Over the span of two weeks in July 2022, two of the largest retail-facing cryptocurrency platforms, Celsius and Voyager, filed for chapter 11 bankruptcy protection. Both cases were precipitated, at least in part, by a "run on the bank" in which retail customers withdrew substantial amounts of cryptocurrency from each platform.1 Recent reports suggest that, in the weeks and months leading up to the bankruptcy, Celsius insiders also pulled tens of millions of dollars' worth of their own crypto assets that had been deposited on the platform.2

In addition to providing retail trading and lending services, Celsius, like many other cryptocurrency platforms, also had significant borrowings under "decentralized finance" (or "DeFi") loans-that is, dollar-denominated loans collateralized by pledged cryptocurrency assets that are often governed by self-executing smart contracts and recorded on the blockchain. In the month prior to its bankruptcy filing date, nearly $650 million of Celsius' DeFi loans were repaid, freeing up excess cryptocurrency that had previously served as collateral for such loans.

In light of these events, the Celsius and Voyager debtors (or their respective statutory committees, seeking to act as fiduciaries on behalf of the estates) will likely explore all avenues for maximizing value, including by considering whether customer withdrawals and repayments or liquidations of DeFi loans in the lead-up to the bankruptcy filings might be deemed as "preferential" and avoided for the benefit of the estate.3 Indeed, the Celsius debtors identified the potential avoidance of customer withdrawals and loan liquidations as preferences as a "key" legal issue that would be "critical to the outcome of the case."4

Although there is a dearth of authority relating to these exact issues, it seems that those seeking to augment creditor recoveries through avoidance of cryptocurrency withdrawals and DeFi loan repayments will face several obstacles in doing so, including: challenges to establishing each necessary element of a preference under the Bankruptcy Code; affirmative defenses that may be raised by defendants; and the potential applicability of one or more "safe harbors" to shield transfers from avoidance. This article considers each of these issues in turn.

The Elements of a Preference

Bankruptcy Code section 547 allows a trustee or debtor-in-possession to avoid as preferential any "transfer" of a debtor's "interest . . . in property" to a creditor "on account of an antecedent debt," if such transfer was "made while the debtor was insolvent . . . on or within 90 days" prior to the petition date, and such transfer enables that creditor to receive more than they would receive in a case under chapter 7 of the Bankruptcy Code.5

In other words, if a creditor receives payment on a pre-existing debt within 90 days of the bankruptcy at a time when the debtor was insolvent, that payment potentially can be clawed back to the extent it allowed such creditor to receive more than his or her pro rata share of the bankruptcy estate. This is generally understood to serve two purposes: preventing a "race to the courthouse" by creditors upon learning of a debtor's distress and furthering the general bankruptcy policy of ensuring equality of distribution among similarly situated creditors.6

Some elements are easier to prove than others

As they relate to the potential avoidance of a crypto withdrawal or DeFi loan repayment, certain of the seven preference elements-that is, a (1) transfer, (2) of an interest in property, (3) to a creditor, (4) on account of a preexisting debt, (5) made while the debtor is insolvent, (6) within 90 days of the petition date,7 (7) allowing the creditor to receive more than it would in a liquidation-are more easily satisfied than others.

For example, the Bankruptcy Code defines "transfer" extremely broadly to include "every conceivable mode of alienating property, whether directly or indirectly, voluntarily or involuntarily."8 This definition certainly encompasses either the voluntary repayment (or involuntary liquidation) of a DeFi loan by the debtor or a withdrawal by a customer from a debtor's rewards program (such as Celsius' "Earn" or Voyager's PIK-bearing deposit accounts).

The Code's definition of "creditor" is similarly broad, and includes any entity that holds a "claim" (virtually any right to payment, whether fixed, contingent, disputed, or otherwise), while an antecedent debt is merely "liability on a claim" that arose prior to the date of the challenged transfer.9 Both DeFi lenders and customers clearly hold a right to payment from a debtor, and that right to payment generally will have arisen prior to the time of the relevant repayment or withdrawal (i.e., any payment or withdrawal would be on account of an antecedent debt). That said, as discussed below, there may be creative arguments raised as to when a transfer was actually made, particularly where a given loan is governed by a smart contract.

