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Courts, without law for guidance, setting value of cryptoassets

Judges determining currency values receive little input from policymakers focused on other issues

Inconsistent classifications and ill-formed definitions of bitcoin and other digital assets are being left to the judiciary to sort out. (AFP via Getty Images)
Inconsistent classifications and ill-formed definitions of bitcoin and other digital assets are being left to the judiciary to sort out. (AFP via Getty Images)

Bankruptcy judges are used to deciding the value of assets, but for cryptocurrencies, which can halve or double in value in a matter of months, determining how much one party is owed gets tricky.

It’s an issue that could be mitigated by regulators or lawmakers, but despite myriad efforts focusing on digital assets this year, U.S. bankruptcy judges are unlikely to get much guidance, according to several lawyers who track the cryptocurrency industry.

Judges are dealing firsthand with issues of how to value cryptocurrencies, and whether bitcoin can even be classified as money, as policymakers tackle more existential issues, such as which agencies should regulate them or whether to take no action at all. 

“For better or for worse, it is the courts who are going to be making the rules,” said Joanne Molinaro, a partner and trial lawyer with Foley & Lardner LLP’s Chicago office and a member of the firm’s Blockchain and Cryptocurrency Task Force.

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The U.S. Bankruptcy Code gives great latitude to judges in determining the type and amount of the recovery in fraudulent transfer cases. If the recovery is not possible because it is lost or too burdensome to return, judges instead will order recovery of the value. And there’s the rub for things like bitcoin.

In a phone interview with CQ Roll Call, Molinaro said courts are being forced to take the lead in resolving many of the controversies surrounding digital assets and their extreme price volatility because of insolvencies of crypto “mining” companies and exchanges.

And courts often have to act swifter than the glacial pace of regulators and legislators, many of whom have adopted a wait-and-see approach on digital assets, she said.

“The law is going to be created by judges until Congress decides cryptocurrency is here to stay,” Molinaro said. Up until that point, it will largely be regulation by litigation, she said.

[Crypto enthusiasts say new products lend bitcoin credibility]

Alan Rosenberg, an attorney with Miami-based bankruptcy law firm Markowitz, Ringel, Trusty, & Hartog PA and a member of the American Bankruptcy Institute, notes that federal agencies and courts each have classified digital assets as currencies or commodities, which affects how they are valued and what constitutes illegal conduct when handling them.

Rosenberg cited a criminal case in Florida in which a defendant who sold bitcoin to an undercover police officer was accused of operating an unauthorized money services business. The defendant challenged the charges in state court, arguing that bitcoin wasn’t money and, as a result, he couldn’t be charged under Florida’s money services business statute. 

A state judge agreed with the defendant, writing, “Bitcoin may have some attributes in common with what we commonly refer to as money but differs in many important aspects,” and dismissed the charges. “This Court is not an expert in economics, however, it is very clear, even to someone with limited knowledge in the area that Bitcoin has a long way to go before it is the equivalent of money.”

An appellate court last year, however, reversed the trial judge, finding that the defendant had engaged in a money transmission business by exchanging virtual currency for cash and that virtual currency fell within the express definitions of “monetary values” and “payment instruments” under Florida law.

Bankruptcy inconsistencies

These issues apply to bankruptcy law, too, where inconsistent classifications and ill-formed definitions of bitcoin and other digital assets are being left to the judiciary to sort out.

In a 2016 case litigated in the U.S. Bankruptcy Court for the Northern District of California, a bankruptcy trustee sought to recover an alleged fraudulent transfer of 3,000 bitcoins worth approximately $363,000 when they were sent. 

The person who received the bitcoins argued that he should only be required to return the value of the bitcoins on the date of the transfer, as opposed to returning the actual bitcoins that had been steadily gaining in value.

Molinaro, in a legal analysis from October 2018 of the case, In re Hashfast Technologies LLC, said the trustee argued that bitcoins are like commodities and, therefore, the bankruptcy court should order the return of the bitcoins themselves or their value at the time of recovery. 

“Central to the dispute was that the value of the bitcoin had increased by 400 percent since the date of transfer,” Molinaro wrote. The value reached a reported $1.3 million. Ultimately, the case settled before the judge had to decide whether bitcoin is a currency or a commodity.

That issue was at least partly resolved in September 2018, when the U.S. District Court for the District of Massachusetts, not a bankruptcy court, ruled in favor of the Commodity Futures Trading Commission, holding that bitcoins met the definition of commodity under the Commodity Exchange Act. 

Although, the CFTC case was a commodity fraud case involving virtual currency, Molinaro has said the ruling could have “enormous implications on valuation in the bankruptcy context.”

Given that decision, the return of the bitcoin or any other cryptocurrency itself will likely be favored instead of a contested and expensive battle over when and how a digital asset should be valued, she argues. However, if the mere return of bitcoin is not feasible because they were stolen or there’s some other impediment, the timing of valuations becomes critical and a legal contest over the asset’s worth becomes inevitable.

The result is that there is still no firm answer from any regulator or statute. 

“There is very little uniformity in the treatment of cryptocurrency in the law,” said Rosenberg. “Everything is in limbo. Nobody is taking the lead on this.”

A legislative solution seems distant, according to Robert Cox, a bankruptcy attorney with the Charlotte, North Carolina, office of Bradley Arant Boult Cummings LLP, who has written about the need for bankruptcy lawyers to understand cryptocurrency issues.

He told CQ Roll Call that amending the U.S. Bankruptcy Code, a lengthy and complex process, to address the questions and challenges posed by cryptocurrency does not appear to be a “high priority” for the bankruptcy bar right now. “They seem to be taking a wait-and-see approach,” he said.

In any case, the U.S. appears to be far behind other nations in coming up with legislation to deal with the unique legal challenges of cryptoassets in bankruptcy proceedings.

The Swiss Federal Council recently adopted a report on a legal framework for distributed ledger technology and blockchain. According to the Swiss law firm Walder Wyss AG, one of the “contemplated legislative amendments” in the report focuses on insolvency law, “where the report calls for unambiguous rules on the segregation of crypto-based assets from the other assets of the bankrupt estate.”

The Swiss firm said the Federal Council would propose a new provision in Swiss bankruptcy law “providing for a right to release data in the event of the insolvency of the data holder to the beneficiary, including a claim to the transfer of digital assets.”

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