Bankruptcy

Crypto Bankruptcy Could Be Investors’ Nightmare

The latest cryptocurrency market slump gives investors a painful lesson about the risks of trading digital tokens through intermediaries.

In a bankruptcy restructuring, crypto investors would be navigating uncharted territory.

“What can be safely predicted is that there will be litigation and there will be delays,” said Adam Levitin, a law professor at Georgetown University who studies bankruptcy. .

Crypto exchanges and lending services offer individual investors an on-ramp to markets, but the cryptocurrency customers put on these platforms might not be theirs in the eyes of a bankruptcy court, regulators say and legal experts.

If a cryptocurrency company goes bankrupt, its users’ digital assets will likely go into the bankruptcy realm that lawyers, financial advisors, lenders, and other creditors share. Customer assets could be redeemed at a loss, rather than simply returned to users. Even if customers of a struggling cryptocurrency firm do eventually gain access to their tokens, they could still suffer severe losses if the market turns against them during the bankruptcy.

Many people were motivated to place crypto assets in Celsius to earn interest rates of up to 18%. The lender took deposits from customers and placed them in decentralized financial investments to earn a return or lent the funds to other users for a fee.

Celsius is like a bank in many ways. But the company lacks the protections that banks have, such as federally backed deposit insurance. Celsius, and other cryptocurrency intermediaries, are also not registered as brokers, which provides account holders with essential bankruptcy protections by separating their funds from brokers’ equity. In the United States, most crypto intermediaries instead have simple money transfer licenses issued by state governments, intended for companies like Western Union.

How Celsius’s crypto lending process works:

Celsius puts customer deposits in decentralized financial investments and lends funds to other users (including exchanges and market makers).

Clients lend money to Celsius in exchange for yield. (It is basically an unsecured loan).

Celsius wins a come back borrowers and investments.

Celsius puts customer deposits in decentralized financial investments and lends funds to other users (including exchanges and market makers).

Clients lend money to Celsius in exchange for yield. (It is basically an unsecured loan).

Celsius wins a come back borrowers and investments.

In a recent article, Levitin argued that the easiest way to protect investors would be for the Consumer Financial Protection Bureau, a federal regulator, to require cryptocurrency exchanges to hold customer funds under ‘remote bankruptcy agreements to separate funds. He said the CFPB was clearly authorized by Congress to take such action, but the agency had not yet done so.

A CFPB spokeswoman declined to comment.

Crypto companies such as the Coinbase Global trading platform Inc.

PIECE OF MONEY 0.33%

have sought to reassure investors in recent weeks that their crypto assets are safe.

“We have strong legal and operational protections in place to ensure that our clients’ assets are safeguarded in all eventualities,” Coinbase Chief Legal Officer Paul Grewal said in an emailed statement Thursday. “This includes accounting for these assets completely separately from any corporate funds.”

Coinbase shares plunged following a disclosure by the company in May that customers could be treated as general unsecured creditors in a hypothetical bankruptcy.

Celsius also sought to reassure customers shortly before freezing withdrawals. A spokeswoman for the company told the Wall Street Journal in an email on Friday that it had no problems responding to withdrawal requests and that it held enough ether – a popular cryptocurrency – to fulfill its obligations.

Celsius chief executive Alex Mashinsky lashed out at skeptics on Twitter who suggested on Saturday the company was on the ropes, accusing them of spreading false information. The company froze the accounts on Sunday evening. As of Wednesday afternoon, the assets were still frozen and Mr. Mashinsky tweeted that the company was “working nonstop” on the matter.

WSJ’s Dion Rabouin explains why Wall Street is now betting big on crypto and what that means for the new asset class and its future. Photo composition: Elizabeth Smelov

In a bankruptcy environment, much will depend on the contract that depositors will have accepted when they place their digital assets. Celsius’ terms of service specify that the legal status of users’ crypto assets will be unclear if the company becomes insolvent.

Some lawyers say that the type of contract between the investor and the company could make the difference and offer some protection of property rights in the event of bankruptcy. The treatment of customer assets may depend on whether the company holds them in a manner consistent with customer ownership as established by applicable commercial laws, said Jonathan Cho, bankruptcy and debt attorney. regulations at Allen & Overy.

For example, many companies have adopted a holding company model, available under most state business laws, which helps define what ownership rights should be, Cho said. Celsius also has a lending branch that offers cash loans, secured by people’s cryptocurrency assets.

A bankruptcy judge may also have to decide whether Celsius depositors would even be considered unsecured creditors or just investors, which rank even lower, said Jim Van Horn, bankruptcy attorney at Barnes & Thornburg LLP. .

State laws on ownership of assets in custodial accounts could be helpful to depositors. But they may not even come into play in a bankruptcy case if a judge determines the users are just investors, Van Horn said.

Write to Paul Kiernan at [email protected], Alexander Gladstone at [email protected] and Soma Biswas at [email protected]

Corrections & Amplifications
Lending service Celsius Network LLC froze all customer withdrawals this week. An earlier version of this article incorrectly listed the company’s name as Celsius Networks LLC. (Corrected June 17)

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