Dealing with cryptocurrency in a bankrupt estate

This content seeks to provide information and guidance to bankruptcy trustees about cryptocurrency, including how to identify, classify and realise digital assets.

It outlines the Inspector-General’s expectations about the handling of cryptocurrency by bankruptcy trustees.

Cryptocurrency

Cryptocurrency is a virtual currency or digital asset that was designed to work as a medium of exchange just like the AUD. Since its creation, its use has evolved and it is now predominantly purchased as an investment or as a speculative instrument (i.e. obtaining it to trade, invest and reap profits).

Cryptocurrency is increasingly likely to form part of the assets that a bankruptcy trustee will be required to deal with upon appointment so consideration needs to be given to identifying that particular class of assets, preserving their value for the benefit of the insolvent estate, realising the assets in a volatile market and distributing proceeds to creditors based on their particular rights.

Treatment of cryptocurrencies in each administration will vary depending upon the circumstances, in particular on the context in which it is being used (i.e. trading, as an investment, or just buying goods and services).

A trustee will require the relevant public and private keys to secure cryptocurrency. The private key is only known to the owner so in a bankruptcy setting, cooperation from the bankrupt is vital. However, there are a number of compliance tools that are available to assist a trustee exercising their duties.

Cryptocurrency acquired prior to bankruptcy

Like any other asset, a debtor’s interest in cryptocurrency on or after the date of bankruptcy will vest in the trustee as an asset of the estate unless an exemption applies pursuant to section 116 of the Bankruptcy Act 1966 (Bankruptcy Act).

A debtor must disclose ownership or interest in any asset including ownership of cryptocurrencies to the trustee of his or her bankrupt estate. Failure to disclose a cryptocurrency (similarly to failure to disclose cash at bank, shares etc.) may constitute an offence under the Bankruptcy Act.

Identifying cryptocurrency in a bankrupt estate

As cryptocurrency can be held and traded under a pseudonym and there is no national “register”, it may require extra diligence from the bankruptcy trustee to identify whether a bankrupt holds cryptocurrency.

Debtor profiling should be undertaken for each bankrupt estate and where warranted (e.g. high earning debtors, debtor’s with high debt to income ratio etc.), on appointment, the trustee should immediately seek and review the bankrupt’s banks statements to identify any transactions that are made to or from what may appear to be related to a cryptocurrency or a cryptocurrency exchange (e.g. transactions with keywords such as bitcoin, coin, crypto, and e-currency).

As cryptocurrency is a digital asset, trustees should also consider collecting electronic evidence to assist investigations. Potential evidence of ownership (e.g. proof of purchase) includes emails, mobile applications, QR codes, recovery seeds, internet browsing history and hardware. Review of electronic devices may also locate public and private keys.

Once a trustee suspects a bankrupt has dealt with or is dealing with cryptocurrency, the trustee must make further enquiries with the bankrupt to seek details of ownership and seek access to the relevant public and private keys. The keys will enable the trustee to trace the past transactions through the exchange where the cryptocurrency is held and identify any voidable transactions prior to bankruptcy. In addition, the following crypto analysis tools can be utilised by the trustee that will assist in determining the exit points for the cryptocurrency and their respective domain addresses:

  • Numisite (open source tools)
  • Blockchain explorer
  • Chainalysis
  • Other licensed tools (Ciphertrace/ Neutrino X Flow)

There is a range of open source tools available on the internet to identify the registrant of the domain owner (e.g. DNS records and Traceroute).

The keys and the aforementioned tools will only enable the trustee to trace the amounts and the bankrupt’s cooperation will be required in order to confirm the nature of these transactions. The trustee may utilise their powers under the Bankruptcy Act to compel the provision of public and private keys through third parties (e.g. cryptocurrency exchanges will be useful when the currency is being stored in the exchange’s custodial (default) wallet).

Where appropriate trustees are encouraged to consider using the compliance tools available to them under the Bankruptcy Act, including:

  • Section 77A request
  • Section 81 examinations
  • Section 130 search warrants

Official Receiver notices

If a trustee suspects that a noncompliant bankrupt has or is dealing with cryptocurrency, the use of Official Receiver powers should be considered. The use of Official Receiver notices will not be appropriate for every administration and should be considered on a case by case basis.

The following Official Receiver notices may be effective when dealing with a noncompliant bankrupt in a cryptocurrency context:

  • Section 77C notice – Compel any person to give information (examination) and/or produce books relating to any matter connected with the performance of the functions of the Official Receiver or a trustee.
    • E.g. compel a bankrupt to provide a private key and/or details of a transaction.
  • Section 77AA notice – Full and free access to all premises and books for the purposes of the Bankruptcy Act
    • E.g. essentially a search warrant which provides an opportunity to seize and copy electronic devices.

