March 2023

Crypto Chapter 11 Proceedings

The prolonged cryptocurrency market turmoil has triggered several high-profile bankruptcies, and more filings are anticipated. Market participants therefore must understand the key issues that may arise in crypto Chapter 11 proceedings.

Partner at McDermott Will & Emery LLP
Partner at McDermott Will & Emery LLP

With the onset of major distress in the crypto market, referred to as the “crypto winter,” crypto and digital asset exchanges and yield-earning platforms (collectively, crypto platforms) have begun to appear as debtors in US bankruptcy proceedings. A handful of bankruptcy proceedings under Chapter 11 and Chapter 15 of the Bankruptcy Code have involved crypto platforms, investment firms, and funds. Distress in the crypto market is likely to lead to more crypto bankruptcies following the filings of Voyager Digital Holdings, Inc. (Voyager) and Celsius Network LLC (Celsius) in July 2022, FTX Trading Ltd. (FTX) and BlockFi Inc. (BlockFi) in November 2022, and Genesis Global Holdco, LLC (Genesis) in January 2023 (for more on these and other key crypto bankruptcies, see Cryptocurrency Lenders File for Chapter 11 Bankruptcy Protection and Bankruptcy: Cryptocurrency Case Tracker on Practical Law and see The FTX Bankruptcy: What Parties Can Expect in the January 2023 issue of The Journal).

This article provides an overview of key issues that may arise in these bankruptcy proceedings. In particular, it discusses:

  • How crypto platforms generally function.
  • Insolvency risks for crypto lending platforms.
  • Whether a crypto platform is eligible to be a debtor in bankruptcy.
  • Whether customers’ digital assets are property of a crypto platform’s bankruptcy estate.
  • Confirmation considerations for a Chapter 11 plan of reorganization (Chapter 11 plan).

(For information on new developments in crypto and digital assets, see HOTPAGE: Crypto & Digital Assets on Practical Law.)

Crypto Platforms Explained

Crypto platforms provide a marketplace for parties to buy, sell, hold, trade, lend, and invest in crypto. Crypto platforms can be custodial (meaning that the platform has control over customers’ crypto) (see Crypto Assets Held in Custody or in Trust below) or non-custodial (where a customer controls their crypto and holds the key to the e-wallet containing their crypto) (see Non-Custodial Accounts below). Custodial crypto platforms may commingle customer holdings in a single crypto e-wallet controlled by the platform (see Customer Account Terms of Service below). (For a collection of resources on crypto and digital assets, see Crypto Toolkit on Practical Law.)

Crypto Ownership

Crypto transfers and transactions take place on a blockchain. Blockchains are often designed so that there is no record of the identity of crypto owners or the persons behind the transactions. Crypto transacted on a blockchain moves from e-wallet to e-wallet, and ownership of an e-wallet is determined by whoever holds the private key. Consequently, the owner of crypto within an e-wallet is the holder of the private key.

Crypto Lending Models

Crypto lending has become one of the most popular applications of crypto and blockchain technology. Crypto lending allows borrowers to secure financing by posting crypto as collateral. (For more on the basics of lending and borrowing in crypto markets, see Practice Point: Crypto Finance on Practical Law.) The two primary crypto lending models are the centralized finance (CeFi) lending model and the decentralized finance (DeFi) lending model.

CeFi Lending Model

In a CeFi model, the crypto platform acting as a lender retains custody of the borrower’s crypto collateral and helps the disbursement of a fiat (US dollar or other cash) loan to the borrower. The lender remains responsible for managing the crypto collateral. If the borrower fails to make an interest payment or if the value of the collateral decreases and the borrower fails to provide the additional required collateral in response to a margin call from the crypto lender, then the lender may liquidate the collateral and terminate the loan. Examples of CeFi crypto lenders include BlockFi, Celsius, Voyager, and Nexo.

DeFi Lending Model

Under a DeFi model, the crypto loan is fully automated using smart contracts on the blockchain. The borrower’s crypto collateral is held in an e-wallet that can be accessed by a smart contract. If certain conditions are met, the smart contract automatically triggers events such as:

  • A loan fund disbursement.
  • A repayment receipt.
  • A liquidation of collateral if the value of collateral decreases below a predetermined level.
  • A release of borrower collateral back to the borrower.

