It's Your Crypto. Until The Platform Goes Bust

bankruptcy filings. In July, two of the major crypto players, Voyager and Celsius, both to chill a bankruptcy. These filings have opened up something of a Pandora's box surrounding the interpretation of US bankruptcy law as it relates to crypto acid holders, lenders, even the courts themselves are navigating pretty uncharted legal waters, and whatever the courts decide now could set landmark precedents for billions of dollars worth of crypto.

To tackle these important and complicated legal questions, I'm joined today by Adam Levitton. The meme of not your keys, not your coins has been around for quite some time. It's not as if this was a completely unknown risk in the cryptocurrency world. Adam is a professor at Georgetown Law and a principle at Gordion not Crypto Advisors. Professor, Welcome to the show. I'm so glad that you're here because in a weird I don't know if it was

prescience or paranoia or what. But months and months ago, way back in the wilds of February, you wrote a blog post about what would happen if a crypto exchange filed for bankruptcy, and this was months before actual crypto companies started filing for bankruptcy. And one of the things that you said, essentially, if I were to summarize that post, is customers would get hosed in sort of the grand

scheme of things. And I'd love for you to just elaborate a little more on what we're seeing in terms of companies like Voyager and Celsius and what folks should really be expecting in the months and years to come. The problem we have here is that there is not a lot of clarity about the nature of the legal

relationship between customers of different types of crypto platforms. And we can call them exchanges for shorthand, but they all do somewhat different things have different functionalities, and there are a lot of different ways that relationship can be characterized. But at core, there's a question about whether the cryptocurrency that is held by the platform for the customers is that property of the customers or is it property of the platform. If it's property of the platform, then the

customers are merely creditors in a bankruptcy. They have to stand their unsecured creditors, which means they have to stand in line with all of the other creditors, and they get basically a pro rated share of what what of

what the assets that are available. On the other hand, if the cryptocurrency that is deposited with the platform remains property of the customers and it's just basically being held in trust or something by the platform for them, that then it's the customers property and the customers should get it back. They won't get it back on day one of the bankruptcy. And with you know that that's something that the voyager and Celsius customers can can tell you

right already. Even if it turns out to be their property, they're not going to get it back immediately, but they should get it back, you know, within a few months, one would expect if it's their proper And that's the

real question, what is this stuff? And there's probably not a one size fits all answer, because determining whether any particular customers assets, or whether the cryptocurrency that any particular customer deposited is the property of that customer or the property of the exchange is going to depend on some particular facts and circumstances, the terms of the user agreement that governed the relationship, for example, and we can get

some twists and turns when the user agreement changes over time, and you might end up with different answers for different types of customers for the same exchange. So, for example, Celsius has several different types of customers, and it's got some custody customers, it's got earned customers, it's got customers who took out loans from Celsius, and then it's got

another group called withdrawal customers. Celsius just filed emotion this week for opposing to release the cryptocurrency of a subset of the custody customers, but it hasn't made any such motion about any of the other groups of customers. And that seems to imply that Celsius thinks that at least the other groups of customers their coins are probably actually Celsius is property. That seems to be a position. So that motion that they filed is interesting for two reasons.

The first is, as you note, it was their first kind of explicit declaration of like, Okay, these particular tokens we don't consider to be our property. But it does follow an earlier filing in July when they were pretty much like, oh, but everybody else's we totally do consider

to be our property. I mean, I remember that was it was one of the first times that people who had, as you mentioned, the Urn accounts and another type of account they're called borrow accounts, were told by you know, Celsius's lawyers, Hey, you transferred the title of your coins to us. It's in this terms of service that you probably did not read, but you know, by that definition, these are hours and we're going to hold onto them.

