Practical Pieces & Perspectives
In early 2009 the United States, along with the rest of the world, was facing the largest financial crisis capitalism had endured since the Great Depression. Later research uncovered that this crisis mostly occurred due to banking institutions, rating agencies, and insurers undervaluing the risk of debtor’s becoming insolvent when banks in effect became their creditors through their offering of new “structured asset-backed securities.”[1] As it turned out, the “assets” that backed these offerings were not as viable as the “Triple A” rating given to them made it seem.[2] The practical result of the crisis was that these banks, which stored the vast majority of American family’s financial resources, were at a risk of becoming insolvent themselves.[3] The same went for the insurers who insured these banks.[4] Faced without any viable alternative, the government was forced to use citizen tax dollars to bail the banks out of impending insolvency.[5] Eventually, financial markets mostly recovered. Looking back, it has been argued that it was the bankers’ fault for being too greedy, the government’s fault for having a lack of oversight, or even the American public’s fault for being uneducated when taking on these obligations. In practical matters, a combination of these factors caused the crisis.[6] The banks failed, and it was the American citizens who had to pay for their failure to save capitalism from collapsing.
Prior to the financial crisis of the late 2000s, the fact that banks were essentially an unknown third party which maintained control of an individual’s livelihood was largely ignored by most of the American public. This lack of acknowledgment likely stemmed in part from President Roosevelt’s response to the Great Depression, through his enactment of expanded government regulation over banks with the adoption of the Glass-Steagall Act, as well as the creation of the Federal Deposit Insurance Corporation (FDIC) as part of the “New Deal”. Yet, a select few remained wary.[7] For these wary individuals, the ability to viably conduct transactions free of third parties or government influence perhaps finally came to fruition in January of 2009.[8] Although it went mostly unnoticed at the time, a still to be identified individual solely known by the moniker Satoshi Nakamoto presented what some have since argued to be the first viable alternative to the banking system in the invention of the “Blockchain” and “Bitcoin”.[9] Eventually, with the post-crisis climate of increased suspicion of financial institutions hanging in backdrop, Nakamoto’s invention would garner the attention of the mainstream.
Blockchain operates as a public ledger in which “[u]sers willing to devote CPU power to running a special piece of software would be called miners and would form a network to maintain the block chain collectively.”[10] Embedded in this software are puzzles, so in maintaining the network, “computers running the software . . . compete to solve irreversibly cryptographic puzzles that contain data from several transactions.”[11] Once a computer completes the puzzle, it is rewarded a small amount of bitcoins, and “the associated block of transactions would be added to the chain.”[12] What this incentive based system for miners ultimately enables for Bitcoin transactions is that “the sender and the received are identified only by a string of numbers—but a public record of every coin’s movement is published across the network . . . Nakamoto’s code can prevent [a person] from spending the coin a second time.”[13] In sum, the creation of this software offered a solution to a common problem regarding digital currency: preventing the same digital currency from being spent in multiple transactions.[14]
Thus, in true ironic fashion, at the same time capitalism’s fate was being held at the brink, if one searched the deep pockets of the Internet they might have uncovered the first viable alternative to the banking system.
By 2017, hysteria over Bitcoin had entered the mainstream. In December of 2017, the value of one bitcoin reached, what remains a record high, over $19,000.[15] For reference, one bitcoin was valued at $780 in December of 2016.[16] Bitcoin may provide an advantage in having an algorithm, rather than humans subject to their own incentives, controlling an individual’s finances. However, its volatile nature, illustrated by these vast shifts in value, has provided an array of concerns.