Examples of DeFi lending platforms include Compound and Aave. (For more information, see Decentralized Finance (DeFi): Overview on Practical Law.)

Crypto Regulation

Although there is no comprehensive crypto regulation in the US, there is a patchwork of state laws and regulations. For example, New York and Wyoming have enacted crypto regulatory regimes. These laws generally remain applicable in a bankruptcy proceeding except when the Bankruptcy Code preempts them (28 U.S.C. § 959(b)). Therefore, a crypto platform debtor must manage and operate property in its possession according to the requirements of the laws of the state in which the property is located. (For more on the regulation of crypto and other digital assets, see Cryptocurrency and Virtual Currency Regulatory Tracker on Practical Law.)

Although there is no comprehensive crypto regulation in the US, there is a patchwork of state laws and regulations. These laws generally remain applicable in a bankruptcy proceeding except when the Bankruptcy Code preempts them.

Key Insolvency Risks for Crypto Lending Platforms

Crypto lending models involve certain risks that are not inherent in traditional finance, such as:

  • Price volatility in crypto markets. In a downturn, where crypto valuations depreciate, CeFi crypto lending platforms issue margin calls for additional collateral to cover their exposure from the reduction in value of the crypto collateral they hold. For example, these circumstances contributed to Voyager’s Chapter 11 filing, the first by a crypto platform (see Decl. of Stephen Ehrlich, Chief Exec. Officer of the Debtors, in Support of Chapter 11 Pets. and First Day Mots., In re Voyager Dig. Holdings, Inc., Case No. 22-10943, Dkt. No. 15 (Bankr. S.D.N.Y. July 6, 2022)). Similarly, sudden crypto market downturns may trigger automatic collateral liquidation within DeFi lending platforms, which protects the DeFi platform but poses risk to the borrower.
  • Contagion. Crypto platforms are not insured by the Federal Deposit Insurance Corporation (FDIC) (for information on the FDIC’s advisory that Voyager and the funds it holds are not FDIC insured, see FDIC Issues Advisory to Insured Institutions and FDIC and FRB Issue Letter to Voyager Digital Regarding Misrepresentations on Deposit Insurance for Digital Assets on Practical Law and see Banking Institution Exclusion below). The FDIC requires traditional banks to maintain certain levels of capital and liquidity. However, if a significant percentage of borrowers were to default on their crypto loans, a crypto lending platform could find itself with insufficient liquidity to continue to operate and to return borrower collateral. The failure of a major crypto lending platform could send ripples across crypto markets. For example, many crypto lenders, including Celsius, Voyager, and Genesis, loaned crypto to fund Three Arrows Capital Ltd., which subsequently defaulted on the loans. Similarly, BlockFi loaned crypto to FTX, which defaulted on its loans. This caused a domino effect because these lenders were then unable to meet obligations to their customers.
  • Cybersecurity gaps. An ongoing risk for crypto platforms is cybersecurity. In DeFi platforms, cybersecurity hacks, human coding error, or lax security can create vulnerabilities in underlying smart contract protocols (for more on DeFi cybersecurity and data privacy vulnerabilities, see Decentralized Finance (DeFi): Overview on Practical Law). Data breaches and ransomware can create a major risk for CeFi platforms as well. However, cybersecurity risk assessments, audits, and cyber insurance can reduce these risks. (For more information, see Cybersecurity in Bankruptcy on Practical Law.)
  • Lack of clarity regarding legal status. Certain countries (such as El Salvador and the Central African Republic) consider cryptocurrencies to be a form of money or a financial instrument. However, the legal status of cryptocurrencies as a form of property and how to determine legal ownership of crypto are unclear. Cryptocurrencies may be classified as general intangibles or investment property under the Uniform Commercial Code (UCC), but they are different from the property that financial institutions are used to dealing with in the ordinary course of business. This uncertainty creates risk about how crypto that crypto platforms hold will be treated in bankruptcy (see Scope of Property of the Estate below).

