Until recently, the nature of ownership of assets on deposit with a third party was not controversial. If a local bank branch goes bankrupt, the cash or other assets deposited with the bank belonged to individual depositors/customers, safely out of the reach of the bank’s creditors, reinforced by numerous federal and state regulations, and bankruptcy case law.

But what happens if the asset that’s been deposited is cryptocurrency, held by a third-party, non-bank custodian?

The regulations and case law governing traditional bank deposits generally do not apply to these situations (whether they should is a policy debate for another day), and in the midst of a wave of chapter 11 filings by crypto custodians, this creates significant risk for customers. In the absence of a regulatory regime governing crypto deposits, the legal nature and rights of customer deposits give rise to a deluge of questions, most notably: Are crypto assets deposited in a third-party account considered an unsecured debt of the estate, or do they remain the property of the depositor separate from the estate?

Crypto assets are any virtual assets that exist on the blockchain (a digital record of all owners of an asset) and are not backed by tangible assets. Types of crypto assets include fungible cryptocurrencies and nonfungible tokens (“NFTs”). Ownership of crypto assets is established by exercising “control” over the asset. While some people “self-custody” crypto assets by holding the assets in a virtual wallet with a private key, many people choose to deposit crypto assets with a third party either in a custodial/non-interest-bearing account or interest-bearing account.

If a custodian maintains operations and customers can keep depositing and withdrawing, the question of whether the crypto assets belong to the custodian is merely an academic exercise. But when the music stops and an insolvent custodian can no longer honor withdrawals, for depositors, it can mean the difference between being made whole or receiving pennies on the dollar.

Issues regarding ownership of crypto assets have been playing out in United States bankruptcy courts in recent crypto industry chapter 11 cases, including Three Arrows Capital, Voyager Digital, Celsius Network, FTX, Core Scientific, BlockFi, Genesis, and Bittrex, among others. Bankruptcy judges in several of these cases have, or will, grapple with the novel question of who owns crypto assets stored on a custodian’s platform.

How the Contours of Crypto Ownership Are Being Defined through Application of the Bankruptcy Code

Because the nature of a chapter 11 proceeding nearly always means that the debtor is insolvent, the issue of ownership of crypto assets is incredibly relevant. Parties involved in a crypto bankruptcy proceeding will compete over which assets belong to the debtor and which belong to third parties. Assets of the debtor can be used to pay creditor claims in their order of priority—usually meaning that the claims of secured creditors will be paid ahead of the claims of depositors/customers who are generally deemed unsecured creditors. If customers are the owners of these assets, however, those assets cannot be used to pay the claims of other creditors and customers are entitled to have their assets returned to them.

In April 2022, the Securities and Exchange Commission flagged the issue of crypto ownership in bankruptcy as part of its Staff Accounting Bulletin 121 (“SAB 121”) which included guidance on accounting for crypto assets held in custody for customers. SAB 121 recommended, among other things, that companies holding crypto assets consider disclosing in their financial statements that these assets may be available to satisfy creditor claims in the event of bankruptcy.

In August 2022, the first court to consider the issue of ownership of customer assets in a crypto company bankruptcy was the United States Bankruptcy Court for the Southern District of New York in In re Voyager Digital Holdings, Inc., No. 22-10943 (MEW), 2022 WL 3146796 (Bankr. S.D.N.Y. Aug. 5, 2022). This case dealt with ownership of cash, not crypto, but set the stage for future rulings on ownership of crypto assets. In this case, the United States Bankruptcy Court for the Southern District of New York held that cash placed in “for the benefit of” FBO accounts was not property of the bankruptcy estate but did not address ownership of crypto assets held directly by Voyager.

In January 2023, the first U.S. bankruptcy court ruled on the issue of ownership of crypto assets. In In re Celsius Network LLC, 647 B.R. 631 (Bankr. S.D.N.Y. 2023), Judge Martin Glenn held that over $4 billion of crypto assets in interest-bearing “Earn” accounts were property of the estate, and not property of the customers who deposited the assets. The court reasoned that the “Terms of Use” unambiguously said that ownership of crypto assets passed to Celsius Network LLC upon deposit into an Earn account, and therefore, were property of the estate and not the depositors. The court did not reach the question of ownership of crypto assets in other types of accounts (including non-interest bearing “Custody” accounts).

In May 2023, Judge Michael B. Kaplan of the United States Bankruptcy Court for the Southern District of New York ruled that assets held in BlockFi customers’ non-interest bearing BlockFi wallets were not property of the bankruptcy estate. Similar to the Celsius case, the court looked to the terms and conditions that users agree to when creating an account and determined that the agreement stated unambiguously that title to the crypto assets in non-interest-bearing wallets remains at all times with the customer and does not pass to BlockFi. The court did not address ownership of crypto assets in interest-bearing or other account types.

In the FTX bankruptcy case, an ad hoc committee of non-US customers filed a complaint in December 2022 seeking a declaratory judgment that their crypto was property of the customers and not property of the estate. The adversary proceeding is currently stayed until July 31, 2023.

In October 2022, the Uniform Law Commission recommended changes to the Uniform Commercial Code that add an article 12 on digital assets (including crypto assets). Article 12 governs the transfer of digital assets, perfecting a security interest, and how competing interests are resolved. To date, article 12 has been adopted in eight states (Alabama, Colorado, Hawaii, Indiana, Nevada, New Mexico, North Dakota, and Washington) and introduced in 20 others.

Know the Risks Before Handing Over Crypto Assets

There is still substantial uncertainty regarding how courts would determine ownership of crypto assets, but it is always important to read a contract before signing it, including the terms and conditions box on a website before you click “Agree.” This is critically important when handing over crypto assets because in the absence of a concrete regulatory regime, the terms and conditions are likely going to be how the court determines your legal rights.

Disclosure: Author Heidi Hockberger represented Celsius Network, LLC at her prior firm.

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