The idea behind Bitcoin is that there are only a finite amount of bitcoins that can be mined up to its cap, which is thought to be somewhere in the range of twenty-one million.[17] As more individuals buy bitcoin, the value of one bitcoin will continue to rise, and more will be created until the cap is reached.[18] Thus, by its nature, purchasing bitcoin is a gamble. On the extremes, bitcoin could eventually replace the dollar, making early adopters very rich; or it could be completely outlawed by government regulation, rendering it valueless. In turn, bitcoin’s value is heavily tied to whether in current circulation there is positive or negative press on its future regarding any indication of potential government regulation.[19]
For our system of bankruptcy laws and governance, the volatility of cryptocurrencies such as Bitcoin present an interesting set of concerns. Since the enactment of the Bankruptcy Act of 1898, United States bankruptcy law has generally been considered to have been crafted in consideration of “facilitating the equitable and efficient administration and distribution of the debtor’s property to creditors.”[20] However, this facilitation becomes more difficult to conduct when the debtor’s property value fluctuates throughout the proceedings. As illustrated above, perhaps the most identifiable characteristic of Bitcoin is its sporadic fluctuation. Bitcoin and bankruptcy are thus at odds with one another. This friction between the two came into focus through the bankruptcy proceedings of Mt. Gox, which was formerly one of the largest bitcoin exchanges.[21] Mt. Gox’s case additionally provided for more irony, although individuals chose to invest in bitcoin instead of banks Mt. Gox found itself bankrupt due in large part to consistent security breaches.[22]
This article will begin by examining the Japanese bankruptcy proceedings regarding Mt. Gox and how the volatile nature of Bitcoin came into dispute during these proceedings. It will then examine how, thus far, United States courts have defined cryptocurrencies in other contexts. Subsequently, this article will conclude with a recommendation for how cryptocurrencies should be defined under the United States Bankruptcy Code in light of the most equitable resolution for all concerned parties. For the purposes of this article, the issue of valuing cryptocurrencies will solely be analyzed in the context of unsecured claims in bankruptcy.
Mt. Gox is a unique case because Mt. Gox itself is a cryptocurrency exchange and thus most of its assets are cryptocurrencies. Yet, it is illustrative of how the volatility of cryptocurrencies can make a large impact in a bankruptcy proceeding.
Mt. Gox’s trouble began on June 19, 2011, when it lost approximately $8,750.00 due to its first of many security breaches.[23] Despite this first breach, which should have placed Mt. Gox on notice, Mt. Gox continued to fail to adequately take measures to ensure its security. As a result, it consistently faced further breaches until ultimately filing for bankruptcy protection. It was eventually discovered that hackers “stole 744,408 bitcoins belonging to the exchange’s customers, as well as an additional 100,000 bitcoins belonging to the company itself.”[24] Additionally, beginning in April 2013, Mt. Gox began facing new issues because it was ill-equipped to handle the random nature of spikes in bitcoin transactions on its platform.[25] This led to numerous users attempting to withdraw from the platform out of frustration with Mt. Gox’s service.[26] On top of all of this, (in perhaps a final blow to any hope for its future), on May 2, 2013, Mt. Gox was served with a $75 million lawsuit for breach of contract with one of its partners, CoinLab.[27]
In February of 2014, Mt. Gox filed for bankruptcy liquidation in Japanese court.[28] Mt. Gox then subsequently filed for United States bankruptcy on March 9, 2014, in an effort to stay legal actions from its U.S. customers.[29] The Tokyo District Court originally held that Mt. Gox’s “distributions would be based upon the value of customers’ claims as of the date Mt. Gox filed for bankruptcy relief.”[30] This was a critical decision, although it would not be fully appreciated until Bitcoin hysteria took hold of the public a few years later. Instead, at the time the larger concern was whether Mt. Gox should be restructured or liquidated, as it was thought that liquidation meant “those with substantial investments are likely to get less of their money back.”[31] Importantly, as of March 10, 2014, one bitcoin was only valued at $630.78.[32] As a reminder, in December 2017, the value of one bitcoin soared to a record high of $19,000.[33] As of November 8, 2018, one bitcoin was valued at $6,422.69.[34]
For Mt. Gox’s creditors, the sudden increase in the value of bitcoin that would come in the late 2010’s completely changed the game. Mt. Gox still owned a substantial amount of bitcoins while the proceedings were ongoing, and suddenly the pot of assets available to them to recoup their investment substantially ballooned.[35] Yet, creditors still had the issue of being bound by the Tokyo District Court’s previous judgment that the value of the Bitcoin was determined as of the date Mt. Gox originally filed for bankruptcy relief.[36] Understandably, they were furious and repeatedly pushed the Tokyo District Court to suspend bankruptcy proceeds and allow instead the “commencement of civil rehabilitation.”[37] Finally in June 2018, their wishes were granted by the Tokyo District Court and Mt. Gox’s bankruptcy was suspended.[38]