Eligibility of a Crypto Platform to File for Chapter 11

Under section 109(a) of the Bankruptcy Code, only a person that resides or has a domicile, a place of business, or property in the US on the petition date is eligible to be a debtor under Title 11. This requirement applies across all chapters of the Bankruptcy Code, including Chapter 15 (see In re Barnet, 737 F.3d 238, 247 (2d Cir. 2013); for more information, see In re Barnet: Second Circuit Applies Debtor Eligibility Requirements to Chapter 15 Cases on Practical Law).

Chapter 11 relief is available to most corporations, partnerships, and limited liability companies, which likely includes most crypto platforms. Chapter 11 relief is not available to:

There is no requirement that a debtor be insolvent to file for Chapter 11 protection. The only requirement for filing a voluntary petition under Chapter 11 is that the debtor seeks relief from its creditors in good faith. (For more on Chapter 11 eligibility, see Bankruptcy: Overview on Practical Law; for information on venue in corporate bankruptcy proceedings, see Venue in Bankruptcy Proceedings on Practical Law.)

Banking Institution Exclusion

While an argument can be made that certain crypto platforms function similarly to banks, it is unlikely that a crypto platform would be treated as a banking institution or financial institution subject to the exclusions under section 109(b) of the Bankruptcy Code. The FDIC has issued many letters specifying that it does not insure crypto platforms (for more information, see FDIC Issues Advisory to Insured Institutions and FDIC and FRB Issue Letter to Voyager Digital Regarding Misrepresentations on Deposit Insurance for Digital Assets on Practical Law). The FDIC letters make it clear that crypto platforms are not FDIC insured and are non-bank entities.

Stockbroker and Commodity Broker Exclusions

A crypto platform that qualifies as a stockbroker or commodity broker under the Bankruptcy Code is not eligible for Chapter 11 relief but instead must file under Chapter 7. Whether a particular crypto platform might qualify as a stockbroker or commodity broker under the Bankruptcy Code is unclear and depends on how the Bankruptcy Code applies the definitions of these terms.

The Bankruptcy Code defines “stockbroker” as a person “with respect to which there is a customer … and that is engaged in the business of effecting transactions in securities for the account of others or with members of the general public, from or for such person’s own account” (11 U.S.C. § 101(53A)). The Bankruptcy Code defines “commodity broker” as a “futures commission merchant, foreign futures commission merchant, clearing organization, leverage transaction merchant, or commodity options dealer … with respect to which there is a customer” (11 U.S.C. § 101(6)). (For more on stockbroker and commodity broker liquidations, see Broker-Dealer Insolvencies Under the Bankruptcy Code and SIPA on Practical Law.)

The Securities and Exchange Commission (SEC) has not issued any binding guidance on whether crypto assets qualify as securities. This unresolved question is the subject of pending legislation and court cases (see, for example, Lummis-Gillibrand Responsible Financial Innovation Act, S. 4356, 117th Cong. (2022) and Pl. SEC’s Mem. of Law in Supp. of its Mot. for Summ. J., SEC v. Ripple Labs, Inc., 2022 WL 16960937 (S.D.N.Y. Sept. 13, 2022)). (For more on the pending legislation and its implications for crypto asset exchange bankruptcies, see Crypto Chapter 11 Proceedings: Overview on Practical Law; for more on the regulation of crypto assets and digital asset securities, see SEC Regulation of Digital Assets on Practical Law.)

The SEC has not issued any binding guidance on whether crypto assets qualify as securities. This unresolved question is the subject of pending legislation and court cases.

Scope of Property of the Estate

Section 541(a) of the Bankruptcy Code defines the scope of property of the estate, which broadly includes all legal or equitable interests of the debtor in tangible and intangible property, wherever located and by whomever held, as of the filing of a bankruptcy case, subject to limited exceptions (for more information, see Property of the Estate: Overview on Practical Law). Whether customer crypto that a bankrupt platform holds is property of the estate depends on how the crypto is held.

Custodial accounts are usually held for the benefit of the customer, but this does not necessarily create a trust relationship in favor of the customer (see Crypto Assets Held in Custody or in Trust below). The amount and value of a customer’s crypto is reflected in the customer’s hosted e-wallet on the platform. However, the platform may have commingled the crypto asset with a common pool of assets, which could include the platform’s own assets and the assets of other customers. The platform’s terms of service generally govern these accounts (see Customer Account Terms of Service below).

