Since April 2022, some crypto exchanges significantly reduced their staff, indicating that margins have been under pressure even for some of the biggest actors in the space. In May, the algorithmic stable coin of Terra (UST), with a market cap of USD 18 billion, lost its peg to the US dollar. Within a few weeks, its valuation dropped to nearly zero. The fall of Terra has left many investors, including established names such as Three Arrows Capital, with weakened balance sheets.
Since then, we've seen several crypto businesses limiting or completely halting withdrawals. In some instances, this has been followed by an insolvency procedure. Crypto platforms Voyager and Celsius both filed for Chapter 11 bankruptcy in New York in July, and there are likely to be more cases of stress and distress to come.
There are more than 600 crypto exchanges around the world, operating in a largely unregulated environment – many of these are small, lesser-known players, trading cryptocurrencies and offering margin loans to their clients, potentially as much as 20 times their initial capital. These players may be particularly vulnerable in the current environment.
Given the current lack of regulation and precedent in the market, the restructuring or insolvency of a crypto business raises several questions about how cryptoassets may be treated in a distressed scenario.
On 31 May 2022, HM Treasury launched a consultation on managing the failure of systemic digital settlement asset (including stablecoin) firms. The proposal is that systematically important cryptocurrency firms are included within a modified Financial Market Infrastructure Special Administration Regime. The consultation may bring more clarity, but until any subsequent changes are realised, the following issues and questions must be considered in any crypto restructuring.
The government's cryptocurrency consultation is open until 2 August 2022. There's no timeline for releasing results.
Cryptoassets have only recently been established as property under English law.
They should be viewed as an intangible asset - and restructuring and insolvency professionals already have both the expertise and tools to trace, secure, and distribute them. These might include disclosure orders and proprietary injunctions, as well as using forensic blockchain analytics.
The popular phrase ‘not your keys, not your coins’ refers to the fact that for cryptoassets, possession rather than ownership is key to control of the assets. Whoever possesses the private keys can move assets wherever they like. If cryptoassets are held offline on ‘cold wallets’, there's no central authority or bank to send you notice of appointment that can transfer or freeze cryptoassets to your own wallet. This differs from ‘hot wallets’ where cryptoassets are typically held with an exchange, which an administrator, liquidator, trustee could write to.
It's therefore crucial to engage experts that can help secure and look to re-key cryptoassets.
Once cryptoassets have been secured by an insolvency practitioner, the difficult question arises of how to accurately value and sell them – a challenging issue given the volatility of the market.
This was an issue that Grant Thornton New Zealand successfully dealt with when they were appointed to liquidate Cryptopia in 2019. Options to consider might include a series of auction sales or a distribution in specie. Our teams also worked with over-the-counter (OTC) traders to realise cryptocurrency assets into fiat currency to fund operational cashflow.
In crypto-lending it's common for one cryptocurrency to be used as collateral for a loan denominated in another cryptocurrency. This collateral may then need to be liquidated in the event of a default in the loan terms, or if the value of the collateral falls below a certain threshold. However, there are several outstanding questions which may cause issues when pursuing an enforcement of crypto-collateral, such as the registration and enforceability of security over cryptoassets in an insolvency. For example, registering the security would de-anonymise the parties to the transaction, which goes against one of the key tenets of cryptoassets.
English law generally doesn't permit a creditor to ‘foreclose’ on their security – meaning to take ownership of the secured asset in lieu of their debt. Instead, assets must be sold. The interpretation of this in the case of crypto-collateral needs to be carefully managed. It also raises questions about valuation. By law, a creditor enforcing security has a duty to get the best price reasonably obtainable. The volatility seen in cryptocurrency markets makes this hard and raises the question of whether a creditor is able to delay enforcement, hoping prices rise.
By its very nature, cryptocurrencies run on distributed ledger technology, and not located in any one jurisdiction. The precedents set by insolvent crypto exchanges around the world have shown the need for office holders and trustees to seek enforcement orders in various jurisdictions. When working on Cryptopia’s liquidation, the proceedings started in New Zealand but our Grant Thornton team had to file a petition in the bankruptcy court of the Southern district of New York in order to retrieve the company’s information.
In the absence of consistent cross border regulation, it's also possible that multiple jurisdictions could have contradictory judgements. As an example, if security hasn't been registered over cryptoassets in England, it may be invalid under English law, but a foreign court might still recognise the security's validity.
When dealing with a stressed or distressed crypto business, there is a need for immediate awareness of the distinctive risks that come with this unique type of asset which also requires a broad range of expertise.
We have in-house crypto investigators analysing blockchain data to trace transactions, monitor wallets, track the movements of illicit funds and identify asset holders using attribution technology to deanonymise entities. In combination with blockchain analytics, the application of corporate intelligence enables consideration of the widest range of recovery strategies by identifying real world assets.
We also have experience acting as court experts on analysing crypto holdings, initial coin offerings (ICOs) and digital assets such as non-fungible tokens (NFTs).
As liquidators on Cryptopia, in the absence of legal precedent in relation to the property rights on cryptocurrency, we obtained legal directions from the New Zealand courts. The decision in that case, that all cryptocurrency assets held by the Company in the control of the liquidators were held on trust for the benefit of account holders has been enshrined in case law (Ruscoe v Cryptopia).
Our restructuring and insolvency team brings together broad expertise in all disciplines any business would need when in distress: corporate restructuring, stakeholder management, contingency planning, recovery strategy, forensics and litigation. By nature, all crypto businesses have an international aspect to them and our network of independent assurance, tax and advisory firms is made up of over 58,000 people in over 140 markets. Together we have worked on some of the highest profile offshore cases.
In our experience, complex and international cases usually require external funding to be pursued. To support crypto businesses, we have set up a specific funding solution to support a plan for recovery in the context of fraud/investigations and litigations recovery.