A view on the recoverability of Cryptocurrencies such as bitcoin
Over the past 12 months, most readers will have come across a plethora of articles about Bitcoin and have either dismissed it as a fad or become staunch advocates. Having considered the opinions of seasoned economists, investors and self-proclaimed cryptocurrency experts, there is little doubt that the long term viability of Bitcoin is at best, uncertain. However, as Bitcoin and other blockchain based cryptocurrencies become more accepted, they are sending shockwaves throughout the global economy as the number of companies and individuals utilising such currencies for either private or commercial purposes has undoubtedly increased. Consequently, insolvency professionals will face a commensurate increase of interaction with cryptocurrencies when performing their duty of realising the assets of an insolvent estate when the relevant company or individual has been using cryptocurrencies as a method of payment. In light of this fact, it is imperative that thought is given to the impact that Bitcoin and other blockchain based cryptocurrencies may have on the insolvency profession, especially in relation to the recoverability of this new asset for the benefit of an insolvent estate's creditors.
Transactional Transparency and Personal Privacy
Bitcoin is a decentralised currency, which means that it is not owned or controlled by a single entity such as a central bank. Instead, it is controlled by a network of individuals and organisations around the world (often referred to as Bitcoin miners) that are using specifically designed software programs that follow a mathematical formula to verify and give effect to transactions.
The advantage of decentralisation is that, for any changes to be made to Bitcoin, 51% of the miners must agree with such a change. As with any other currency, Bitcoin is of course susceptible to changes in value that occur based on the principle of supply and demand but, as we have seen in times of economic turmoil, unlike fiat currencies, Bitcoin's value cannot be affected by a central bank's change in monetary policy.
Closely affiliated with Bitcoin's decentralised nature is its transparency (often referred to as being open-source). The detail of every transaction that has ever happened in the Bitcoin network is stored on a public ledger called the blockchain which is available for everyone to see. Although this ledger is public, no personal information (such as names or postal addresses) is discoverable as users hold Bitcoins in Bitcoin addresses which by analogy are similar to bank account numbers. Each Bitcoin address is comprised of a unique set of numbers and letters and each address is controlled either by an individual or corporation. However, the primary difference between these Bitcoin addresses and bank account numbers is that, in order to open a bank account, there are a number of procedural requirements which include a requirement for you to prove your identity to the respective bank. Setting up a Bitcoin address, however, can take a matter of seconds and there are, for the most part, no identification requirements. Moreover, a Bitcoin address is intended to be used only once, therefore for each new transaction, a recipient will generate a new Bitcoin address to which the funds in question should be sent. As a result, when viewing the blockchain, it is possible to determine the amount of Bitcoin that has been sent to a specific Bitcoin address, but from the blockchain alone, it is not possible to determine who has control of the address in question and it is not possible to tell how many Bitcoin addresses a particular user has had control of. In fact the only way that the owner of a Bitcoin address can be identified is if they reveal themselves.
In effect, this means that the users of Bitcoin can hold innumerable Bitcoin addresses that are not linked to any names, personal addresses or any other form of identification that is conventionally used to determine the ownership of a bank account and the money held therein. This poses a serious problem when considering the recoverability of a company's assets.
Admittedly, there is an exception to this principle and that is, if Bitcoin purchases are made through a trading platform or exchange, the registration process for the platform will often require personal information from the user.
Recoverability in Insolvency
As many readers will be aware, in order to protect the pari passu distribution of assets and to assist the office holder in achieving the best possible return to the creditors of an insolvent company, one of the primary tools in an insolvency practitioner's arsenal, is the power to review transactions. Given that Bitcoin can offer individuals and corporates the opportunity to operate in a clandestine manner, practitioners should be worried about Bitcoin transactions.
In the event that a company utilises Bitcoin as a mode of making or receiving payment and a transfer of Bitcoin is made from the company to a Bitcoin address that is not associated with the company, it will be necessary, in the normal course of the officeholders' investigations, to determine if any of these transactions should be challenged and set aside. Generally speaking, if the court is satisfied the conditions exist for an antecedent transaction to be adjusted, a normal remedy would be for the property to be re-vested in the company. Practically speaking, this is often achieved by compelling the recipient to return the ill-gotten gains. However, if the property in question is Bitcoin, an order requiring the recipient to send the Bitcoin back to the company will be of very little use.
As discussed above, when viewing the blockchain, the only useful information on display will be the amount of the transaction and the recipient's Bitcoin address. Consequently, unless the owner of the recipient Bitcoin address makes his identity known, it would be impossible to identify them and so impossible to enforce a court order requiring that they make repayment. This problem is only compounded by the fact that there are no singularly identifiable third party entities involved in the management and delivery of the money. As such, conventional remedies such as the freezing of the account at the recipient's bank cannot be used.
If faced with this situation, logically, it would be expected that the court would compel the employee or director who effected the transaction to reveal the identity of the Bitcoin address owner as it would not be possible to identify the owner by any other means. Although this seems like an obvious solution, it is necessary to consider situations in which the director or employee is non-compliant (which is not uncommon) or specifically in relation to blockchain technology, where the payment was made accidentally to the wrong address (again, not uncommon). In such cases, the identity of the recipient would remain unknown.
In the event that the sender truly wants to conceal the destination of the funds, the office holders' ability to trace the funds by viewing the blockchain ledger can be thwarted even further by splitting the payment into fractions and executing multiple transactions to different Bitcoin addresses. This would make the task of locating the ultimate recipient by reviewing the blockchain incredibly laborious and in many situations, not cost-effective.
Undoubtedly, when faced with such a scenario, the court will have no option but to require that the director or employee who affected the transfer reimburse the company for the amount that has been transferred or the difference in value. As a result of this, insolvency practitioners should be aware that in such situations, a lot more focus will need to be placed upon the ability of the company's directors to remedy the deficit. Inextricably linked to this problem will be the increased likelihood that the relevant director or employee will be made bankrupt.
One point for which no obvious solution exists is, given the fact that the ultimate recipient of the payment could be anyone, including a creditor of the company, this gives rise to the risk of creditors double proving in the liquidation. So even if the officeholder was able to secure repayment of the misappropriated funds by the company's director, the rule of pari passu distribution could potentially be breached by creditors proving for a debt which has already been paid in cryptocurrency. Unfortunately, in such cases, there is very little an officeholder can do to prevent this.
Despite frequent fluctuations in value, Bitcoin has achieved (at the time of writing) a market capitalisation exceeding £110 billion with the price of 1 bitcoin being valued at over £6,000. As such, Bitcoin (which has been in circulation for almost a decade) is slowly solidifying itself as a realistic alternative to fiat currencies (i.e. currencies such as the US Dollar and the pound Sterling, whose values are backed by the governments that issue these). This is confirmed by the number of multinational companies and household names such as Microsoft, Shopify.com, Paypal, and Expedia that accept bitcoin as payment for goods and services. Only recently, PricewaterhouseCoopers accepted its first ever bitcoin payment for its services.
Eventually, the use of cryptocurrencies and blockchain technology by companies and individuals in the UK will become more commonplace and in the absence of a regulatory framework that tempers the Bitcoin network, the profession and the courts will need to be adaptable and ready to devise novel ways of utilising the tools that we are equipped with to address the complications caused by this new asset class.
If any of you have had any experience with insolvent companies that use cryptocurrencies or have any comments on the above, we would love to hear from you.
If you would like more information on how the points raised could impact you, please contact Jerome Small.