Non-custodial accounts vary in structure, which creates doubt about their treatment in bankruptcy (see Non-Custodial Accounts below).

Unlike traditional bank accounts or brokerage accounts, crypto assets are not backstopped or guaranteed by any governmental or other agency, such as the FDIC or the Securities Investor Protection Corporation. If a crypto platform files for Chapter 11 bankruptcy protection and its customers’ assets are held in commingled accounts at the platform level, a court is likely to deem these assets property of the bankruptcy estate (see Crypto Assets Held in Custody or in Trust below). Customers of the bankrupt platform would hold general unsecured claims against the estate of the bankrupt platform for the value of their crypto assets that the platform held at the time of its filing, but they would not have the protections afforded traditional investment or bank account holders.

However, the UCC recognizes that if the arrangement between the platform and its customers is characterized as custodial, the crypto assets that the platform holds should be distributed to satisfy customer claims (UCC Articles 8 and 12).

Crypto Assets Held in Custody or in Trust

A crypto platform customer’s crypto holdings may not be part of the bankruptcy estate if the crypto platform has entered into either:

  • An express trust agreement with a customer naming the customer as beneficiary.
  • A custody agreement providing for a separate, identifiable account for the customer, rather than the terms of service or user agreement that permit the platform to control and use the customer’s crypto.

Beneficial interest in custodial trust assets remains with the trust beneficiaries, precluding distribution of the assets to creditors. By contrast, if a crypto platform’s customers are not direct beneficiaries of trust or custody agreements with the platform, their account holdings likely fall under section 541 of the Bankruptcy Code’s broad definition of property of the estate (see Customer Account Terms of Service below).

Express Trusts

An express trust may be direct or intermediate. In a direct trust, funds are placed in trust for individual customers of a platform. In an intermediate trust, the funds are placed in trust for the platform, which is the trust beneficiary.

With a direct trust, the interest of the bankrupt crypto platform in the customer’s crypto would be limited to legal title (11 U.S.C. § 541(d)), and the estate must return the crypto assets to the platform’s customers, as beneficial owners. Customers could still face liquidity disruption if required to obtain a court order authorizing the transfer of the assets from the platform to them. In cases where there is a third-party custodian, the legal and beneficial title to the crypto assets remains outside of the estate.

Platform customer user agreements typically do not provide for the creation of an express trust. Therefore, an express trust is uncommon for most individual crypto platform customer accounts (see Customer Account Terms of Service below). However, certain institutional investors may have express direct trust agreements with platform custodians. These trust agreements are created by bilateral contracts rather than user agreements.

In In re Voyager Digital Holdings, Inc., the bankruptcy court granted the debtors’ unopposed motion to permit customer withdrawals of funds held in “for benefit of” (FBO) accounts at a third-party bank. The court ruled that the funds held in the FBO accounts were not property of the Voyager bankruptcy estate because the “Debtors do not have either legal title or equitable interests to the funds in the FBO accounts.” (2022 WL 3146796, at *2-3 (Bankr. S.D.N.Y. Aug. 5, 2022).)

If a crypto platform’s customers are not direct beneficiaries of trust or custody agreements with the platform, their account holdings likely fall under section 541 of the Bankruptcy Code’s broad definition of property of the estate.

The court further found that the “Debtors had administrative rights to direct cash movements, but that is all.” The court cautioned that its decision was based on the facts and arguments presented without opposition from competing creditors. Therefore, it “is not intended to be a ruling as to the rights that customers might have in cryptocurrency cases generally, or as a ruling on any issues that competing creditors might raise in other cases.” (2022 WL 3146796, at *3.)

In In re Celsius Network LLC, an ad hoc group of Celsius customers brought an adversary proceeding seeking a declaratory judgment that funds the debtor held in individual custodial accounts were not property of the estate (see Compl. for Declaratory J., Case No. 22-10964, Dkt. No. 662 (Bankr. S.D.N.Y. Aug. 31, 2022)).

A constructive trust is a judicially created implied trust. It is a remedy used when a party has been unjustly enriched by acquiring title to identifiable property at the expense of another or in violation of another’s rights. Whether a constructive trust exists in a particular case is a matter of state law. No court has yet to issue a ruling creating a constructive trust under state law involving crypto-asset customer holdings.