Guidance about applying for Official Receiver notices is available in ORPS7.

The redesigned Statement of Affairs will also prompt the debtor to disclose their interest held in any digital assets including crypto-currencies.

Post-bankruptcy income used to purchase cryptocurrency

Although income earned post-bankruptcy does not vest in the trustee, cryptocurrency acquired by a bankrupt with his or her income may vest unless it is established that the intent of purchase and use of cryptocurrency is as a substitute to legal currency i.e. using it to buy and sell goods and services.

Where the debtor is a high income earner, the trustee should seek and review debtor’s bank account statements periodically (ideally at the time of each income review) to identify any investments made towards crypto-currencies. Once identified, the trustee must seek further information to establish the intent and use of cryptocurrency and determine if it vest as an asset in the bankrupt estate.

Selling cryptocurrency

Once identified, the trustee must immediately take control of the cryptocurrency by transferring it to a wallet held by the trustee. To enable that, the trustee should seek immediate provision of the relevant private keys of the wallet where the cryptocurrency is held.

Where the exchange is located overseas, the trustee should consider utilising provisions under UNCITRAL Model Law to secure and sell the cryptocurrency.

After the cryptocurrency has been transferred to a wallet held by the bankruptcy trustee, a request can be made to the cryptocurrency exchange to sell the cryptocurrency and transfer the proceeds to the trustee’s bank account. The process is very much similar to selling shares through a share broker or through a share trading account held online.

Due to high volatility, the cryptocurrency should be realised immediately for the benefit of the bankrupt estate to avoid the asset being dissipated. For example, the price of Bitcoin plunged to 1/3rd in value in February 2018. An estate with unsold cryptocurrency as a main asset in this scenario would have had its creditor’s return cut by 2/3rd.

Any advice contrary to immediate realisation of cryptocurrency and decision making should be carefully documented.

For any reason, the trustee is required to hold a cryptocurrency asset, it must do so in cold storage. This involves storing cryptocurrency offline– meaning away from any internet access as the online environment is vulnerable to hacking.

Example

A trustee has carriage of an estate where the debtor during bankruptcy:

  • Purchased around $32,000 total worth of Bitcoin with his savings/income
  • Traded the Bitcoin on the platform Coinspot
  • Converted the bitcoins from Coinspot into his/her bank and transferred to a savings account
  • Bankrupt made a profit of $21,000 from trade

The trustee has the following issues to consider:

  1. Whether the Bitcoin is after-acquired property of the bankrupt pursuant to section 58(1)(b) of the Bankruptcy Act, and
  2. Whether the bank money profits from trading in the Bitcoin is after-acquired property and/or income of the bankrupt.

The trustee concludes:

  • The Bitcoin constituted “property” for the purpose of the Bankruptcy Act. Given that the bankrupt acquired this property after his bankruptcy commenced, even though they were purchased using his after-acquired income, the bankrupt acquired proprietary rights in the Bitcoin and pursuant to section 58(1)(b) these rights vested in the Official Trustee upon purchase.
  • The bitcoin did not produce ‘dividends’ in the sense of regular, periodic payments while still belonging to the bankrupt; it simply rose in value when it was disposed of. Similarly to selling a real property which has increased in value, the increased value of the bitcoins vest in the Official Trustee
  • Accordingly, proceeds of sale of the cryptocurrency including monetary gains made from trading vested in the Official Trustee as an asset of the estate

Possible offences

In accordance with subsections 19(1)(h) and (i) of the Bankruptcy Act, while administering an estate, a trustee must consider whether a bankrupt has committed an offence against the Bankruptcy Act and if appropriate, refer the matter to the Inspector-General in Bankruptcy. Examples of offences involving cryptocurrency and other digital assets may include:

  • failure to disclose ownership or disposal of property (if >$5,000) in Statement of Affairs form,
  • failure to disclose ownership of property when asked by the trustee during bankruptcy, and
  • concealing, disposing, removing or dealing with property within 12 months prior to bankruptcy and during bankruptcy.

Guidance about referring offences against the Act is available in IGPS14.

Other considerations

Cryptocurrency will be easier to identify and trace if purchased and sold through an Australian exchange. If cryptocurrency is purchased and sold in cash and peer-to-peer, it will be near impossible to trace and realise.

Cryptocurrency can be traded and moved very quickly. If a trustee becomes aware of the existence of cryptocurrency, it is important that it is secured as soon as possible. This is also important when the trustee has both the public and private keys. If someone else has these keys, they may move it before the trustee does. This approach is common in organised crime.