Extracted from Law360
Few were surprised when on Jan. 19, Genesis Global Capital LLC filed for bankruptcy.
Genesis, a portfolio company of Digital Currency Group Inc., suspended customer redemptions following the bankruptcy of FTX Trading Ltd. Earlier, the withdrawal of Binance Holdings Ltd. from a rescue deal with FTX precipitated the filing of FTX on Nov. 11, 2022.
BlockFi Inc. followed, filing for bankruptcy on Nov. 26, 2022. These cases were preceded by the Chapter 11 cases of Voyager Digital Holdings Inc. and Celsius Network earlier in 2022.
The largest bodies of claimholders in these cases are retail account holders. Understanding cryptocurrency title issues will be key to recoveries for customer account holders and developing future practices for digital assets.
Cryptocurrency is new, and there is no body of developed law precisely defining title to digital assets.
What account holders are entitled to will be cases of first impression, turning on what is property of the estate under Section 541 of the U.S. Bankruptcy Code. Under that section, "all legal and equitable interests of the debtor in property as of the commencement of the case" is property of the estate, and this is determined by applicable nonbankruptcy law.
There are statutes establishing property rights and rules for security interests in digital assets, like Idaho's H.B. 583, enacted last year, that clarify where those jurisdictions' laws apply.
But many jurisdictions are without statutory law adopted specifically to deal with establishing title in digital assets. So, title determinations will be largely based on customer account terms and shaped by the creative judicial application of analogous law.
There are two recent cases to look to, both from the U.S. Bankruptcy Court for the Southern District of New York.
The first case, In re: Voyager Digital Holdings Inc., dealt with cash held by Voyager customers in certain bank accounts designated as FBO, or for the benefit of, with the Metropolitan Commercial Bank.
The court in Voyager ruled in August 2022 that cash held in FBO accounts when the customers of the exchange are the beneficiaries is not property of the estate but the property of the beneficiary.
The decision drew on established law and unambiguous terms establishing "each Customer is a customer of the [Metropolitan Commercial Bank]."
The ruling dealt only with FBO bank accounts and was uncontested. U.S. Bankruptcy Judge Michael Wiles highlighted this last fact, signaling caution on the weight of the ruling.
The second opinion, In re: Celsius Network, dealt with earn accounts at Celsius. The Celsius court ruled in January based on the terms of the customer account, finding the language unambiguous.
These terms stated "you grant Celsius ... all right and title to such Eligible Digital Assets [cryptocurrency], including ownership rights" Celsius had the right to rehypothecate, pledge or transfer all cryptocurrency in the accounts. These customers were ruled, unsurprisingly, unsecured.
As the Voyager and Celsius cases suggest, account terms and derivatively governing law are the principal ways a property right to cryptocurrency or unsecured status is created.
What is a cryptocurrency, and how does it work?
Cryptocurrency uses internet-enabled technologies known as a distributed ledger and blockchain. The distributed ledger records all transactions in the cryptocurrency on a decentralized basis on multiple nodes of the internet.
Transactions occur on the distributed ledger by the recording of units of cryptocurrency at various public addresses. These public addresses are numbers on the distributed ledger in which a coin is lodged. These public addresses have related public keys and private keys.
The private keys originate when a party seeking to transact in cryptocurrency on the distributed ledger creates a conforming alphanumeric number, a random high-value number expressed in a high base, e.g., bitcoin uses base 58. This randomly generated number — the private key — is translated into a public key and a public address through a one-way encryption process, which creates a new usable public address on the ledger.
To transmit cryptocurrency, a transferee provides a public key related to the transferee's public address, and the transferor uses the transferor's private key to initiate the change of recordation on the ledger from the transferor's public address to the transferee's public address. This transaction process is verified by a process known as mining.
Critically, the encryption process from the private key to the public key and public address makes it impossible to discover the private key from the public address or the public key. If a private key is lost, the ability to transact in the coin recorded at the corresponding public address is lost forever.
Logically, indicia of ownership of a public address on the distributed ledger revolve around lawful control or possession, directly or through a custodian, of a related private key. Intuitively, this is odd because the private key is just a number.
With a distributed ledger, unlike, say, a Swiss bank account, there is no institution or intermediary to authenticate ownership or control of a number representing an account.
Knowing and keeping secure the private key is a bit like knowing a Swiss bank account number, but also a bit like having the key to a locker somewhere in which cash bills are stored.
There are several obvious permutations of ownership of coin, i.e., control over a coin on a public address by a private key. One permutation is cold storage.
Cold storage is possessing the private key on a device like a hard drive, a thumb drive or even a piece of paper. The privacy and freedom of cold storage comes with risk. Lose or get locked out of the device or lose the paper, and the related coin is gone forever.
Another permutation of ownership is a basic wallet that digitally stores private keys. The wallet party holds custody of the private key, so the owner of the private key does not lose it.
The wallet party agrees to do nothing with the private key except securely store it and to return it to the owner and delete it from the wallet at the owner's direction. Complicating things, the wallet party might be permitted per the wallet terms to transact with the owner's private key at the owner's direction.
