Crypto‐claimants and bitcoin bankruptcy: Challenges for recognition and realization

DOIhttp://doi.org/10.1002/iir.1346
Published date01 June 2019
Date01 June 2019
RESEARCH ARTICLE
Crypto-claimants and bitcoin bankruptcy:
Challenges for recognition and realization
Janis Sarra
1
| Louise Gullifer QC (Hon)
2
1
Peter A. Allard School of Law,University of British Columbia, Vancouver, BC, Canada
2
Commercial Law, Universityof Oxford, Oxford, UK
Correspondence
Janis Sarra, Professor, Peter A. Allard School of Law, University of British Columbia, Vancouver, BC, Canada.
Email: sarra@allard.ubc.ca
1|INTRODUCTION
Bitcoin ATMs
1
dot the streets of cities from Prague to Hong Kong, and there are now more than
2,500 such machines in the United States.
2
One news source reports that there are approximately
15 million bitcoins in the global market and that USD 2 billion was pumped into cryptocurrency
hedge funds in 2017 alone.
3
In 2017, the price of bitcoin rose from about USD 1,000 in early January
to an all-time high of USD 19,738 on December 17, with an average of about 360,000 transactions
per day that month.
4
The price has declined sharply in 2018, and by January 1, 2019, it stood at USD
3,817.
5
Despite this roller coasterfluctuation in value, it still merits consideration in respect of its
potential interaction with commercial law. Not unlike an onion, bitcoin has layers and layers in
respect of its conceptualization, algorithmic under pinnings, and immutability of data. Peeling away
some of the opaqueness reveals how it may be dealt with in insolvency. It might also identify issues
that assist in understanding other digital assets.
What exactly bitcoin is and how to calculate its value are still unclear, which could be significant
during insolvency, when creditors are looking to realize on their claims. This article is aimed at
1
An ATM machine is an automated teller machineor at the momentcash machine, depending on the jurisdiction, in this
usage a machine that dispenses bitcoin or performs other transaction services when an account holder inserts a card (Oxford
Dictionary 2018).
2
See: ; .
3
Bloomberg Businessweek, What Bitcoin Is Really WorthMay No Longer Be Such a Mystery(19 April 2018), available at:
eatures/2018-04-19/what-bitcoin-is-really-worth-may-no-longer-be-such-a-mystery>.
4
Bank of Canada, Bitcoin Awareness and Usage in Canada: An Update (July 2018), available at: ofcanada.
ca/wp-content/uploads/2018/07/san2018-23.pdf>.
5
See: .
Received: 16 January 2019 Revised: 24 April 2019 Accepted: 8 July 2019
DOI: 10.1002/iir.1346
© 2019 INSOL International and John Wiley & Sons, Ltd
Int Insolv Rev. 2019;28:233272. wileyonlinelibrary.com/journal/iir 233
generating discussion on some of the challenges bitcoin poses for insolvency and bankruptcy.
6
It
looks at different definitions and uses of bitcoin, and although the ar ticle situates bitcoin within
cryptocurrencies more generally, it focuses only on bitcoin as an example of a number of crypto-
coins in the market and does not address the breadth of different products that could come under the
broad definition of cryptocurrency.
Insolvency risk raises several important questions. What is the nature of bitcoin? Is it property,
and if so, what type? Is it currency, commodity or another form of property? What does this charac-
terization mean for insolvency and claims on the estate of the insolvent bitcoin holder? How is the
cryptocurrency stored or otherwise protected or possessed,and what is the relationship of a bitcoin
exchange or storage mechanism to the estate of the insolvent debtor? Are rightsto the bitcoin per-
sonal rights or proprietary rights? What happens when a direct owner of bitcoin becomes insolvent in
terms of the ability of creditors to realize on its value? The article raises the issue of what asset or
value may be associated with bitcoin, such that an insolvency officer can access, realize on, and dis-
tribute that value among the debtor's creditors.
It is important to acknowledge at the outset that the answer to these questions may differ
from one jurisdiction to the next, given the varying ways that insolvency is addressed. This arti-
cle uses examples, mainly from the United Kingdom and Canada, to illustrate some of the chal-
lenges, although the approach of other jurisdictions is mentioned where there are relevant
decided cases or other developments. While some issues discussed will resonate with other
cryptocurrencies, each type has different variables that may alter the legal analysis, so for the
purposes of this article, the discussion is confined to bitcoin. This ar ticle addresses only
blockchains that are distributed technology ledgers used to host forms of bitcoin, as opposed to
other types of blockchain.
Section 2 commences with how bitcoin is created and transferred. It continues with a discussion
of distributed ledger technology/blockchain in bitcoin and cryptocurrency and some of the multiple
potential uses of bitcoin, including as a method of payment, a store of value, or a form of investment.