In addition, although a transfer can be preferential only if made while the debtor is "insolvent," there is a rebuttable presumption under the Bankruptcy Code that the debtor is insolvent in the 90 days leading up to the petition date.10 If the preference defendant can introduce even "some evidence that the debtor was not in fact insolvent at the time of the transfer," then the burden shifts back to the debtor to prove by a preponderance of the evidence that it was in fact insolvent at the time of the challenged transfer.11 This leaves the door open for individual defendants to raise solvency as a defense, particularly if a crypto exchange's downfall was due to a sudden and precipitous drop in crypto prices that occurred immediately prior to the petition date (and after the transfer at issue).

Are the crypto assets property of the estate?

Assuming that the debtor could show that there had been a transfer to a creditor on account of an existing debt within the preference period, the determination as to whether that transfer was of an "interest of the debtor in property"12 is more complicated. Generally speaking, a debtor only has an interest in property if that property "would have been part of the estate had it not been transferred" prior to the bankruptcy filing.13 For these purposes, property held in trust for the benefit of another is not considered the debtor's property (and a transfer of that property thus cannot be avoided as a preference). On the other hand, property to which the debtor has legal and equitable title, and which it is free to use or spend in its own discretion, generally will constitute estate property.

Thus, in the context of crypto debtors, a key question is, who has title to the cryptocurrency held on the platform? The answer will be highly fact specific.

For example, Celsius' "Earn" program-far and away Celsius' most popular product, representing approximately 77%14 of the crypto deposited on the Celsius platform as of its bankruptcy filing-allowed customers to enter into "open-ended loans" to Celsius of certain eligible crypto assets and earn "Rewards" in the form of yield paid either "in-kind" (i.e., Bitcoin would earn yield denominated in Bitcoin) or in Celsius' proprietary token.15 The terms of use for the Earn program clearly and explicitly state that, in exchange for earning yield, customers "grant Celsius all rights and title" to the underlying crypto, which will become "Celsius' property, in every sense and for all purposes." Thereafter, Celsius "may lend, sell, pledge, hypothecate, assign, invest, use, commingle or otherwise dispose of" such assets in its sole discretion.16 Based on the foregoing, it would appear that there is a strong argument that any crypto enrolled in the Celsius Earn program would constitute estate property, and therefore that the withdrawal of such crypto by customers is potentially susceptible to avoidance.17

By contrast, under Celsius' Custody Service-which is described as being more akin to a traditional deposit or custodial account, and on which users cannot earn yield-title to any deposited crypto "shall at all times remain with the customer and not transfer to Celsius," who may "not transfer, sell, loan or otherwise rehypothecate" such crypto without the customer's consent.18 Voyager maintained a similar custodial program, but also allowed customers to earn yield on deposited assets.19 At first glance, then, Crypto deposited in such programs would seem to fall outside of the ambit of the estate, given that title purportedly remains with the customer and may not be used freely by the debtor.

However, neither Celsius nor Voyager establish individualized wallets or accounts for each customer; rather, customers transfer crypto from an external wallet to the exchange's wallet. Thereafter, that crypto is reflected on the blockchain as belonging to the exchange, and the customer's rights with respect thereto are reflected solely in the exchange's own internal database.20 In light of crypto's essential nature as a digital bearer instrument-reflected in the popular saying, "not your keys, not your coins"-such an arrangement may give rise to an argument by debtors (or their trustees) that, notwithstanding the terms of any custody agreement, title to deposited crypto does not remain with the customer, and that such crypto instead constitutes property of the estate.21

Further, both Voyager and Celsius commingle crypto assets deposited in their custody programs with those of other customers.22 This would complicate efforts to establish any sort of trust relationship and could require a tracing exercise to establish the extent to which a given customer's crypto assets were separate from the debtor's estate. Both platforms also disclaim the existence of any fiduciary relationship with their customers and go to great lengths to disclose that the custodial accounts are not true deposit accounts, as such term is used in the context of banking and financial regulation.

So while customers certainly might be forgiven for thinking that crypto assets deposited with platforms like Celsius or Voyager remain their (the customer's) property, the reality may not be so cut and dried.23

>More than in a chapter 7: considerations of timing and valuation

Of course, in order to be avoidable as a preference, a transfer must have allowed the recipient to receive more than it would have in a hypothetical liquidation under chapter 7 of the Bankruptcy Code. After all, the key policy advanced by avoiding preferences is to ensure equality of treatment of similarly situated creditors and prevent a race to the courthouse, and in the absence of more favorable treatment, there is no harm, no foul.