And I think if I were to summarize the reaction of various of those folks that would have been shocked up, pulled and gobsmacked to hear that these things that they thought was their crypto had been you know, claimed as it were, and is now subject to this distribution method that you've described. Should those folks have been surprised. On the one hand, the whole sort of meme of not your keys, not your coins has been around for quite some time. It's not as if this was a completely

unknown risk in the cryptocurrency world. That said, I'm not sure how much your typical retail investor paid attention to that insider focus a risk focus. You know, it was a noable risk, but you'd have to know to go look for it that if you were not aware that this kind of risk could exist, and I'm not sure that you're you know, least sophisticated customer out there would have known that. So even if you read the agreement,

you might not understand the implications. The bankruptcy rules on this stuff are really technical, and they're not something I would expect a lay person to understand. Most people are not themselves bankruptcy lawyers with what you're saying. No, unfortunately, not everyone's in the club. As a representative of the folks in this club, And given that you know, it sounds like you spend days, nights, and weekends pouring over the intricacies of these things. What are some of the

other types of considerations that folks misunderstand? The bankruptcy process is not set up for dealing with the individual circumstances of creditors. If you're a creditor, it doesn't matter if you need the money for your kids college education or to take care of a six spouse. We trade. Bankruptcy law is going to treat vendors the same way as depositors, the same way as bond holders. They're just all creditors

and bankruptcy losses. Look, there's some money that's owed at the end of the day, and everything gets reduced to dollars and cents. It's what are you owed? And we don't care why you're out it. It's just this is what your owed. At least that's the case in the corporate bankruptcy context. When you're dealing with an individual bankruptcy, the nature of the debt can affect things like can you get a discharge of your student loan, the drunk

driving liability, things like that. It's different, But for corporate bankruptcy there's really no way to make the system work. Though if we try and do, everyone's with their own special pleading because the nature of bankruptcies, there's not enough assets to go around to satisfy all the creditors, and everyone's going to have to bear some part of that loss. It's a loss spreading device in some way. There's no easy way to say, well, this customer is more deserving

than this one, and to rank them. That's an impossible exercise. I think. In addition to what you're describing around the fact that folks should be prepared to not be made whole as it were, it also sounds like this is going to be a fairly drawn out process. Yes, so there's kind of to two dimensions. One is how much are you going to get back? And in crypto there's a subsidiary question of what form are you going to get distribution? And it's going to be in cash, is

it going to be in crypto? Is it going to be an equity of a reorganized company? Is going to be the same kind of crypto you put in right? Maybe you're getting a new token then you may or may not think as valuable. There's a question of what you're going to get paid, but there's also a question of when and when can matter just as much as what,

because you're not getting interest in the interim. So if it takes three years for distribution, or take the case of Mountain Ox where it's you know, like a decade for a distribution and there's no interest to cruing, that is actually affecting the value of the distribution you're getting. Coming up more from Professor Adam Levitton about how crypto bankruptcy is like Celsia's Voyager and three hours capital could shape bankruptcy law. We'll be right back. I want to

go back to something that you said about employees. I remember there was, you know, a headline coming at the end of August that Voyager, who like Selsia's, filed for bankruptcy and July was arguing that they should be allowed to pay out millions of dollars I think it was sixteen million dollars worth of retention bonuses two employees, because they were like, if we don't pay people these bonuses, they're all going to leave and then the outcomes are going to be even worse for the people on the

other side of this situation. And again folks were like, we don't understand, how can you be paying bonuses. You're cutting into you know, my claims on voyage. Could you give a sense of whether these kinds of payments, these kinds of transactions are like typical in bankruptcies and corporates. Sure, it actually is not to say that they're not controversial. So what I was saying before that you've got to distinguish between two things. One is employees who were owed

money for work they did before the bankruptcy. That's very clear that up to a limited amount that gets prioritized. And the reason why we do that is we don't want employees running right before the bankruptcy because if they thought that they wouldn't be able to get paid, they'd leave the sinking ship. And we hope that maybe they stick around, maybe you know, maybe they keep the ship afloat. This issue is about, once there's been a bankruptcy filing,

can you pay the employees extra to stick around? And the bankruptcy code makes it very difficult to do that for at least your senior most type of employees, for your kind of line employees, you absolutely can. For very senior employees, pretty much, they have to show that they have an equally good job offer somewhere else, so they have to go out and shop the resume it's it's impossible.

There are two standard workarounds for this. One is to pay out retention bonuses just before the bankruptcy filing, and that looks really bad, but it happens sometimes. Toys r Us, for example, did this. Um. The other move is what's called a key employee incentive plan, where the debtor sets certain performance targets and if those targets are met, then

the employees get a bonus. Now, you can have an incentive plan where you set the goals too low, where're you know, just they're obviously going to be met, and that ends up working like a disguised retention payment as opposed to an incentive payment. These things are done frequently, they are, you know, not without controversy. Whether they need to be done in any particular case to retain employees, that's that's going to depend on the facts on circumstances, right.