Section 3 contains an analysis of what bitcoin is, whether money or other form of property or asset,
and continues with a discussion of whether security can be taken over bitcoin. Section 4 is aimed at
the key question of what happens when a direct holder of bitcoin becomes insolvent, what remedies
may exist for creditors, and what framework may help them realize on the value, and then examines
whether the issues are the same or different where the insolvent debtor is holding bitcoin through one
or more intermediaries. Section 5 posits some initial questions and challenges that may arise for cred-
itors if a bitcoin exchange becomes insolvent. Although bitcoin exchange insolvency is not the focus
of this article, the first bitcoin exchange insolvencies raise some important issues deserving of future
research.
6
The terms insolvencyand bankruptcyare used interchangeably in this article, although it is important to note that
different jurisdictions have differentmeanings, for example, insolvencyin both Canada and the United Kingdom is a defined
term based on tests of generally being unable to meet debts as they become due or an asset/liability test. However, in Canada,
bankruptcyrefers to the process of liquidating the assets of the debtor for the benefit of creditors, and in the United
Kingdom, bankruptcyrefers to this process in relation to an insolvent individual, whereas in relation to companies, the term
is liquidationor winding up.
234 SARRA AND GULLIFER
2|BITCOIN BASICS
2.1 |The contextCryptocurrency generally
Although the idea of electronic payment denominated in fiat currency is not new,
7
the generation and
holding of value not so denominated, by the use of public ledgers operating blockchain technology,
has developed rapidly over the last few years. Value is set by the marketprice, whereas the market
includes all participants, not just those participants that are nodes.
8
It also includes those individuals
and entities that buy bitcoin for fiat currency and those who accept it for goods and services, even if
they themselves are not nodes but do their transactions through intermediaries. Value is recognized
by agreement within the community of users of the virtual currency.
9
Cryptocurrencies can take many forms, and as a group, they share few common characteristics.
10
A cryptocurrency is a digital asset designed to act as a store of value or medium of exchange in the
digital economy. Cryptocurrencies are not controlled or regulated by any single authority and can, in
some circumstances, be issued without any major approval process. There is no centralized issuer of
such products or a trusted third party that manages them, and until very recently, they have been inde-
pendent of central banks and other financial institutions.
11
In addition to being used for the money-
likefunctions
12
of being a method of payment and a store of value, issues of digital coinsare
frequently used as a means of raising financing.
13
One of the difficulties in defining cryptocurrencies
such as bitcoin is that the holder of the cryptocurrency does not physically holdthe coin. Unlike
money,
14
which is either in physical form or takes the form of a right against a trusted third party
such as a deposit-taking bank, or securities, which are rights against the issuer and are either materi-
alized or held by trusted intermediaries regulated by securities law, the coin holder
15
has neither any-
thing physical nor a right against an intermediary. Instead, at least in the case of bitcoin, the coin
holder has the ability to transfer bitcoin that are recorded as being held by a particular public key,
by use of a private key.
2.2 |The role of blockchain in bitcoin and other cryptocurrencies
Blockchain technology is critical to bitcoin and other cryptocurrencies. A blockchain is a distributed
ledger containing a record of all transactions. The term blockchainwas crafted as shorthand for a
7
It has existed for many years through mechanismssuch as bank debit cards and PayPal. See Dan Awrey and Kristin van
Zwieten, The Shadow Payment System(2017) 43 Journal of Corporation Law 775.
8
See Section 2.2 for a definition of nodes.
9
Odiet observes that the utility of cryptocurrency often relies on recognition of the thing's existence by other servers and users
across a vast network: Christopher Odiet, Bitproperty and Commercial Credit(2017) 94 Washington University Law Review
649, 650653.
10
Financial Markets Law Committee, Issues of Legal Uncertainty Arising in the Context of Virtual Currencies(July 2016),
1, available at: .See also the Bank for International
Settlements, which has drawn attention to the potentially disruptive innovations associated with digital currency schemes that
are issued automatically and that are not a liability of any party: Committee on Payments and Market Infrastructures of the
Bank for International Settlements, Digital Currencies (November 2015), 6.
11
Bank of Canada, Decentralized E-Money (Bitcoin) (2014), 1, available at:
uploads/2014/04/Decentralize-E-Money.pdf>.
12
See Charles Proctor (ed), Mann on the Legal Aspect of Money (7th edn) (OUP, 2012), paragraph 1.07.
13
See below at Section 2.5.3, where these functions are examined in more detail.
14
Usually referred to as fiat moneybecause it is legal tender whose value is backedby the government that issued it.
15
This refers to a direct coin holder, that is, not one who is holding through an intermediary. Most holders do not, in fact, hold
in this way, because in order to do so, the holder needs to havevery considerable computing power at his disposal.
SARRA AND GULLIFER 235

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