This requirement eliminates right off the bat liability for oversecured creditors, who are entitled to receive the value of their collateral in a chapter 7 liquidation. Thus, any distribution to them prior to the petition date cannot, by definition, have allowed them to recover more than what they would have received in a chapter 7. Most institutional DeFi loans are overcollateralized by a significant margin (e.g., by crypto assets that have a value well in excess of the nominal fiat value of the loan). Assuming that they have properly perfected their security interests in the cryptocurrency assets serving as collateral, lenders that liquidate (or otherwise receive repayment of) such loans in advance of a bankruptcy filing should generally be safe from preference actions.24

The same will not necessarily be true with smaller, uncollateralized loan liquidations (or liquidations of loans occurring after a precipitous drop in collateral value) or customer withdrawals from rewards programs (where customer claims are generally not backed by any collateral). In those cases, the preference defendant will need to show that they were not in fact rendered better off by the prepetition transfer.

In order to demonstrate that a creditor received more as a result of a preferential payment than it would have in a chapter 7, the preference plaintiff must reconstruct the bankruptcy estate as it existed on the petition date and then show what hypothetical distributions would have been absent the challenged transfer.

Ordinarily, this is a rather straightforward analysis: one merely looks at the assets in the estate as of the petition date (adding back the amount of the challenged payment and subtracting out any accrued administrative expense claims) and compares the value of those assets to the dollar amount of claims existing as of the petition date (again, adding back the amount of the challenged payment); so long as the creditor would have received a distribution of less than 100% on account of its claim in the hypothetical liquidation, then the payment is clearly preferential.25

The analysis with respect to DeFi loan repayments and crypto withdrawals, on the other hand, might not be so simple. For instance, imagine a scenario where:

  • Bitcoin crashes down from previous trading levels of around $20,000 to as low as $12,000, precipitating a "run on the bank."
  • 89 days before the petition date, Customer A withdraws 1 BTC from their account at a price of $15,000.
  • On the petition date, the price of Bitcoin has recovered to $18,000, and there are customer claims of 120 BTC against assets held in customer accounts of 100 BTC; every customer thus is entitled to receive 0.833 BTC per 1 BTC of claim (i.e., 100/120).
  • The trustee subsequently files a complaint seeking to avoid Customer A's withdrawal of 1 BTC.

Under these facts, did Customer A receive a preference, assuming all other elements are met?

The trustee clearly thinks so (after all, in this hypothetical, they have sued Customer A): prior to the petition date, Customer A received 1 BTC; other similarly situated customers only received .833 BTC in the actual bankruptcy; and all would have received only .835 BTC in a hypothetical chapter 7 (as the challenged payment must be added back to both the numerator and the denominator in the equation). Thus, based on an apples-to-apples (or BTC-to-BTC) comparison, Customer A has clearly come out ahead.

But if one converts these distributions to fiat currency value, then a different result obtains: whereas prior to the petition date, Customer A received 1 BTC that was worth $15,000, in a hypothetical chapter 7, they would have received a distribution worth $15,025 as of the petition date (.835 BTC × $18,000). In other words, Customer A could argue that they were in fact worse off as a result of their prepetition withdrawal.

Perhaps surprisingly, this argument is not entirely without support. To the extent that Bitcoin is considered a currency, then it appears generally accepted that a transfer of Bitcoin to a creditor is to be valued as of the date of the transfer.26 Or if Bitcoin is considered a commodity, there is also at least some support in the caselaw for the proposition that the transfer should be valued as of the transfer date.27

By contrast, for the purposes of section 547(b)(5)'s liquidation test, the value of a creditor's claim and the distribution thereon are to be determined as of the petition date.28 Thus, when considering the analogous question of whether a secured creditor (generally one whose collateral is subject to volatile price swings) has received a preference, courts will compare the amount received prepetition to the value of the collateral as of the petition date. As one court put it:

What about the valuation of the collateral? This too must be valued as of the day of the bankruptcy petition, if only for the narrow purpose of conducting the hypothetical liquidation test. The collateral itself, as it exists in the hypothetical chapter 7 proceeding, is part of the secured party's hypothetical dividend. Therefore, it follows that this distribution must be considered as it existed on bankruptcy day sic.