A bailment is a delivery of property from one person to another for a specific purpose under a contract providing that the property will be returned when that purpose has been accomplished or the bailor returns the property. When platforms transfer custodial customer account holdings into e-wallets that also hold other customers’ holdings, the assets become commingled. This commingling of custodial assets complicates the question of whether the transfer can be considered a bailment or a sale. Typically, when the commingled assets are money, courts have held that the commingling of customer funds defeats a bailment and creates a sale (see In re Bernard L. Madoff Inv. Sec. LLC, 721 F.3d 54, 73 (2d Cir. 2013); Hossain v. Rauscher Pierce Refsnes, Inc., 15 F. App’x 745, 748 (10th Cir. 2001)).

Wyoming’s special purpose depository institution system appears to ensure that custodial holdings are treated as bailments rather than as property of the estate. (Wyo. Stat. Ann. §§ 13-12-101 to 13-12-126.)

Customer Account Terms of Service

A crypto platform’s terms of service or user agreement often includes language stating that although the crypto assets are being held for the customer’s benefit:

  • The assets are not segregated.
  • The platform has no obligation to segregate an individual customer’s crypto assets from other customers’ assets or from the platform’s assets.
  • The platform has the right to move, lend, stake, or otherwise use the customer’s assets.

The terms of service may also indicate that the platform maintains control over the private keys associated with the e-wallet addresses holding customer assets.

In In re Celsius Network LLC, the bankruptcy court found that terms of service governing approximately 600,000 accounts in the crypto platform debtors’ interest-bearing Earn program created valid and binding contracts between the debtors and account holders. The court ruled that these contracts unambiguously transferred title of the approximately $4.2 billion in crypto assets deposited into Earn accounts from accounts holders to the debtors. Based on this finding, the court authorized the debtors to sell stablecoins valued at $23 million (as of September 2022) outside of the ordinary course of business under section 363(b) of the Bankruptcy Code to provide liquidity for the Chapter 11 proceedings.

The court also noted that because the debtors owned the crypto assets in the Earn accounts, the account holders were unsecured creditors whose recovery would depend on the distributions to unsecured creditors under a confirmed Chapter 11 plan, or under the Bankruptcy Code’s priority rules in the event of liquidation. (In re Celsius Network LLC, 2023 WL 34106, at *2, *13-19, *21 (Bankr. S.D.N.Y. Jan. 4, 2023).).

This decision is not binding on courts in other crypto cases and may be distinguishable from other cases based on differences in the particular terms of service or allegations of fraud, misrepresentations, or other criminal activity. However, courts will certainly consider it precedent.

Commingling of Crypto Assets

Even if a crypto platform acknowledges that customers have title and some form of control over the assets in their accounts, the platform itself has a possessory right to the assets and the right to move, pool, and even use the assets under the terms of service to which its customers have agreed (see Customer Account Terms of Service above). If a platform has access to a customer’s assets and at any point commingles those assets with other assets, a customer asserting a trust relationship must trace the assets to recover them.

When funds are commingled, a claimant does not have rights in the funds unless the claimant both:

  • Demonstrates that the trust relationship and its legal source exist.
  • Identifies and traces the trust funds that have been commingled. (See In re Columbia Gas Sys. Inc., 997 F.2d 1039, 1063 (3d Cir.1993).)

Non-Custodial Accounts

Crypto platforms often offer non-custodial wallet options. Assets in non-custodial wallets are segregated, and only the customer has access to the wallet and control over the assets it contains. Customers are free to move assets from custodial wallets to non-custodial wallets outside of the platform, including:

  • Hot wallets, which are connected to the internet.
  • Cold wallets, which are stored offline.
  • Warm wallets, which are available through downloadable software that provide additional layers of security.

If the customer, and not the platform, is the only party with access to a non-custodial wallet within a platform’s ecosystem, then the account may not constitute property of the estate. Even if the platform could assert control over the crypto assets in the customer’s non-custodial wallet, the customer has a colorable claim that those assets are not property of the estate because the platform is holding the assets in trust.

Generally, assets that a debtor is holding in trust for a third party are not property of the bankruptcy estate. It is the customer’s burden to establish that a trust relationship exists under statutory or common law.