So one of the arguments with Voyager is, hey, right now, it's not as if this is a great time to go out and look for a job in the crypto industry. There's another big bankruptcy affected crypto company, or I would say I should say crypto hedge fund. Three arrows Capital and these folks are complicated. They are facing you know, bankruptcy claims in multiple jurisdictions. You know, like the original order for liquidation of assets was filed out of the

British Virgin Islands. The two founders of Three Arrows, Susu and Kyle Davies, are arguing that their Singapore assets should be off limits and it's only like this b v I shell company that should be affected. They are in a fairly public spect with the courts up point to liquid Data's, you know, the folks who are assigned to kind of resolve these issues. It reminds me of a very ugly, very public divorce where you know, the folks on either side of this are in theory they have

aligned incentives around distribution. In practice that's not exactly playing out that way. The biggest problem in Three Arrows is that most no one knows where most of the assets are. So you know, the last I saw was that the liquidators that managed to find about forty million in assets, you know, and half completed yacht or something with that.

Unless they can recover substantially more assets, this is not really a meaningful fight because the forty million that they found so far, I guarantee you every one of those dollars is going to go to pay professionals fees. Not not a single one of those forty million dollars will ever be seen by a creditor. I'm so glad you mentioned that, because it does seem like there is a particular category of user, as it were in bank or see filings always makes money. It feels like it's lawyers.

Well yeah, and you know, and I'm obviously a member of that tribe. Here's here's here's the way that this I think it can be very credibly defended. You have to pay the grave diggers. If you don't pay them, no one diggs the grave. Now, the problem that exists in bankruptcy is you don't have normal kind of cost controls. Normally, if a company has legal counsel and legal counsels running the bills up too high, the company will talk to them, maybe get them to knock down the bills, or will

take the business elsewhere. On the debtor side, you pretty much have a captive audience, right, The debtor is not captive client. It's extremely rare for a debtor to switch counsel mid case and part it's not the debtor's money. At this point, the debtor is playing with the crew

with predators money. In theory, there are supposed to be some checks, right, so the fees of the debtor's professors and the professionals of any official committee, they have to submit those their fee applications to the court for approval. Something the U S Trustees Office does regularly is to challenge fee applications. Bankruptcies are expensive, There's no there's no way around it. I would not be shocked if you see professionals fees that total, you know, over a hundred million.

Voyager is I think probably the most straightforward of cases. Voyager just had like ridiculously bad risk management. It seems that they know to have a single borrow or exposure of the size that they did with Three Arrows Capital is like beyond shocking, right, But that's that was kind of Voyagers problem, right, that they made a bad loaning Three Ars Capital. But for that, Voyagers seems like it

was doing okay. Celsius seems more complicated. It's not entirely clear what you know, there's some different stories of what went wrong with Celsius and Three Arrows Capital. Is you know, the hottest mess you can find. You know, what you see think here is that there's really tremendous variety and why companies end up in bankruptcy and how these bankruptcies

are going to play out. Voyager, there's gonna be some litigation, you know, against presumably all of the promoters of Voyager and anyone else that you can put a target on. Essentially that's typical, but it doesn't have the complications that Celsius has where there you know, there's a lot of anger directed at Alex Maschinski for example, But massinsky situation seems very different than Kyle and Sue. You can't expect to see kind of cookie cutter results. These cases are

probably going to play out differently. I would expect Voyager will be the first one resolved, and that three Arrows ten years from now they might still be trying to recover assets and three Arrows, Wow, I'm not sure that's an optimistic note. On that note, well, thank you so much for taking this. I really appreciate having you on the show. Okay, my pleasure. On the next episode of Bloomberg Crypto, the companies that mind bitcoin are starting to

show signs of financial distress. As the ongoing crypto winter means that bitcoin prices are hovering well below their all time highs. We'll hear more from Bloomberg, reported David Pan and from Amanda Fabriano, head of Mining at Galaxy. This is Bloomberg Crypto at Daily podcast from Bloomberg and I Heart Radio. For more shows from I heeart Radio, visit the I Heart Radio app, Apple Podcasts, or wherever you

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