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The Crypto Conundrum: Difficulties In Valuing Cryptocurrency Property Held In Alternate Custody: Half Two – Fin Tech

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Mayer Brown LLP; Charlotte, N.C.1

Half Considered one of this two-part article reviewed custodially held
crypto property as a part of the chapter property. This installment
discusses intrinsic worth as a correct valuation technique for crypto
property held in alternate custody, elements to contemplate when
calculating the intrinsic worth of custodially held crypto property,
and risk-mitigation approaches to protect asset worth.

Intrinsic Worth as a Correct Valuation Methodology for Custodially
Held Crypto Property

When a document proprietor of crypto property held in alternate custody
information for chapter, trustees and counsel should acknowledge the
danger of an alternate chapter throughout the pendency of the
record-owner’s chapter case. As mentioned in Half One,
crypto property held in alternate custody can’t be valued in accordance
to face worth as a result of danger an alternate chapter’s
computerized keep will forestall the record-owner from exercising its
directing curiosity over the property.

Whereas truthful market worth displays the asset’s present market
value, intrinsic worth displays the asset’s true worth primarily based on
its “elementary monetary traits.” 2
As a consequence of elements corresponding to the danger of an alternate chapter, a scarcity
of typical shopper and investor regulatory protections, restricted
market liquidity, and value volatility, intrinsic worth could also be a
extra correct valuation for crypto property held in alternate custody.
Trustees and counsel to a record-owner’s chapter (as opposed
to the alternate chapter), due to this fact, could must estimate the
intrinsic worth of custodially held crypto when calculating the
feasibility of a reorganization plan or estimating creditor
distributions in a liquidation to account for the sensible dangers
distinctive to custodially held crypto property.

Whereas many debtors could maintain solely de minimis crypto
property, due to this fact rendering any danger low cost inconsequential,
companies and people with giant stability sheets, or which can be
significantly tech-savvy, may maintain substantial crypto property. In
these instances, the danger low cost from the asset’s market worth to
its intrinsic worth might end in a considerable change, affecting
the record-owner’s chapter case.

Danger Elements to Think about When Calculating a Crypto Asset’s
Intrinsic Worth

First, trustees and counsel should estimate the probability
that the alternate holding custody will file for chapter
safety throughout the pendency of the record-owner’s case. As
management over crypto property will solely divest from a record-owner if
the alternate information for chapter, this estimation is crucial to
decide the danger low cost. Estimating the danger of chapter is
troublesome, however an alternate with a wholesome stability sheet, cheap
debt ranges and regular income will current a lesser danger than an
alternate with persistently adverse money circulation, safety breaches
and an overleveraged stability sheet. Moreover, trustees and
counsel can even have to evaluate the estimated size of time the
record-owner shall be in chapter, as an extended chapter case
will current a wider window of alternative by which an alternate could
additionally file chapter. Whereas a person’s chapter 7 case could
solely final just a few months, chapter 11 and 13 instances can take years and
due to this fact current a larger danger of alternate chapter
prevalence.

Second, trustees and counsel ought to examine the liquidity of
the record-owner’s crypto property. Liquidity in markets
usually refers to “[t]he attribute of getting sufficient
models out there that giant transactions can happen with out
substantial value variations.” 3 Whereas many crypto
property could have hundreds of thousands or billions of excellent models, a low
variety of keen market contributors can create an illiquid market
for any given asset. Crypto property range broadly of their respective
market liquidity, with some, corresponding to Bitcoin, proving very liquid
whereas many new “alt-coins” wrestle to take care of worth and
undergo from giant bid-ask spreads. Because of this, dozens of internet sites
now provide data on crypto arbitrage methods, with some
specializing in much less fashionable cryptocurrencies within the perception that they
will current wider arbitrage gaps.4 Much less fashionable crypto
property, due to this fact, can current liquidity points that will play a
appreciable position in ascertaining a crypto asset’s intrinsic
worth.

Third, trustees and counsel ought to look at the volatility of the
crypto property at concern. Volatility means an asset that has
“the standard of . . . sudden and excessive value modifications.”
5 Whereas associated to liquidity (certainly, an illiquid market
can usually create larger volatility), volatility refers solely to the
variation in an asset’s market value. As crypto property are
notorious for his or her excessive value fluctuations,6
record-owners holding crypto property in alternate custody will be
topic to the danger of value depreciation when the alternate information
for chapter, partially relying on whether or not the chapter courtroom
determines the declare to be “liquidated” or
“unliquidated” below § 502.7 The relative
volatility of the record-owner’s crypto property, due to this fact, can
current a substantial danger relying on the courtroom’s
willpower of liquidated claims or its chosen date for §
502(c) estimation.

Fourth, counsel ought to look to the phrases of the consumer settlement
of the alternate holding custody of the crypto property. If the
settlement permits the alternate to pool crypto property held in
custody or in any other case management the personal keys to be used in ventures
corresponding to staking, 8 the record-owner has a larger danger
of loss in worth, because the record-owner is extra more likely to be
thought-about a basic unsecured creditor. If the settlement
specifies, nevertheless, that every buyer’s crypto property shall be
held in separate custodial accounts, the worth of the crypto property
shouldn’t be discounted as severely, as a result of the record-owner will
have a stronger argument to determine a constructive belief.
9

Primarily based on these elements, trustees and counsel could low cost the
face worth of crypto property anyplace from 10-90% relying on the
crypto asset, the alternate chapter danger, and the phrases of the
alternate’s consumer settlement. Whereas a extra broadly accepted crypto
asset corresponding to Bitcoin or Ethereum will probably have a smaller
low cost attributable to decrease liquidity danger, the dangers of alternate
chapter, asset-commingling and excessive volatility persist, and
require trustees and counsel to low cost the asset’s market
worth to find out its intrinsic worth.