This arrangement requires some trust, because the wallet party could breach the agreement and abscond with the coin, accidentally misuse the private key or lose the data, i.e., the private key.
Another permutation of custody is the custodian maintaining its own private key, public key and public address. The custodian accepts the coin of a specific customer onto a specific public address.
That specific public address records only cryptocurrency of the specific customer and is controlled by the custodian on behalf of the specific customer using a private key known only to the custodian. The custodian agrees not to commingle and not to take any action except at the customer's direction.
Another permutation is a customer sending his coin to a public address or public addresses controlled by the custodian, with a clear agreement not to transact in the customer's portion of that coin without the express instruction of the customer, but the custodian commingles the coin of several customers on the public address or several public addresses.
The last permutation considered is the customer sending his coin to an exchange's address, to be commingled with other coin, and the exchange has the right to transact in the coin.
We can eliminate the easiest two.
At one end of the spectrum, in an arrangement entitling the exchange to transact in the coin, to rehypothecate or otherwise, all bets are off, and account customers are almost certain to go to the back of the line with unsecured creditors.
At the other end of the spectrum is cold storage. In this arrangement, title is not in question.
This leaves wallet custody of private keys of customers, segregated custody on public addresses when the private key is controlled by the custodian, and commingled custody on public addresses when the private keys are controlled by the custodian.
The first two, with clear account terms, should be sufficient to establish ownership.
The last is problematic, even with clear account terms, because the commingled coin blurs exclusive control of the private key and public address that we connected earlier to ownership.
Indeed, New York's virtual currency guidance emphasizes the importance of segregating custodial accounts. This invites a look beyond the guidance regulating practice to analogous legal rights.
There are many paradigms in the world of property in which ownership interests are commingled, and commingling does not, necessarily, destroy a property right.
One such well-worn paradigm is a bailment. Through a bailment, several persons can have an ownership interest in the entirety of an asset that can be divided into shares.
There is well-established law dealing with bailments of different owners' commingled fungible assets, like metals, natural gas in storage tanks and pipelines, and grain in silos. A bailment, in a sense, can create a common ownership interest.
This is like a tenancy in common, when two or more owners own an undivided interest in a whole, or perhaps like a trust, a legal creature bifurcating legal and beneficial title, and beneficial title in the whole corpus is owned in an undivided manner among several beneficiaries.
Commercial statutory law derived from older common law rules reflects this. For example, Section 1-207(16) of the New York Uniform Commercial Code specifically incorporates the concept of a bailment of commingled goods under a document of title.
Section 1-201(16) of the Uniform Commercial Code further defines a document of title to include an electronic document of title, which "means a document of title evidenced by a record consisting of information stored in an electronic medium." Section 7-207 of the Uniform Commercial Code permits warehousemen to commingle fungible goods:
If different lots of fungible goods are commingled, the goods are owned in common by the persons entitled thereto and the warehouse is severally liable to each owner for that owner's share.
There is analogous law for commingled distinct, non-fungible assets that become a fungible mass once irretrievably mixed.
Section 9-336 of the Uniform Commercial Code deals with "goods that are physically united with other goods in such a manner that their identity is lost in a product or mass." Under Section 9-336, "[i]f collateral becomes commingled goods, a security interest attaches to the product or mass."
Traceable cryptocurrency custody arrangements, even where commingled, ought to be granted a status similar to an easily divisible bailment creating an ownership in common, trust arrangement or other fungible mass analog.
Commingling on multiple public addresses arguably should not matter so long as the account terms are clear that the customers have control over their portion of the fungible coin.
But commingled fungible cash dissolves property rights in banking insolvencies, although this may be distinguishable on the ground that a bank deposit account, unlike a safe deposit box, inherently permits the bank to transact in the depositor's cash.
While there are likely good arguments to be made in favor of account customer ownership of cryptocurrency taking the coin outside the property of the estate under Section 541 of the Bankruptcy Code, when terms are unclear or when practices, particularly commingling, are inconsistent with title, it may well be that account customers are out of luck.
The arguments need to, and will, be made shaping precedent and law, and laying ground for adequate future regulation of the untamed world of cryptocurrency.
 In re Voyager Digital Holdings Inc. , 2022 Bankr. Lexis 2178, 2022 WL 3146796 (Bankr. S.D.N.Y. 2022).
 In re Celsius Network , Memorandum of Opinion and Order Regarding Ownership of Earn Account Assets in Case No. 22-10963 Ordered January 4, 2023 (Bankr. S.D.N.Y. 2023).
 See, for example, In re Miami Metals I Inc., 603 B.R. 727 (Bankr. S.D.N.Y. 2019), In re Enron Corp., 2003 WL 23965469 (Bankr. S.D.N.Y. 2003 Jan. 22, 2003), and Pub. Serv. Elec. & Gas Co. v. Fed. Power Commission, 371 F.2d 1, 4 (3d Cir. 1967).
 NYUCC 7-207(b).
 Comment 4 to 9-336 discusses proportionate division of equally ranking security interests in a cake, made from lienholder 1's eggs and lienholder 2's flour.