Thus far, U.S. bankruptcy courts have punted on the issue of defining how to value cryptocurrencies under the Bankruptcy Code. The United States Bankruptcy Court for the Northern District of California was presented with the issue head on.[39] Yet, the Court sidestepped the issue and held instead that it does “not need to decide whether bitcoin are currency or commodities for purposes of the fraudulent transfer provisions of the bankruptcy code. Rather, it is sufficient to determine that . . . bitcoin[s] are not United States dollars.”[40] Here, the Court elected to not decide the issue unless the liquidating trustee prevailed in holding onto the bitcoin after other proceedings. Only then, “the court will decide whether, under 11 U.S.C § 550(a), he may recover the bitcoin (property) transferred or their value, and if the latter, valued as of what date.”[41]
Recently, in their article “Crypto as Commodity, and the Bankruptcy Implications”, Joanne Lee Molinaro and Susan Poll Klaessy highlighted the critical distinction alluded to by the Court in In Re Hashfast that bankruptcy courts will have to make.[42] That is, in deciding whether cryptocurrencies are a currency or a commodity.[43] As Molinaro and Klaessy point out, if bankruptcy courts conclude cryptocurrencies are currency, then seemingly they “would be valued on the date of the . . . filing, with the amount denominated in the prevailing (fiat) currency.”[44] If, however, cryptocurrencies are determined to be commodities under the Bankruptcy Code, “[t]he return of bitcoin . . . will likely be favored . . . . However, if the mere return of bitcoin is not feasible (for example, if they are stolen as was the case of Mt. Gox), the protocol for valuation becomes critical.”[45] This valuation would likely be governed then by Section 503(b)(9) of the Bankruptcy Code, which states commodity valuation is “based on the price at which it could be purchased during the relevant period on the commodity market.”[46] Thus, if bankruptcy courts determine cryptocurrencies are commodities, trustees would likely prevail in recouping the increase of value in bitcoin if this occurs during the proceedings.[47]
As of October 2018, at least one District Court has concluded that cryptocurrencies are commodities under the context of the Commodity Exchange Act.[48] For example, in CFTC v. My Big Coin Pay, Inc., the Court found that the relevant language defining ‘commodity’ within the CEA was whether virtual currencies fell within the scope of “all other goods and articles . . . and all services rights and interests . . . in which contracts for future delivery are presently or in the future dealt in.”[49] The Court further noted that the nature of Bitcoin futures trading on exchanges necessitated “future delivery of virtual currencies.”[50] As a result, it was satisfied that the requirement of “contracts for future delivery” to be “dealt in” applied to Bitcoin.[51] Consequently, the Court concluded that it was at least sufficient to plead that Bitcoin was a commodity under the CEA.[52]
Following this decision, it is unclear whether bankruptcy courts will be persuaded that Bitcoin is a commodity in the context of a bankruptcy proceeding. However, it is inevitable that bankruptcy courts will not be able to punt on deciding this issue for much longer. Eventually, an American corporation holding a significant amount of cryptocurrency as assets will be forced into a protracted bankruptcy during which the value of bitcoin or another cryptocurrency will either skyrocket or plummet. Moreover, the pool of American citizens and small businesses owning cryptocurrencies as assets continues to consistently grow. By virtue of these impending circumstances, the need for a determination by bankruptcy courts will only continue to intensify.
So then, how should Bitcoin be defined by bankruptcy courts? Is Bitcoin more like currency, i.e U.S. dollars, or is it more like a commodity engaging in futures trading? And subsequently, under the twin aims of the Bankruptcy Code of allowing creditors to get paid and debtors a fresh start, what is the most equitable resolution?
Thus far, the discussion concerning whether Bitcoin is a commodity or a currency has ignored three important facts. First, Bitcoin, in contrast with commodities such as securities or oil futures etc., can be used to purchase goods like a currency.[53] Second, the value of a currency is not static over time. Currencies are subject to deflation, inflation and other market forces. For instance, since Bitcoin was created in 2009, the value of the U.S. dollar has inflated by a rate of 17.7%.[54] In the past year alone, the value of the U.S. dollar has inflated 3%.[55] Thus, bitcoin’s value fluctuation is not all that different in kind to what a currency may undergo. Additionally, due to Bitcoin’s decentralized nature, debtors have no way of predicting whether its value will rise or fall throughout a proceeding. Conversely, entire businesses are based upon predicting the future value of commodities.
