Mixing Cryptocurrency and Bankruptcy

Cryptocurrency has evolved from an obscure virtual niche to a widespread consumer investment. And as more individuals and businesses collect crypto in their digital wallets, issues arise regarding how these virtual currencies are valued and categorized in bankruptcy cases.

Working with a trusted law firm like Ritter Spencer Cheng is the best way to build an understanding of how the bankruptcy process accommodates modern complexities like cryptocurrency. Read on to learn more about how the bankruptcy process addresses cryptocurrency.

What is Cryptocurrency? 

Cryptocurrency, nicknamed crypto, is a virtual currency underpinned by networked computer systems. It is not tangible. Cryptocurrency holders exchange their assets through digital entries on an online blockchain database, which may be public in many cases. Blockchain technology maintains secure and decentralized records of transactions among crypto-owners, holding users accountable for their payments without the need for third-party intermediaries like banks and monetary institutions. 

Founded in 2009, Bitcoin was the first form of cryptocurrency. Today, it remains the most popular and valuable cryptocurrency on the market. However, several other newly founded cryptocurrencies like Ether, Litecoin, and Ripple XRP exist. As a whole, crypto markets have become popularized worldwide, as eliminating centralized third parties allows for direct, faster money transfers, unfortunately at the expense of safety and fraud. As a result, cryptocurrency has skyrocketed in value, and sometimes fallen just as suddenly, leaving investors in the lurch. 

Do I have to Disclose my Cryptocurrency as an Asset in Bankruptcy? 

The answer is yes: Debtors must disclose all assets and income when filing for bankruptcy, regardless of the asset’s value or tangibility. Some dishonest debtors may think that a trustee would be hard pressed to find crypto assets without disclosure. This may have been the case before, but not any longer. 

In its early days, cryptocurrency was not on trustees’ radars. However, as cryptocurrency has become more well-known, trustees and other insolvency professionals have found new ways to access crypto assets. Transactions are public. Digital platforms, like Coinbase, have emerged in recent years to aid bankruptcy trustees. These resources allow trustees to locate specific debtors’ crypto assets, transfer digital assets from their digital wallet, freeze debtors’ accounts, and convert cryptocurrency to fiat currency to repay creditors. In addition, platforms such as FTX that file bankruptcy themselves are required to make disclosure of crypto owners.

Is Cryptocurrency an Exempt Asset?

Under Texas law and federal law, cryptocurrency is not classified as an exempt asset category in bankruptcy cases. However, exemptions are possible under federal law using what is known as a wildcard exemption. Wildcard exemptions are not limited to any specific property type and can be used for assets worth $1,475 plus up to $13,950 of any unused portion of the federal homestead exemption. 

Like federal exemption statutes, some states also offer wildcard exemptions. However, certain states may have stricter limitations than others. For example, some states may prohibit wildcard exemptions for specific property types like cash or real estate. Meanwhile, other states, like Alaska, Arkansas, Connecticut, and several others, can resort directly to federal exemption statutes rather than abiding by state regulations. Texas does not have any wildcard exemption.

How Much is Cryptocurrency Worth?

An asset is valued in a bankruptcy case as of the petition date, i.e., the date the bankruptcy is filed. Therefore, debtors and trustees alike can struggle to finalize any exemption or transfer of crypto assets, as these coins could be worth little when the debtor files their petition but be worth more after the fact, and vice versa.

Cryptocurrency can notably cause problems in Chapter 7 bankruptcy cases when trustees liquidate debtors’ assets to repay creditors. It can also raise concerns in Chapter 11 and Chapter 13 bankruptcy cases when trustees establish repayment plans based on the value of the debtor’s non-exempt assets. If a debtor’s crypto holdings fluctuate in value, this could affect the increment amounts paid in the case’s reimbursement schedule. 

How is Cryptocurrency Categorized in Bankruptcy?

With an ambiguous use and value, cryptocurrency does not fall into one specific asset category. In fact, it possesses characteristics of various different assets. For example, cryptocurrency functions like cash, as users can exchange it for goods and services. However, its form of trade is more similar to that of stocks or bonds. At this point, the law is still unclear as to the classification of crypto assets.  

Ritter Spencer Cheng has a team of commercial bankruptcy attorneys in Dallas, Texas, who can help debtors navigate cryptocurrency in their bankruptcy cases. Our experienced attorneys develop effective and actionable strategies to help companies sort their assets, eliminate debts, and gain financial freedom. Learn more about our practice areas by connecting with our team of commercial bankruptcy attorneys at Ritter Spencer Cheng today.