditors—as well as foreclosing the option to recover crypto rather than liquidated assets.
SEC trial counsel noted that, “regulatory actions, whether involving Voyager, Binance.US or both, could render the transactions in the plan impossible to consummate, thus making the plan unfeasible.” In April 2023, Binance.US sent Voyager a legal notice canceling the prospective transaction, writing that “the hostile and uncertain regulatory climate in the United States has introduced an unpredictable operating environment impacting the entire American business community.”
The SEC’s desire towards regulating cryptocurrency as securities appears to be growing. On August 15, 2023, the SEC settled for $24 million its claims against Bittrex, which included violations of Section 5 of the Securities Act. Upon the settlement, the director of the SEC stated that Bittrex “worked with token issuers . . . in an effort to evade the federal securities law. They failed.” Uncertainty combined with aggressive enforcement leaves cryptocurrency entities in an uncertain and precarious position.
The Voyager case also highlights issues with plan feasibility in Chapter 11. In Voyager, the SEC objected to plan feasibility on the basis that one known digital asset of Voyager was a security, and therefore, the purchaser should register as a securities dealer. Although the court overruled the SEC’s objection, as noted above, Binance.US ultimately withdrew its purchase offer, placing blame on the overall regulatory climate. As regulations remain uncertain, and government authorities have shown a willingness to assert themselves into the process of reorganization, debtors who file for bankruptcy will have to brace for new or unforeseen objections to an otherwise confirmable plan.
Cryptocurrency has been seen by some as a disruptive force in finance. As the above issues show, it also appears to be a disruptive force in bankruptcy cases. Debtors and creditors alike will have to weather the disruption as best they can while the courts continue to grapple with the many open issues raised by cryptocurrencies.
 See 11 U.S.C. § 550(a).
 This position would arguably be consistent with cases interpreting section 550(a) of the Bankruptcy Code that have held that the estate is entitled to recover the value of the property when value has appreciated subsequent to the transfer. See, e.g., In re Am. Way Serv. Corp., 229 B.R. 496, 531 (Bankr. S.D. Fla. 1999) (noting that when the value of the transferred property has appreciated, “the trustee is entitled to recover the property itself, or the value of the property at the time of judgment.”).
 No. 14-30725DM (Bankr. N.D. Cal. Feb. 22, 2016),
 Order on Motion for Partial Summary Judgment at 1-2, Hashfast Techs. LLC v. Lowe, Adv. No. 15-3011DM (Bankr. N.D. Cal. 2016) (ECF No. 49).
 See 11 U.S.C. § 547(b)(5) (requiring the transferee to have received more that it would have received in a Chapter 7 liquidation).
 Maginnis, supra note 3.
 See In re CIS Corp., 195 B.R. 251, 262 (Bankr. S.D.N.Y. 1996) (“Thus, the Code § 547(b)(5) analysis is to be made as of the time the Debtor filed its bankruptcy petition); Sloan v. Zions First Nat’l Bank (In re Casteltons, Inc.), 990 F.2d 551, 554 (9th Cir. 1993) (“When assessing an alleged preferential transfer, the relevant inquiry . . . [is] . . . the actual effect of the payment as determined when bankruptcy results.”).
 11 U.S.C. § 362(a).
 141 S.Ct. 585, 590 (2021).
 319 B.R. 163 (Bankr. E.D. Ark. 2005).
 Hampton, 319 B.R. at 165-170.
 See 11 U.S.C. § 362(k) (providing that, subject to a good faith exception “an individual injured by any willful violation of [the automatic stay] shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”).
 See 11 U.S.C. § 542(c).
 David Gura, The White House calls for more regulations as cryptocurrencies grow more popular (Sept. 6, 2022, 6:00 AM), https://www.npr.org/2022/09/16/1123333428/crypto-cryptocurrencies-bitcoin-terra-luna-regulation-digital-currencies.
 See, e.g., CFTC v. McDonnell, 287 F. Supp. 3d 222, 228-29 (E.D.N.Y. 2018) (“The jurisdictional authority of CFTC to regulate virtual currencies as commodities does not preclude other agencies from exercising their regulatory power when virtual currencies function differently than derivative commodities.”).
 See Treasury Announces Two Enforcements Actions for over $24M and $29M Against Virtual Currency Exchange Bittrex, Inc., (October 11, 2022), https://home.treasury.gov/news/press-releases/jy1006.
 See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).
 Emily Mason, Coinbase Hit With SEC Suit That Identifies $37 Billion of Crypto Tokens As Securities, (June 6, 2023 5:08 pm), https://www.forbes.com/sites/emilymason/2023/06/06/coinbase-hit-with-sec-suit-that-identifies-37-billion-of-crypto-tokens-as-securities/?sh=3cc4c6d667a9; SEC Charges Crypto Asset Trading Platform Bittrex and its Former CEO for Operating an Unregistered Exchange, Broker, and Clearing Agency, https://www.sec.gov/news/press-release/2023-78 (last visited July 31, 2023).
 Jack Schickler, SEC Objects to Binance.US’ $1B Voyager Deal, Alleging Sale of Unregistered Securities, (last updated Feb. 23, 2023 at 2:32 p.m.), https://www.coindesk.com/policy/2023/02/23/sec-objects-to-binanceus-1b-voyager-deal-alleging-sale-of-unregistered-securities/.
 See NYDFS Objection to Plan, In re Voyager Digital Holdings, et al. at 9-10, No. 22-10943 (Bankr. S.D.N.Y. Feb. 22, 2023) [ECF No. 1051].
 Kari McMahon, SEC and New York Regulators Push Back on Binance.US’s Acquisition of Voyager, The Block (Feb. 23, 2023), https://www.theblock.co/post/214333/sec-and-new-york-regulators-push-back-on-binance-uss-acquisition-of-voyager.
 Yueqi Yang & Steven Church, Binance US Ends $1 Billion Deal to Buy Bankrupt Crypto Firm Voyager, Bloomberg (April 25, 2023), https://www.bloomberg.com/news/articles/2023-04-25/binance-us-terminates-deal-to-buy-bankrupt-crypto-firm-voyager.
 See Crypto Asset Trading Platform Bittrex and Former CEO to Settle SEC Charges for Operating an Unregistered Exchange, Broker, and Clearing Agency, https://www.sec.gov/news/press-release/2023-150 (last visited Sept. 18, 2023).
 See Objection of the U.S. Securities Exchange Commission to Confirmation at 3 n.5, In re Voyager Digital Holdings, et al., No. 22-10943 (Bankr. S.D.N.Y. Feb. 22, 2023) (ECF No. 1047).
 See supra at n. 23.