On this latter point, it is important to note that bankruptcy is not solely concerned with allowing creditors to receive all of their investment back. Bankruptcy also considers debtors’ ability to have a “fresh start” in being able to continue onwards with their lives after discharging debts. Without this balance, reorganization plans would be unable to function. Debtors would have no incentive to earn money if it would all be given to creditors regardless. Moreover, the ability of a debtor making an accurate prediction for when a substantial spike in bitcoin value will take place roughly equates the odds of one winning a bet on which properties would be spared if a tornado were to suddenly descend upon a town. Holding a debtor hostage to a future increase in the value of bitcoin which they could not have reasonably predicted would not only be unfair to the debtor but could also severely harm their ability to have a fresh start after liquidation has concluded. Furthermore, in a reorganization context, allowing for an increase in the value of bitcoin to be considered would likely help the creditors at the top of the pecking order but subsequently harm not only the debtor but all the other creditors who are relying on a successful reorganization to occur.
Conversely, in the context of commodities, a debtor may have knowledge that the value of a particular commodity, such as a company’s stock or an oil future, will rise in the near future. In fact, a debtor may file for bankruptcy based on this very knowledge. Yet, the worry for manipulation in a bitcoin context is substantially less because it is maintained by a decentralized algorithm which cannot be pried for information. Government officials charged with the regulation of cryptocurrencies and perhaps the largest crypto exchanges who may be privy to a spike in users would seemingly be the select few who could predict an increase in value. If one of these individuals or corporations file for bankruptcy immediately prior to the value of bitcoin or another cryptocurrency soaring, creditors and courts alike should be immediately alarmed. Furthermore, the Bankruptcy code specifically accounts for misrepresentation and fraud in sections 523(a).[56] If a debtor is proven to have acted in bad faith in one of these manners, the debt will not be discharged. Creditors would be free to pursue civil remedies outside of bankruptcy to fully recover the amount of debt. In fact, if Mt. Gox had filed for bankruptcy in the United States, creditors would have likely pursued this option.
This is not to say that the Court in CFTC v. My Big Coin Pay, Inc. was wrong in concluding that it was sufficient to plead that bitcoin was a currency under the Commodity Exchange Act.[57] But, this is an entirely different context. The Court was considering whether Bitcoin could be considered a commodity under the Commodity Exchange Act; not that it was more like a commodity than a currency.[58] Moreover, the Court did not affirmatively decide that Bitcoin was a commodity under the CEA.[59] It solely held that it might be considered a commodity and that this was enough to survive a summary judgment motion by the Defendant.[60] Critically, the Court did not have to weigh the equities evoked in a Bankruptcy proceeding in reaching its decision. Bankruptcy courts would thus be ill-advised in analogizing to this case in making their determination for how a cryptocurrency should be defined in bankruptcy.
At first glance, the fact that Bitcoin and other cryptocurrencies are presented on a live exchange may lend to an inherent assumption that they are analogous to securities by nature. However, upon further examination, a different view comes into focus when the actual characteristics of Bitcoin and other cryptocurrencies are considered, in that unlike securities or futures they can be used to purchase goods.[61] And, more significantly to the balancing of equities invoked between debtors and creditors in a bankruptcy proceeding, their decentralized nature makes it virtually impossible for a debtor to accurately predict future value and in turn manipulate the bankruptcy system. Thus, upon weighing the equities, bankruptcy courts should conclude that Bitcoin and other cryptocurrencies are to be considered currency under the law.
[1] Michael Lewis, The Big Short: Inside the Doomsday Machine (2010).
[2] Id.
[3] Andrew Ross Sorkin, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves, (2009).
[4] Id.
[5] Id.
[6] Lewis, supra note 1.
[7] Joshuah Bearman and Steven Leckart, The Untold Story of Silk Road, Part 1, Wired (Apr. 2015), https://www.wired.com/2015/04/silk-road-1/.
[8] Nick Bilton, American Kingpin: The Epic Hunt for the Criminal Mastermind Behind the Silk Road, (2017).
[9] Joshua Davis, THE CRYPTO-CURRENCY: Bitcoin and its Mysterious Inventor., the New Yorker, (Oct. 10. 2011), https://www.newyorker.com/magazine/2011/10/10/the-crypto-currency.
[10] Benjamin Wallace, THE RISE AND FALL OF BITCOIN, Wired, (Nov. 23, 2011), https://www.wired.com/2011/11/mf-bitcoin/.