The effect of this rule is that the secured party takes the consequences of appreciation or depreciation of collateral between the time of the challenged transfer and the time of the bankruptcy petition. For example, suppose the secured party was oversecured at the time additional collateral is transferred. Because of depreciation, the creditor is undersecured at the time of the bankruptcy petition. The secured party flunks the hypothetical liquidation test. . . . On the other hand, if the collateral increases in value after payment, an undersecured party might be relieved of liability by the timing rule in question.29

The above logic would seem to apply in our hypothetical as well. Customer A received $15,000 worth of property prior to the petition date, and they bore the risk or reward that such property would subsequently decrease or increase in value. Just because that property happened to have increased in value, Customer A should not be penalized in order to provide the bankruptcy estate with a windfall. Conversely, if the Bitcoin received by Customer A had instead decreased in value, then they would have been liable to the estate.

This will no doubt strike many as being the "wrong" result, and for good reason. For one thing, it relies on an arbitrary bifurcation of the valuation process, whereby the respective recoveries of Customer A and their fellow customers are valued as of completely different dates. In that sense, it also runs contrary to the stated policy undergirding the preference provisions of the Bankruptcy Code-i.e., ensuring equality of treatment and disincentivizing a scramble by creditors-by rewarding Customer A with a larger slice of the pie than similarly situated customers. It also ignores the commercial reality that crypto debtors, investors, and other stakeholders (at least so far) have shown a strong preference toward making and receiving distributions of estate property "in kind," as opposed to dollarizing claims30; that is to say, most customers and other market participants appear not to be valuing recoveries in terms of fiat value as of an arbitrary date, but rather how much of the desired cryptocurrency can be distributed from the estate.31

Those taking this view may find support in a line of cases interpreting Bankruptcy Code section 550(a)-which permits a trustee to recover the "value" of property subject to a successfully avoided transfer-holding that a trustee should be "entitled to recover the greater of the value of the transferred property at the transfer date or the value at the time of the recovery."32 That is, where a party has received property in a subsequently avoided transaction and such property has subsequently decreased in value, courts taking this approach essentially shift the risk of such depreciation to the transferee and away from the estate. Conversely, in the event the property appreciates in value, the estate will reap the benefit.

This approach "serves the equitable underpinnings of restorative justice by discouraging a 'wait and see' approach by transferee defendants holding property . . . that may be subject to wide, rapid swings in value on account of volatile markets" and seems aptly suited for cryptocurrency.33 These same policy arguments ring true in the context of section 547(b)(5), and it would not be surprising for plaintiffs (or possibly courts) to apply such reasoning by analogy in valuing prepetition transfers of cryptocurrency.

When is a transfer made?

As noted above, the time at which the transfer is deemed to have occurred is relevant to multiple elements of a preference, and particularly when determining if a transfer was made within the 90-day preference window prior to the petition date.

While this is often a straightforward analysis, smart contract counterparties that received payments in the lead-up to the bankruptcy filing may be able to argue that the relevant "transfers" actually occurred earlier in time, outside of the 90-day preference period. Specifically, because smart contracts are self-executing and irrevocable (in the sense that, once entered into and recorded on the blockchain, their terms cannot be altered or revoked by either party),34 one might argue that a transfer of property subject to a smart contract is made at the time the contract is entered into, as opposed to the time that the property is actually received by the counterparty.35

Subject to exceptions not relevant here, Bankruptcy Code section 547(e)(2) provides that a transfer is deemed to occur when it is "perfected." In the case of personal property (like cryptocurrency), a transfer is perfected when "a creditor on a simple contract cannot acquire a judicial lien that is superior to the interest of the transferee,"36 which is generally determined by reference to state law.37

Although phrased in a technical manner, whether a transfer has been perfected (i.e., whether a creditor could obtain a judicial lien that is senior to the transferee's interest in the property at issue) can, in many cases, boil down to whether title to the property has passed from transferor to transferee. After all, it is axiomatic that a lien against a debtor generally only attaches to the extent that the debtor has an interest in a given piece of property. Said another way: if a debtor does not have title to property, then a judgment creditor of the debtor cannot obtain a lien against it.38

The question thus becomes, at what point does title to the relevant property pass from the debtor to a third party? The answer will vary, based on the type of transaction at issue.