Chapter 11 Plan Considerations

There are various crypto Chapter 11 plan considerations, including how the claims of crypto platform customers should be treated and whether the Chapter 11 plan is proposed in good faith and is feasible.

Treatment of Crypto Platform Customer Claims

Treatment of crypto platform customer claims under a Chapter 11 plan depends on how the platform holds or owns customer digital assets. There are at least four potential outcomes based on the following classification determinations:

  • If crypto assets are property of the debtor’s bankruptcy estate (see Scope of Property of the Estate above), then crypto platform customers will be treated as general unsecured creditors entitled to a pro rata distribution from the estate remaining after the payment of higher priority claims. In this scenario, crypto platform customers must receive a recovery in an amount at least what they would receive in a hypothetical Chapter 7 bankruptcy liquidation.
  • If customers hold a valid and perfected security interest in the crypto assets in their accounts, then they will be treated as secured creditors entitled to a plan distribution in an amount no less than the value of their collateral, which could take the form of:
    • a return of the collateral;
    • a distribution of at least the value of the collateral; or
    • a lien on the proceeds of the collateral.
  • If crypto assets are held in trust for the benefit of customers (see Crypto Assets Held in Custody or in Trust above), then the assets cannot be distributed under a plan and will likely be turned over to platform customers, as in In re Voyager Digital Holdings, Inc. (see Express Trusts above).
  • If the crypto is deemed a security, then crypto platform customers might be treated as equity security holders entitled to no distribution under a plan until general unsecured claims are paid in full.

(For more on plan classification and considerations on the treatment of claims, see Chapter 11 Plan Process: Overview on Practical Law.)

If crypto assets are property of the debtor’s bankruptcy estate, then crypto platform customers will be treated as general unsecured creditors entitled to a pro rata distribution from the estate remaining after the payment of higher priority claims.

Good Faith

A Chapter 11 plan must be proposed in good faith and not by any means forbidden by law (11 U.S.C. § 1129(a)(3); for information on objections based on lack of good faith, see Objecting to Plan Confirmation: Overview on Practical Law). Most bankruptcy courts have held that this does not require that the contents of the plan comply in all respects with the provisions of all non-bankruptcy laws and regulations. Instead, courts have held that section 1129(a)(3) of the Bankruptcy Code requires that only the plan’s proposal, as opposed to its contents, be in good faith and comply with all non-bankruptcy laws (see Garvin v. Cook Invs. NW, SPNWY, LLC, 922 F.3d 1031, 1035 (9th Cir. 2019); In re Irving Tanning Co., 496 B.R. 644, 659-60 (B.A.P. 1st Cir. 2013); In re 431 W. Ponce De Leon, LLC, 515 B.R. 660, 673 (Bankr. N.D. Ga. 2014); In re Gen. Dev. Corp., 135 B.R. 1002, 1007 (Bankr. S.D. Fla. 1991)). Therefore, regulatory compliance could be a hurdle for crypto platforms seeking to satisfy section 1129(a)(3) and emerge from Chapter 11, if the court were to determine that the debtor sought Chapter 11 protection to avoid regulatory compliance.

Plan Feasibility

A Chapter 11 plan cannot be confirmed unless it is feasible (for information on plan feasibility, see Chapter 11 Plan Process: Overview on Practical Law). Section 1129(a)(11) of the Bankruptcy Code, also known as the feasibility test, requires that plan confirmation is not likely to be followed by the debtor’s liquidation or the need for further reorganization (for more information, see Feasibility Test: Confirmation of a Plan Under Section 1129(a)(11) on Practical Law). A plan is not feasible when, if implemented, it leads to another reorganization or bankruptcy filing by the debtor or successor entity. A lack of plan feasibility in a crypto platform Chapter 11 case might be found on the basis that, for example:

  • The assumptions on which cash flow projections are based are unreliable given market volatility.
  • Economic and industry conditions could impact whether the present economic climate and new regulatory schemes will sustain a successful reorganization.
  • Concerns exist about the track record and previous accomplishments of management selected to run the reorganized debtor.

(For more on objections based on lack of feasibility, see Objecting to Plan Confirmation: Overview on Practical Law.)