[11] Id.
[12] Id.
[13] Davis, supra note 9.
[14] Id.
[15] Bitcoin (USD) Price, Coindesk, www.coindesk.com/price/.
[16] Id.
[17] Davis, supra note 9.
[18] Id.
[19] Aaron Mak, Bitcoin Had a Strange Week. Does it Matter?, Slate, (Jan. 19, 2018), https://slate.com/technology/2018/01/bitcoin-had-a-strange-week-does-it-matter.html.
[20] Charles Jordan Tabb, The History of the Bankruptcy Laws in the United States, 3 Am. Inst. L. Rev. 5, 25 (1995).
[21] Coinlab Inc. v. Mt Gox KK, 513 B.R. 575 (W.D. Wash 2014).
[22] Yoshifumi Takemoto and Sophie Knight, Mt. Gox Files for Bankruptcy, Hit with Lawsuit, Reuters, (Feb. 24 2014), https://www.reuters.com/article/us-bitcoin-mtgox-bankruptcy/mt-gox-files-for-bankruptcy-hit-with-lawsuit-idUSBREA1R0FX20140228.
[23] Jason Mick, Inside the Mega-Hack of Bitcoin: the Full Story, DailyTech, (June 19, 2011), https://www.scrib.com/document/166277990/DailyTech-Inside-the-Mega-Hack-of-Bitcoin-the-Full-Story-pdf.
[24] Joanne Lee Molinaro and Susan Poll Klaessy, Crypto as Commodity, and the Bankruptcy Implications, Law360, (Oct. 17, 2018), https://www.law360.com/articles/1093091/crypto-as-commodity-and-the-bankruptcy-implications.
[25] Sam Byford, ‘Mt. Gox, Where is Our Money?!’, The Verge, (Feb. 19, 2014), https://www.theverge.com/2014/2/19/5425220/protest-at-mt-gox-bitcoin-exchange-in-tokyo.
[26] Matt Clinch, Bitcoin Investor Fury at Mt Gox Delays, Cnbc, (Feb. 20, 2014), https://www.cnbc.com/2014/02/20/bitcoin-investor-fury-at-mt-gox-delays.html.
[27] Coinlab Inc. v. Mt Gox KK, 513 B.R. 575 (W.D. Wash 2014).
[28] Id.
[29] Id.
[30] Molinaro and Klassey, supra note 25.
[31] Sam Byford, Mt. Gox Abandons Rebuilding Plans and Files for Liquidation: WSJ, The Verge, (Apr. 16, 2014), https://www.theverge.com/2014/4/16/5619636/mt-gox-asks-for-permission-to-liquidate.
[32] Bitcoin (USD) Price, Coindesk, www.coindesk.com/price/.
[33] Id.
[34] Id.
[35] Molinaro and Klassey, supra note 25.
[36] Id.
[37] Id.
[38] Id.
[39] In re Hashfast Technologoies LLC v. Marc A. Lowe, No.14-30725DM, 2016 WL 8460756 (Bankr. N.D. Cal. Feb 19, 2016) (order on motion for partial summary judgment).
[40] Id.
[41] Id. at *2.
[42] Molinaro and Klassey, supra note 25.
[43] Id.
[44] Id.
[45] Id.
[46] Id.
[47] Id.
[48] CFTC v. My Big Coin Pay, Inc., No. 18-10077-RWZ, 2018 U.S. Dist. LEXIS 164932 (D. Mass. Sep. 26, 2018).
[49] Id. at *7.
[50] Id. at *8.
[51] Id.
[52] Id.
[53] Yoni Blumberg, Here’s How You Can—and Can’t—Spend Bitcoin, Cnbc, (Dec. 7, 2017), https://www.cnbc.com/2017/12/07/heres-how-you-can-and-cant-spend-bitcoin.html.
[54] US Inflation Calculator, Coin News Media Group LLC, https://www.usinflationcalculator.com.
[55] Id.
[56] 11 U.S.C. § 523 (2018).
[57] CFTC v. My Big Coin Pay, Inc., No. 18-10077-RWZ, 2018 U.S. Dist. LEXIS 164932 (D. Mass. Sep. 26, 2018).
[58] Id.
[59] Id.
[60] Id.
[61] Blumberg, supra note 54.