In a sale of goods subject to the Uniform Commercial Code, for instance, depending on what the parties agree to, title will pass to a buyer either upon identification of the goods, upon shipment, upon delivery, or at any other time specified in the sales contract.39 A check or other negotiable instrument is transferred upon delivery, although ownership of the underlying cash does not change hands until the bank has honored the check.40 And the general rule followed in most states is that, when a grantor places property into an irrevocable escrow, though legal title remains with the grantor, a superior equitable title passes to the escrow beneficiary (such that any judgment lien obtained against the grantor is junior to the beneficiary's interest).41

Based on these principles, the Supreme Court has held that, for purposes of the preference statute, a transfer of funds by check occurs on the date the check is honored (as opposed to when the check is written or delivered by the debtor), as it is not until such time that the recipient of the check actually obtains title to the underlying cash, explaining that:

Receipt of a check gives the recipient no right in the funds held by the bank on the drawer's account. Myriad events can intervene between delivery and presentment of the check that would result in the check being dishonored. The drawer could choose to close the account. A third party could obtain a lien against the account by garnishment or other proceedings. The bank might mistakenly refuse to honor the check.42

By the same token, where the parties have entered into a contract obligating the debtor to pay a sum certain to a creditor, no transfer occurs for purposes of the preference statute until a cash payment is actually made, because "at any time prior to said payment, a judicial lien creditor could have executed against those funds."43

In contrast, with respect to attempts to claw back escrowed funds, courts have generally held that a transfer is perfected at the time the debtor places the funds into escrow, and not when the funds are released to the alleged preference defendant.44 That is because, as a general principle, funds placed into an irrevocable escrow account (i.e., one where the grantee has superior title to the grantor) "cannot be reached by the debtor's judgment creditors," and thus a "subsequent release of the monies does not deprive the estate of anything of value."45 Accordingly, a transfer of funds out of escrow cannot be avoided, "for to be avoidable a transfer must deprive the debtor's estate of something of value which could otherwise be used to satisfy creditors."46

Against this backdrop, DeFi lenders and other smart contract counterparties would appear to have a good argument that, where liquidation of a loan occurs or payment is made pursuant to a smart contract, the underlying transfer should be deemed to have occurred at the time the smart contract was entered into (and not at the time the crypto, funds, or other property were released to the recipient).

As discussed previously, when dealing with ordinary contracts or negotiable instruments (like checks), courts have held that the transfer does not occur until the property at issue is actually transferred because, until then, there are any number of potentially superseding actions that could occur. The same cannot be said for a smart contract.

Before a smart contract is uploaded to the blockchain, the parties "must reach an agreement on the contents" of the underlying "computer algorithms" contained therein.47 "Once deployed in the blockchain," a smart contract is a "self-executable and self-verifying agent that cannot be changed," and any associated cryptocurrency can no longer be transferred except in accordance with the smart contract's terms.48 In that sense, smart contracts function more like escrow arrangements than they do as ordinary contracts or negotiable instruments: like a debtor depositing funds into an irrevocable escrow, a debtor that enters into a smart contract cannot retrieve associated crypto assets except in accordance with the contract's terms, and as a result, the debtor is left no worse off upon the release of crypto to a creditor. It thus could be persuasively argued that, much as the subsequent release of funds from escrow is treated essentially as a disregarded transfer for the purposes of the preference statute, so too should crypto released pursuant to a smart contract.

In the case of DeFi loans in particular, this treatment also would comport with the fact that such loans are, in substance, secured transactions: the crypto posted in connection with the smart contract serves as collateral for the loan. This commercial reality is reflected in the approach taken by those state legislatures (such as that of Wyoming) that permit an interest in cryptocurrency to be perfected by "control," including control via a "smart contract created by a secured party with the exclusive legal authority to conduct a transaction relating to a digital asset."49

Affirmative Defenses

Even assuming that the seven elements of a preferential transfer under section 547(b) of the Bankruptcy Code can be met, the Bankruptcy Code also provides for a number of affirmative defenses against preferences, set forth in section 547(c). A preference defendant has the burden to prove these defenses by a preponderance of the evidence.50 The most relevant defense for DeFi lenders or other crypto customers is likely to be the ordinary course of business defense, discussed below. Individual crypto customers may also be able to avail themselves of the Bankruptcy Code's statutory minimum threshold for asserting a preference claim, currently set at $7,575.51

The "ordinary course of business" defense

The Bankruptcy Code exempts from avoidance any transfer "made in the ordinary course of business" or "according to ordinary business terms" of the debtor to repay any "debt incurred by the debtor in the ordinary course of business or financial affairs . . . ."52 So-called "ordinary course" transactions are exempted from preference liability because such transactions do not implicate the policy of discouraging "unusual action by . . . the debtor or his creditors during the debtor's slide into bankruptcy."53

