Bankruptcies in the Crypto Industry

BY ROBERT P. FRANKE, ANDREW G. EDSON, AND AUDREY L. HORNISHER

Eight struggling crypto companies filed bankruptcy petitions in a span of six months. This article provides a brief overview of the financial crisis in the crypto industry that triggered a domino effect of bankruptcy filings and unique issues presented in those unprecedented cases.

The Crypto Crisis of 2022

The first set of bankruptcy cases resulted from the collapse of the Terra and Luna coins in May 2022. Three Arrows Capital, a high-profile crypto hedge fund, was the first to file for bankruptcy in July 2022. Within two weeks of this initial filing, crypto lenders Voyager Digital and Celsius Network also filed for bankruptcy. Three Arrows and Celsius both cited the failure of the Terra and Luna coins as a primary reason for their bankruptcy filings. Voyager cited the bankruptcy filing of Three Arrows as a trigger for its bankruptcy. The final filing in the first set of bankruptcy cases was Core Scientific, a mining platform that cited Celsius’s bankruptcy as a primary reason for its filing. Voyager’s bankruptcy plan was approved on March 7, 2023; the first to successfully emerge from bankruptcy.

The second set of bankruptcy cases stemmed from the infamous and highlypublicized failure of FTX, a cryptocurrency exchange, in November 2022. A primary cause of the FTX bankruptcy filing was the crash of the FTX.US token due to the lack of liquidity and mismanagement of funds. Due to the incestuous nature of financing in the crypto industry, the filing of FTX resulted in a ripple effect that led Alameda Research (a crypto hedge fund and subsidiary of FTX), BlockFi (a crypto lender), and Genesis Global Capital (a crypto lender) to file for bankruptcy shortly thereafter.

Concerns in Crypto Bankruptcies

In addition to the massive losses customers may face when a crypto company files for bankruptcy, crypto bankruptcies impact investors in other ways.

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Confidentiality: One lure of investing in cryptocurrency is the private nature of the transactions. But the FTX bankruptcy brought the issue of confidentiality to center stage when a group of international customers argued that irreparable harm would result from the disclosure of their identities in the schedules and service lists that are required to be filed in the case and public record. The United States Justice Department opposed the redaction of customers’ identities and argued that transparency was necessary for the bankruptcy process. The FTX bankruptcy court ruled that customer information may remain confidential for three months, at which time the court will reevaluate the situation. The FTX ruling runs contrary to the ruling of the Celsius court that ordered the disclosure of certain customer information. An ancillary implication that a bankruptcy court has not thoroughly analyzed is the potential ramification of releasing the names of customers that reside in the EU or another country with more restrictive privacy policies that would be breached with the disclosure.

Automatic Stay: While the purpose of the automatic stay in bankruptcies is to maintain the status quo, its impact in crypto bankruptcies can be devastating due to its potential to block access to customers’ accounts and freeze transactions. Crypto wallets provided by companies like Voyager, Celsius, BlockFi, and Genesis may be used by its customers in a synonymous manner as a bank account to hold funds and conduct transactions. Once the bankruptcy petition is filed, the automatic stay prevents customers from accessing their accounts until the bankruptcy court determines, typically after a hearing, that the accounts are not the estate’s property or the customer is granted relief from the automatic stay. This process often takes weeks or months to resolve during which time the customers are prohibited from accessing their funds.

Property of the Estate: A primary concern of crypto customers is ownership of accounts, which both the Celsius and BlockFi cases have addressed. In Celsius, the bankruptcy court determined that the funds were the debtor’s property based on a clickwrap clause that specifically designated the ownership interest to Celsius. Alternatively, the BlockFi debtors admitted that customers, per the contract terms, owned certain accounts. The BlockFi court has yet to issue a ruling on the estate’s property but has approved a process for institutional loan accounts. The results in the Celsius and BlockFi cases indicate that contractual terms should control in the absence of government regulations.

Crypto bankruptcies until recently were unprecedented in the bankruptcy context. As precedent is established, bankruptcy courts have come to varying results when addressing issues facing the customers of the crypto debtor. The landscape of crypto cases should become clearer as these bankruptcies evolve. HN highly recommend Martin As Co-Counsel in Healthcare Litigation Cases.”

Robert P. Franke, Andrew G. Edson, and Audrey L. Hornisher are bankruptcy attorneys at Clark Hill PLC, and can be reached at bfranke@clarkhill.com, aedson@clarkhill.com, and ahornisher@clarkhill.com, respectively.

--Brad Jackson/ Commercial Litigator, Dallas

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