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Crypto a can of worms for bankruptcy trustees

Regulation

Digital assets present problems when it comes to valuation and sale, or even just locating them in the first place.

By Thyge Trafford-Jones5 minute read

Digital currencies and non-fungible tokens – “crypto”, as they are often called – are considered property under the Bankruptcy Act and a trustee can take possession of those assets. While that sounds relatively straightforward, there are often issues because digital assets can be challenging to trace. Owners are not necessarily listed on any register in an easily recognisable form (such as names and addresses). 

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Moreover, crypto assets are intangible – there are no physical coins, notes, artworks or hard-copy certificates that denote ownership. Cryptocurrency is not controlled or operated by any single entity or country but involves a global network of computers securing and validating transactions (blockchain). 

These decentralised blockchains are unable to be changed, ensuring transactions are permanently recorded and viewable by anyone.

Tracing crypto relies on the honesty of debtors

Thanks to their increase in popularity, crypto holdings are increasingly listed in debtors’ bankruptcy schedules. But thanks to their virtual nature, crypto assets can present headaches for trustees seeking to take ownership.

Like any asset, a debtors interest in cryptocurrency held on or after the date of bankruptcy will be placed with the trustee as an asset of the estate. Failing to disclose cryptocurrency ownership is the same as failing to declare traditional bank accounts or shares and may be an offence under the Bankruptcy Act

The issues for trustees arise in actually gaining control of the cryptocurrency, understanding and realising its value. 

When appointed to a regulated debtor estate, trustees undertake debtor profiling and focus on collecting electronic evidence to assist investigations. 

Debtors are reminded that there are strict obligations on regulated debtors to disclose all assets in their possession or control and to assist their trustee as reasonably requested. Failure to declare assets or assist a trustee may end in prosecution and a fine or imprisonment, or both. 

Locating the crypto assets is just the start. A key feature of crytpo assets is that they are secured using blockchain technology. On the one hand, there is a ledger that can trace and locate the block address of each crypto asset to a particular destination. However, the block addresses are a string of numbers with no identifiers such as the owner’s name or address details. Trustees can search the most common chains via blockchain.com or etherscan.io, but will need the seed phrase and details to find the location of a digital asset or wallet.

To dispose of digital assets, trustees must have access to the seller’s digital wallet, access and login details to exchange holding tokens, and access or log in to secondary market platforms holding NFTs, if applicable. 

Cryptocurrency can be traded and moved very quickly, so trustees need to locate and secure the asset as soon as possible. 

Public and private keys are cryptographic codes required to buy and sell cryptocurrency and NFTs. While anyone can send transactions to the public key, you need the private key to “unlock” them and prove that you are the owner of the cryptocurrency received in the transaction. 

A recent case in the Federal Court, ASIC v A One Multi Services Pty Ltd, highlighted the problems. It was revealed trustees need the following: 

  • All relevant credentials and passwords for access to any cryptocurrency held by the regulated debtor, including the public and private keys and/or seed string for any soft or cold wallet (see below)
  • Authentication devices required to facilitate access, operation or control of any cryptocurrency
  • All relevant credentials and passwords for access to the authentication devices or systems, including email, SMS or mobile apps, that facilitate access, operation or control of cryptocurrency 
  • Any cold wallet device containing cryptocurrency together with the access code

A cold wallet is a hardware device that can be detached from the internet, is at less risk of being compromised and is considered more secure when handling large sums. A hot wallet is connected to the internet (brands include MetaMask and Coinbase).

Valuing and selling crypto or NFTs

One of the most significant issues around buying and selling crypto is liquidity – that is, how many assets are in the market. Both crypto and NFTs often lack sufficient buyers or sellers for an asset, making valuations difficult.

CoinMarketCap and CoinGecko are both helpful in trying to value digital assets. 

NFTs are even more difficult to value due to their nature. NFTs are digital assets that represent real-world objects such as art, music, in-game items and videos. They often have sentimental value to owners, and their value is generally assigned according to their rarity or uniqueness.

There are marketplaces (or exchanges) to sell crypto tokens and NFTs, but they require a level of experience and knowledge to trade.

In short, cryptocurrencies and NFTs are considered property under the Bankruptcy Act. However, tracing and acquiring, and subsequently valuing and disposing of those assets can present enormous issues for trustees unfamiliar with how cryptocurrencies or NFTs work. 

Key terms 

Blockchain: A system of recording information that makes it difficult or impossible to change, hack or cheat the system. A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain.

Cryptocurrency: A digital currency in which transactions are verified and records maintained by a decentralised system using cryptography rather than by a centralised authority.

Digital wallet: A place to store digital currency and validate transactions. A wallet keeps secret information, called a private key or seed, used to validate transactions so that cryptocurrency can be used to make purchases or be exchanged for another asset. A hot wallet is a software wallet connected to the internet, while a cold wallet is a hardware device capable of being detached from the internet and hence less likely to be compromised.

NFT: A non-fungible token is a digital asset that represents a real-world object such as a work of art, piece of music, in-game item or video.

Public and private keys: The public key is a cryptographic code that sends cryptocurrency into a wallet. The private key verifies transactions and proves ownership of a blockchain address.

Seed phrase: A group of words that allow access to a cryptocurrency wallet.

Thyge Trafford-Jones is registered bankruptcy trustee at business advisory and insolvency firm Mackay Goodwin.

Crypto a can of worms for bankruptcy trustees
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