Who Owns the Custody Crypto Assets? New Bankruptcy Court Ruling Amplifies Concerns | Tonkon Torp LLP

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As we first warned last summer, crypto assets held in an account controlled by a custodian could become the property of that custodian in the event of a bankruptcy filing. At the time, we recommended that crypto investors avoid this possibility by self-storing their assets in a “cold” or “hot” wallet. We urgently reiterate this suggestion now.

On January 4, 2023, our concerns were confirmed. A U.S. bankruptcy judge in New York has ruled that under the clear terms of the Terms of Use, Celsius Network owns the assets of approximately 600,000 interest-bearing customer accounts and can use those funds as the bankrupt company does. deems appropriate in its bankruptcy process. For account holders, the judge’s decision means that instead of immediate full repayment, they are unsecured creditors, which lowers the repayment line and most likely means they will never receive all of their funds.

While the ownership issue is far from settled – the decision will most certainly be appealed – it further muddies the waters for cryptocurrency investors with custodial relationships. Celsius isn’t the only company claiming ownership of client funds. In May, crypto giant Coinbase Global caused waves when the company’s SEC 10-Q form indicated that in the event of insolvency, it could treat customer assets as corporate assets. At the time, Brian Armstrong, the chief executive of Coinbase, attempted to clarify in a tweet. However, he did not retract the statement, he simply stated that the investors’ funds were safe as Coinbase was far from filing for bankruptcy. And it does not appear that Coinbase has changed its terms of service to ensure that account holders actually own the assets in their accounts should Coinbase file for bankruptcy.

Bankruptcy filings are on the rise among crypto custodians, however. For example, Voyager Digital’s bankruptcy filing in July essentially paralleled Celsius’ filing. Then things got interesting: FTX imploded and Sam Bankman-Fried became a household name. The fallout had a ripple effect and one casualty was BlockFi. In late November, BlockFi filed for Chapter 11 bankruptcy, after the collapse of crypto hedge fund Three Arrows Capital created a liquidity crunch and an attempted bailout by FTX failed to materialize. Given the upheaval within the cryptocurrency industry, further bankruptcy filings may follow.

What should crypto investors do now?

The recent Celsius ruling on asset ownership issued by US Bankruptcy Judge Martin Glenn certainly brings the issue to the fore. Cryptocurrency custodians are not traditional brokerage institutions or banks. Regulations require traditional brokerages to keep client assets segregated and segregated from company assets and bank deposits to be insured up to $250,000 by the FDIC.

According to the Court, crypto investors who held assets in interest-bearing Celsius accounts do not enjoy such protections.

Just as we recommended several months ago, we again encourage crypto investors to own your crypto assets themselves. Choose a “cold” or “warm” wallet, or both.

A cold wallet is offline. The most common type is on a hardware wallet that connects to the internet only when you transact. A paper wallet is also a form of cold storage involving printing of relevant information needed to complete a crypto transaction. A hot wallet is an application that allows online storage, which carries a small risk of hacking. Remember that you will be responsible for protecting access to your wallet. If you lose access to your crypto assets, they are most likely gone, just like losing a physical asset.

It is unclear how the cryptocurrency ownership debate will ultimately be settled, and the outcome may be different depending on which court hears the argument. Each condition of use in question may also be different, which may lead to different results. But it is quite clear that the road to legal clarity will be long. Assets taken in the process will, at the very least, remain in limbo and can never be returned except in the form of reduced payments to unsecured creditors. By far the safest course of action is for investors to withdraw their funds from interest-bearing accounts at crypto custodians, unless the terms of service clearly state that they are not the property of the custodian but rather held in trust for the benefit of the account holder.

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