Digital Assets Defined: Writing Digital Assets Into The Bankruptcy Code

• Published date: 09 November 2022
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Technology, Insolvency/Bankruptcy, Fin Tech
• Law Firm: Jones Day
• Author: Ms Dorothy Giobbe, Abradat Kamalpour, Dan Moss, Mark W. Rasmussen, Benjamin Rosenblum, Joshua B. Sterling, Jayant W. Tambe, Samuel (Sam) Walling and Ryan Sims

As discussed in previous installments of this White Paper series, the Lummis-Gillibrand Responsible Financial Innovation Act (the "Bill")¹ proposes a comprehensive statutory and regulatory framework in an effort to bring stability to the digital asset market. One area of proposed change relates to how digital assets and digital asset exchanges would be treated in bankruptcy. If enacted, the Bill would significantly alter the status quo from a bankruptcy perspective.

OVERVIEW OF DIGITAL ASSETS IN BANKRUPTCY

There is little reported jurisprudence in the United States specifically relating to insolvency proceedings involving digital assets (e.g., cryptocurrencies). In fact, how these assets are treated in bankruptcy in certain aspects is currently developing, as several significant players in the cryptocurrency arena have commenced bankruptcy and insolvency proceedings in the United States and abroad (e.g., Voyager Digital Holdings, Celsius Network, Three Arrows Capital). The only other analogue was in 2014, when the high-profile cryptocurrency exchange, Mt. Gox, commenced a bankruptcy proceeding in Japan after halting bitcoin trading due to major security breaches and bitcoin theft. After years of legal proceedings, the Japanese trustee announced in October 2021 that a civil rehabilitation plan was accepted by a majority of creditors, yet it remains uncertain when distributions to creditors will occur and the effect market volatility will have on such distributions.²

In light of the lack of U.S. precedent and overall volatility in the cryptocurrency market, if passed, the Bill could provide muchneeded certainty relating to the treatment of digital assets in a U.S. bankruptcy proceeding. To do so, the Bill largely proposes to integrate digital assets into existing statutory and regulatory frameworks relating to the treatment of commodities and the relief available to commodity brokers in bankruptcy.

The primary objective of the existing provisions of the Bankruptcy Code³ relating to commodities is to minimize the ripple effect and disruption that the bankruptcy of a major commodities player could have on the markets. The statutory framework relating to the liquidation of a commodity broker has been tested very little.⁴ Moreover, the U.S. Commodity Futures Trading Commission ("CFTC") has enacted a complicated web of rules'the Part 190 Rules⁵'which apply in conjunction with, and sometimes supersede, the Bankruptcy Code in a commodity broker liquidation.

The Bill proposes to amend, among other things, the definition of "commodity broker" to include "digital asset exchange," which the Bill in turn defines as "a centralized or decentralized platform which facilitates the transfer of digital assets"⁶ and "a trading facility that lists for trading at least one digital asset."⁷ This, among other proposed changes, would enact significant changes to both the relief...