This article originally appeared on Law360 and is republished here with permission.

On Aug. 23, 2018, Nobuaki Kobayashi, the trustee over the estate of the troubled Mt. Gox — the hacked Japanese cryptocurrency exchange — opened an online claims submission process that would allow creditors to recoup their losses. On Sept. 22, 2018, the trustee made the same online claims process available to corporate creditors, and on Oct. 3, 2018, the trustee opened the process for transferees (claims purchasers). This follows the Tokyo District Court’s June 22, 2018, order suspending Mt. Gox’s bankruptcy proceeding and commencing civil rehabilitation proceedings. With the June 22 shift to a civil rehabilitation proceeding, the Mt. Gox trustee has the ability to make distributions in bitcoin and BCH (bitcoin cash), in lieu of paying the claims’ value in fiat currency — a huge victory for creditors, if the trustee confirms (and the Tokyo District Court approves) his plan to do so.

On Sept. 26, 2018, the U.S. District Court for the District of Massachusetts ruled that bitcoin and other cryptocurrencies are “commodities,” as defined by the Commodity Exchange Act. With this determination, the question remains whether bankruptcy courts in the United States will follow suit and take a flexible approach to claims valuation and distributions when it comes to cryptocurrency, like the Mt. Gox trustee, given the unprecedented volatility of this particular bankruptcy asset.

Brief History of Mt. Gox

Mt. Gox was created by a U.S. programmer, Jed McCaleb, in 2010. At that time, the price of bitcoin was approximately $0.08. As of 2013, Mt. Gox was the single largest bitcoin exchange in the world, managing over 70 percent of all bitcoin transactions across the globe. At that time, bitcoin’s value experienced an astronomical increase, selling at $1,200 per coin. In February 2014, it was discovered that as early as 2011, hackers began raiding Mt. Gox and ultimately stole 744,408 bitcoins belonging to the exchange’s customers, as well as an additional 100,000 bitcoins belonging to the company itself.

On Feb. 28, 2014, Mt. Gox filed for bankruptcy protection in Japan, as well as a petition under Chapter 15 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Northern District of Texas. Subsequently, in March 2014, Mt. Gox reported that it had rediscovered 200,000 bitcoins.

In April 2014, Mt. Gox petitioned the Tokyo District Court for liquidation (Hasan), which provides for the winding up of the debtor’s estate: All of Mt. Gox’s assets, including the bitcoin it possessed, would be sold, converted to cash, and distributed to creditors. The Tokyo District Court appointed the trustee over the bankruptcy estates. Notably, distributions would be based upon the value of customer claims as of the date Mt. Gox filed for bankruptcy relief.

In order to drum up cash to make distributions to creditors, the trustee began to sell large chunks of the bitcoin, selling $400 million in bitcoin and bitcoin cash from December 2017 through February 2018. During that time period, bitcoin’s price fluctuated — clocking in at $10,000 to $19,000 in the month of December 2017 alone. Experts criticized the Mt. Gox trustee for having a hand in bitcoin’s price volatility by unloading such huge quantities of bitcoin onto what was (and still is) a nascent market.

After repeated petitions by creditors, in June 2018, the Tokyo District Court suspended the bankruptcy proceedings and approved the commencement of civil rehabilitation. The key difference between the two proceedings — at least for creditors — is that the trustee now possesses the ability to make distributions in bitcoin or BCH, instead of paying out claims in cash based upon their valuation as of the date of bankruptcy.

Valuation of Claims in Bankruptcy

Typically, the value of an unsecured claim is readily available — the amount reflected on an invoice or purchase order, loan documents, or lease. These documents paper the parties’ mutual understanding of the value of whatever goods or services are traded. In the context of securities, a customer’s unsecured claim would be valued on the date of the financial institution’s bankruptcy filing, with the amount denominated in the prevailing (fiat) currency.

The Mt. Gox bankruptcy unveiled the conundrum created by the uncertainty regarding cryptocurrency: Is it a currency? Or is it a commodity? Or some hybrid? If it is truly a currency, one would argue that any claim arising should first be “translated” into the prevailing fiat currency (e.g., yen or U.S. dollars) and then paid out in accordance with the value as of the petition date. This was the approach originally undertaken by the Mt. Gox trustee while the case was still in bankruptcy.

The “bitcoin as currency” approach has also been advanced in U.S. bankruptcy court. In In re Hashfast Technologies LLC, the defendant (the transferee of an allegedly fraudulent transfer of bitcoins by the debtor) asserted that to the extent he was held liable, he should only be required to return the value of the bitcoins (as opposed to the bitcoins themselves) on the date of transfer.[1] In contrast, the plaintiff-trustee argued that bitcoins are more like commodities, and therefore, the bankruptcy court should order the return of the bitcoins themselves or their value at the time of recovery.[2] Central to the dispute was the fact that the value of bitcoin had increased by 400 percent since the date of transfer. Ultimately, the bankruptcy court made no decision regarding the currency vs. commodity dispute, concluding that bitcoins are not U.S. dollars. The court deferred making a decision as to whether the bitcoin would be returned and if not, what the valuation date would be for purposes of its liquidation, if and when the trustee prevailed in his count for avoidance.[3]