Danger-Mitigation Approaches

Given these varied danger elements for a record-owner’s
custodially held crypto property, counsel could search to reduce the
danger of dropping the property’ present worth. One choice for the
recordowner’s counsel to contemplate can be to instantly
liquidate all crypto property earlier than submitting the chapter petition.
[10] This may not solely be sure that the document proprietor won’t lose
entry to the crypto property if the alternate information for chapter
throughout the pendency of the record-owner’s case, however would additionally
present a liquid money supply to pay collectors.

A downside of this method is the potential lack of worth in a
giant asset liquidation, particularly if the actual crypto asset
has an illiquid market. Moreover, this method shall be extra
troublesome to implement if the record-owner is a enterprise that
accepts cryptocurrency in alternate for its items or companies, as
the record-owner would then be required to hunt courtroom approval
below § 363 to promote crypto property acquired post-petition.
Lastly, if the record-owner should maintain crypto property to generate
income by means of staking, this technique is probably going unfeasible, because the
sale of those property would remove the record-owner’s income
supply.

A second choice for counsel in search of to reduce danger is to maneuver
the record-owner’s crypto property to a chilly storage pockets, an
offline digital pockets that shops crypto property’ personal
keys in a bodily format.11 This feature would equally
remove the danger of an alternate chapter however would additionally
protect the crypto property of their present kind, permitting the
trustee or counsel to distribute crypto property as a part of the
reorganization or liquidation. Then again, trustees or
counsel missing expertise with crypto storage or with out
ample storage capabilities might result in the lack of the
property’ personal keys, rendering the underlying property
unrecoverable. Moreover, if the record-owner is a enterprise that
requires crypto property for income or accounts receivable, the
trustee or counsel should constantly switch crypto property
to and from the cold-storage pockets, leading to extra labor
and lowered enterprise capability. Even when the record-owner operates as
a debtor in possession and retains crypto property in its personal
cold-storage services, transferring crypto property from an
alternate to chilly storage is each burdensome and
pricey.12 Lastly, retaining crypto property earlier than and
throughout a chapter case bears the danger that the property’ worth
will lower throughout the case.

A one-size-fits-all resolution to maximise the worth of a
record-owner’s crypto property and decrease dangers doesn’t exist.
Trustees and counsel, due to this fact, should weigh the information
earlier than them to resolve whether or not a risk-mitigation method is
applicable for the record-owner. The advantages of those
risk-mitigation methods are magnified when alternate chapter,
asset and liquidity dangers trigger a extreme low cost from a crypto
asset’s present market value to its estimated intrinsic worth.
In that case, trustees and counsel could pursue these methods to
protect asset worth and improve the probability of success in a
record-owner’s chapter.

Footnotes

1. on Schlotterback wrote this text throughout his tenure
because the 2021-22 time period legislation clerk for Hon. Paul M. Black, Chief Choose
of the U.S. Chapter Courtroom for the Western District of Virginia.
The views expressed herein are these of the writer and never of the
U.S. Chapter Courtroom for the Western District of
Virginia.

2. James M. Lukenda, Westlaw Sensible Legislation, Valuation
Fundamentals in Chapter: Overview
(2022).

3. “Liquidity,” Black’s Legislation Dictionary
(eleventh ed. 2019)

4. Colin Dodds, “Crypto Arbitrage: How It Works
& Buying and selling Methods,” Sofi Study (July 23, 2021), www.sofi.com/be taught/content material/crypto-arbitrage/
(“Traders can discover greater value spreads for a similar
cryptocurrency digital property amongst less-popular, less-frequently
traded types of crypto.”).

5. “Volatility,” Black’s Legislation
Dictionary, supra
n.3.

6. See Shaurya Malwa, “Terra’s LUNA Has
Dropped 99.7% in Below a Week,” CoinDesk (Could 12, 2022), www.coindesk.com/markets/2022/05/12/terras-luna-hasdropped-997-in-under…
(reporting that cryptocurrency LUNA misplaced 96% of its worth in a single
day).

7. Report-owners are probably topic to larger danger if
their claims are thought-about liquidated as a result of they bear most of
the danger of post-petition asset value depreciation however stand to
achieve little from asset value appreciation till all secured and
precedence collectors are paid in full. If the courtroom thought-about the
record-owners’ claims to be unliquidated, nevertheless, the date of
a § 502(c) declare estimation would probably current the best
danger for record-owners as a result of volatility of crypto asset
costs.

8. Staking is the method by which buyers “lock
up” models of cryptocurrency to validate transactions and forge
new blocks on the blockchain. In alternate for “locking
up” their property with exchanges, buyers earn curiosity as
a part of a “staking pool” (a pool of staked crypto property
used to realize required minimal asset ranges). Sam Becker,
“What to Know About Staking,” Private Fin., Bus. Insider
(July 12, 2022), www.businessinsider.com/personalfinance/staking-crypto.

9. A profitable argument that an alternate holds crypto
property in a constructive belief would help the record-owner
as a result of property held in belief for an additional usually don’t enter the
chapter property. 11 U.S.C. § 541(d); Begier v. IRS,
496 U.S. 53 (1990).

10. ] Whereas counsel must be aware of pre-petition
switch restrictions corresponding to these present in §§ 547 and
548, this technique is probably going viable if the record-owner sells the
crypto property for market (i.e., fairly equal) worth and
maintains the money proceeds for distribution to
collectors.

11. Glob. Digit. Fin., Crypto Asset Safekeeping
and Custody: Key Issues and Takeaways
, at 17
(2019).

12. Transfers from exchanges to chilly storage usually
require transaction prices.

Initially Printed by American Chapter
Institute

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