Cryptocurrency, investing apps, and digital wallets in bankruptcy

I finally gave in to the cryptocurrency hype and bought Litecoin and EOS (I can’t afford Bitcoin). I’ve been trading stocks and options for years but have been hesitant to venture into crypto. While doing research comparing trading fees on crypto, I was amazed at the number of institutions offering cryptocurrency trading, banking, and traditional stock/ETF investing all in one. All I could think about was how would I even list one of these accounts on a client’s bankruptcy paperwork? Are these accounts listed as a checking account or are they listed as stocks? How would I value any cryptocurrency a client has? Are there even account statements the client could provide to the trustee?  

In recent years, our office has started to see an increase in clients holding stock trading accounts like Robinhood, Coinbase, or Stash and digital wallet/money sharing accounts like Venmo and Cash App. There is limited caselaw on the issue of cryptocurrency in bankruptcy and combined with the use of these digital wallets it may be hard for a debtor to provide a paper trail for the trustee. This post will highlight some of the issues with these types of accounts and bankruptcy.  

Disclosure of all accounts and assets in bankruptcy 

The Bankruptcy Code requires that a debtor make a full disclosure of their assets and liabilities on their bankruptcy paperwork in order to gain a discharge of their debts. You must disclose your accounts and any amounts of crypto you have when you file your bankruptcy. Digital currencies are property, and all property must be listed in your bankruptcy schedules.  

Need for Accounting and Transaction History 

During a typical individual Chapter 7 case, the debtor is required to provide the trustee with the last 90 days of statements for all accounts the debtor held on the date of filing. This is sometimes difficult for debtors because some of these companies do not issue monthly statements or provide any account history. When these situations occur, one of the only solutions is to make sure the debtor takes a screenshot of their accounts on the date of filing and print out the current values of cryptocurrency on the date of filing and provide that to the trustee.  

In a recent Kansas case, the issue of recordkeeping and crypto trading was discussed. The debtor could not provide detailed records of his trading transactions because the trading platform he used just did not issue them. In this case, the court did not determine what was sufficient and customary recordkeeping but denied the US trustees motion of summary judgment because the US Trustee did not provide a basis for what is standard and customary recordkeeping (I’m not sure anyone knows what customary recordkeeping in crypto trading entails).  

Income from Trading Bitcoin—The Means Test and Chapter 13 

A debtor’s income is one of the first things we’re looking at when we’re meeting with clients. The income received in the last 6 months may impact whether a debtor qualifies for Chapter 7 under the means test and can affect Chapter 13 plan payment amounts. If crypto has been sold and a gain realized, the debtor may be placed in a Chapter 13 case over a 7, or plan payments will be high and unsustainable if on-going crypto income is not being made. This also gets into the tricky tax situation  associated with crypto accounts. Typical brokerage accounts will send a 1099 form showing capital gains and losses, but crypto accounts may not. This may pose a problem down the road with incurring tax debt during an active chapter 13.  

How is crypto categorized? 

There is a debate on whether crypto is a currency or a commodity. The argument against crypto as a currency is that crypto is not issued by the government or accepted as payment. However, El Salvador just announced it will make Bitcoin legal tender, which may change this argument. On the other side, Bitcoin has been labeled “digital gold” where it has a finite value which makes it an asset not a currency. For now, we will have to wait and see what the courts decide in future cases.  

How might my crypto holding be valued? 

There is no clear answer on how to value cryptocurrency. First, the valuation of bitcoin outside of bankruptcy is hard to calculate as it is not backed by the government, by some precious metal, or something with intrinsic value like traditional currency is. In short—the value is determined by what people will pay for it.  

Similar to traditional currency exchanges, platforms that allow trades have crypto/traditional currency pairs. Probably the most logical valuation would be to assign the pairs value on the date of filing. The complication occurs due to the dramatic changes in value over short periods of time in these underlyings. The value listed on the schedules when the forms were completed may be much different than the value on the date the schedules are filed with the court. Chapter 13 debtors that elect to keep their crypto and pay the value through the chapter 13 may end up paying a higher (or lower) value to unsecured creditors than the asset is worth.  

Can the trustee locate, access, and liquidate my cryptocurrency account?  

Like any other asset, a transfer made close to the bankruptcy filing may be scrutinized by the trustee. The trustee can avoid the payment or transfer and use those funds to pay other creditors. Some trading platforms have stated they will work with trustees to freeze debtor accounts, transfer assets to creditors, and create trustee accounts.  

Can I protect any of my cryptocurrency? 

Under Kansas exemptions, there is no specific exemption that would protect a cryptocurrency account. While thinking about this, I think it would be possible to protect the crypto amount that was used as a deposit to a landlord.  Under federal exemptions, a debtor may be able to protect their cryptocurrency account using the “wildcard exemption” and protect $1325 and up to an additional $12575 if the debtor does not use all their homestead allowance.  

Conclusion 

No matter what we call or classify cryptocurrency, the bankruptcy code requires that debtors disclose the ownership of crypto. Failure to list crypto or failure to disclose a transfer of crypto close to the filing will be treated the same as failing to list a diamond ring or bank account. If you hold cryptocurrency, one of our attorneys will be able to go over how these assets may be viewed in your bankruptcy case. 

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