Cryptoassets play a growing role in insolvency practices

A combination of political uncertainty, increasing inflation and tightening monetary policy has caused an increasing number of insolvency cases in which the estates are comprised, at least in part, by cryptocurrencies and other cryptoassets. In these cases, there can be significant challenges in identifying, securing and realising cryptoassets for the benefit of creditors. As a result, IPs are seeking to improve their skills and knowledge around cryptoasset technology and investing in the relevant people and relationships.

Securing cryptoassets

Upon appointment, IPs should immediately investigate whether a distressed company holds any cryptoassets and take rapid steps to secure them. These assets could have a high value, and are easily transferable by anyone with access to a private key or the custodial account that holds them. Because of this, failure to secure assets for the benefit of the estate and deal with them appropriately could lead to potential claims being brought against the practitioner in the future.

Having identified a cryptoasset, the next task facing the IP is to secure and safeguard it. While this process will be familiar, cryptoassets bring with them additional challenges, including the technical environment and infrastructure in which they are held. There are many different types of cryptoassets and they can be held in a number of ways. Two of the most common methods of holding cryptoassets are ‘custodial’ and ‘non-custodial’ arrangements.

Custodial arrangements

Cryptoassets can be held by a third-party custodian, such as a cryptocurrency exchange. In this situation, the asset’s owner does not have direct control over their cryptoassets. Instead, the custodian will hold the alphanumeric private keys to blockchain accounts that hold the assets in question, and therefore have practical control of the assets themselves. In this situation, an IP will have to deal directly with the custodian in order to secure it. A custodian might be cooperative, but if they are not, it might be necessary to seek court orders compelling them to return the assets or other civil law remedies.

Non-custodial arrangements

Cryptoassets can also be held by non-custodial means. For example, the owner might possess the alphanumeric private key required to make transactions using the account recorded on the blockchain as holder of the cryptoassets. This might take the form of a software wallet on a phone or computer app, or hardware wallet, similar to a USB drive, which contains a copy of the private key.

In these cases, it is essential for IPs to transfer the cryptoassets held in this way to an account controlled by them. Until this occurs, there is a risk that a director, employee or other individual associated with a distressed company could effect a transaction in the business’s cryptoassets. If the person holding the keys cannot be identified or located, or is unwilling to transfer the cryptoassets to a designated wallet controlled by the insolvency practitioner – and cannot be compelled to do so – it might be practically impossible to recover the cryptoassets even if a court has ordered them to be returned.

Next steps

Having identified and secured cryptoassets, the next question is how they can and should be realised. Two important factors to consider are timing and market conditions. Unlike any other asset class, the value of cryptoassets can be highly volatile, and so the IP will need to consider whether to hold or sell them. This volatility is likely to make IPs nervous and criticism might be levelled at them if sales are taken too slowly or too rapidly, particularly as IPs have to act in the best interest of creditors. In most cases, we would expect IPs to liquidate cryptoassets as soon as they can, rather then holding on to them in the hope that they will increase in value.

When considering market conditions, it is important to note that, alongside volatility, liquidity is also a crucial factor. For cryptoassets or non-fungible tokens (NFTs) that are not traded on larger exchanges, it can be difficult to find potential buyers or adequate liquidity. However, firms do exist that can support IPs to secure and realise cryptoassets. These firms have secure locations where cryptoassets can be transferred and appropriate insurance coverage put in place.

The future of insolvency practices

Some IPs have already started adding cryptoassets to their checklists when investigating distressed estates. A small number have even invested in cryptoasset tracing technology to assess the risks of financial crime and sanctions potentially associated with wallet addresses. Those who invest in developing the right skills, platforms and partnerships now will be best placed to take advantage of future opportunities.