The debate may be over. On Sept. 26, 2018, the U.S. District Court for the District of Massachusetts, in U.S. Commodity Futures Trading Commission v. My Big Coin Pay Inc., ruled that bitcoin did meet the definition of a “commodity” under the Commodity Exchange Act.[4] In My Big Coin Pay, the CFTC brought an action against defendants alleging a fraudulent virtual currency scheme in violation of the CEA. According to the complaint, defendants induced customers to buy its virtual currency by making untrue and misleading statements, including that their currency was “backed by gold,” would be accepted anywhere Mastercard was accepted, and was being “actively traded” on several currency exchanges. Defendants filed a motion to dismiss on the basis that virtual currency did not constitute a “commodity” under the CEA. The court considered case law related to the treatment of natural gas as analogous to virtual currency. Reasoning that as with natural gas, there is futures trading in virtual currencies (like bitcoin), the court held that virtual currencies are commodities under the CEA and therefore denied defendants’ motion to dismiss.[5]

Accordingly, in theory, bitcoin and other cryptocurrencies should be treated like gold or oil. The “crypto as commodity” ruling could have enormous implications on valuation in the bankruptcy context. The return of bitcoin or any other cryptocurrency (i.e., transfer avoidance, recoupment or claims distribution) will likely be favored in lieu of a contested and expensive valuation battle. 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.

In the context of a fraudulent transfer (or other award of damages to a plaintiff trustee or debtor in possession), if the transferred property is not returned, the court can award its value, which is “measured at the time of recovery where the property naturally increases in value.”[6] In the context of Section 503(b)(9) of the Bankruptcy Code (which governs the valuation of goods provided to a debtor in the 20 days preceding the petition date), commodities are valued “based on the price at which it could be purchased during the relevant period on the commodity market.”[7] Trustees and debtors may argue that the “increase in value” should be retained by the estate, for the benefit of other creditors (i.e., holders of claims for commodities that have decreased in value).

The valuation of commodities have also played a large role in assessing the feasibility of Chapter 11 plans. For example, in In re Sabine Oil and Gas Corp., the bankruptcy court confirmed a Chapter 11 plan despite a heated battle over the amount of proposed adequate protection payments to the debtors’ lenders.[8] In Sabine, the debtors’ proposed adequate protection payments were based upon the historical value of the lenders’ collateral, which consisted of oil and gas (i.e., the lower the value, the higher the adequate protection payments). The committee claimed that the adequate protection payment amounts should be based upon the most recent valuation of oil and gas. The court noted that there is an “inherent tension involved in performing valuation analysis using data that is subject to constant change” and observed that “[r]esolving this tension is specially challenging in the context of a commodity industry ... in which pricing is subject to significant volatility, seasonality, and other factors that increase the dynamism of pricing information.”[9] Although the most current information was “most pertinent,” the court cautioned that its valuation should also take into consideration the “practical reality” of the delays within the Chapter 11 process and that “the concern that what may be a temporary shift in commodity prices could lead to a determination of value that is inequitable to one or more parties.”[10] The court ultimately sided with the debtors’ valuation based upon historical prices, in lieu of looking exclusively to more recent pricing information.[11]

Conclusion

Given the volatility of cryptocurrency, with the recent clarifications coming out of the courts regarding the “currency vs. commodity” debate, bankruptcy courts will likely have greater discretion regarding how to treat the valuation of bitcoin and other cryptocurrencies in a variety of contexts throughout the duration of a bankruptcy proceeding. Indeed, the more protracted a bankruptcy proceeding is, the greater likelihood that the valuation of cryptocurrency — whether as collateral, damages or claim distribution — will become a pivot point in such a proceeding.

[1] Adv. No. 14-30725, 2016 WL 8460756 (Bankr. N.D. Cal. Feb. 5, 2016).

[2] Adv. No. 14-30725 at Dkt. No. 42.

[3] Id. at Dkt. No. 49.

[4] CA No. 18-10077-RWZ, 2018 WL 4621727 (D. Mass. Sept. 26, 2018).

[5] Id. at *4-5.

[6] Heller Ehrman LLP v. Jones Day (In re Heller Ehrman), Adv. No. 10-3221DM, 2014 WL 323068, at *8 (Bankr. N.D. Cal. Jan. 29, 2014) (citing USAA Fed. Savings Bank v. Thack (In re Taylor), 599 F.3d 880, 890 (9th Cir. 2010)).

[7] In re Pilgrim’s Pride Corp. , 421 B.R. 231, 243-44 (Bankr. N.D. Tex. 2009).

[8] 555 B.R. 180 (Bankr. S.D.N.Y. 2016), motion to certify appeal denied, No. 16-CV-2561 (JGK), 2016 WL 6238616 (S.D.N.Y. Oct. 25, 2016), and appeal dismissed as moot, No. 16 CIV. 6054 (LAP), 2017 WL 477780 (S.D.N.Y. Feb. 3, 2017).

[9] Sabine , 555 B.R. at 272.

[10] Id.

[11] Id.