As noted above, a preference defendant has the burden of demonstrating by a preponderance of the evidence that both the debt underlying the challenged transfer was incurred in the ordinary course of business and the repayment of such debt was also done in the ordinary course of business or on ordinary business terms. In practice, however, the first element (that the debt was incurred in the ordinary course) is rarely in dispute. Instead, the focus is on establishing that the repayment was in the ordinary course of business, which is a subjective inquiry into whether the challenged payments were irregular or if they were consistent with the previous course of dealing between the parties.54

Although this is a fact-specific inquiry that is undertaken on a case-by-case basis, courts tend to have coalesced around four primary factors in making this determination: (1) the length of the parties' relationship, (2) whether the amount or form of payment differed from prior transactions, (3) whether either party engaged in unusual payment or collection activities, and (4) the circumstances under which the challenged payment was made.55 Importantly, although this test presupposes the existence of a prior relationship between the debtor and the transferee, a prior relationship generally is not required in order for a transferee to successfully raise the ordinary course defense. Instead, to the extent the challenged transfer is the first transaction between the parties, then the analysis may be made by reference to the parties' practices with others or based on the terms of any written agreement governing the parties' relationship.56

It is unclear how a court would apply these factors-which seem more tailored to the analysis of a commercial relationship between a debtor and its vendors or suppliers-to the relationship between a crypto exchange and its depositors, or a DeFi borrower and its lenders. In the event of a "run on the bank" of the type that precipitated the Celsius collapse, the application of these factors might weigh against a finding that large withdrawals in the run-up to the bankruptcy filing were in the ordinary course, particularly if the relevant defendant were a long-time customer (factor 1) that had traditionally kept their crypto invested on the platform, and only began making large withdrawals (factors 2 and 3) in reaction to adverse media reports surrounding the financial health of the debtor and rumors of a run on the bank (factor 4).

Preference defendants, on the other hand, would seek to downplay these factors. Instead, they would likely rely on the terms of the agreements governing their relationships with the debtor, which generally provide for withdrawal of deposited crypto at any time, on demand, or the automatic liquidation of the relevant loan if the collateral drops in value below a predetermined price.57 Thus, they would argue, any such withdrawal or liquidation was per se within the ordinary course of business. This argument has found at least some traction previously in the context of insolvent investment managers, where some courts have held that it is ordinary industry practice for investment clients to withdraw funds from their accounts at will.<58/sup> This also appears to have been the conclusion reached by the Voyager debtors, who have stated their belief that any preference actions against customers would be exempt from avoidance as transfers made in the ordinary course of business (although they have not articulated their basis for so concluding at any great length).59

Aggregate transfers of less than $7,575 are not subject to avoidance

Retail customers of bankrupt crypto exchanges that have made relatively small withdrawals may also be protected by Bankruptcy Code section 547(c)(9), which prohibits the avoidance of a transfer or series of transfers involving property with an aggregate value of less than $7,575.60

This is a relatively high limit that should provide meaningful protection to many, if not the vast majority of, retail crypto investors. For reference, according to Voyager's bankruptcy papers, 97% of their customers held less than $10,000 on the platform.61 As to Celsius, 84% of its users held $100 or less in their accounts as of July 2022.62

Bankruptcy Code Safe Harbors

Finally, retail crypto customers and DeFi lenders are likely to seek refuge in one or more of the "safe harbor" provisions set forth in section 546(e) of the Bankruptcy Code. Although phrased in a painstakingly technical (and often circularly defined) manner, these safe harbors exempt a wide array of financial, securities, and commodities contracts and transactions from avoidance. This not only provides certainty and finality to counterparties in the financial markets, but is also intended to mitigate the potential systemic risk caused by the failure of a major financial institution and to prevent the contagion of insolvency "from spreading to other firms and possibly threatening the collapse of the affected market."63

Pursuant to section 546(e), the trustee cannot avoid as a preference any transfer that is, among other things, (a) a "settlement payment" or (b) otherwise made in connection with a "securities contract," in each case made "by or to (or for the benefit of)" a "stockbroker" or a "financial participant."64

"Settlement payment" is defined extremely broadly to encompass payments in connection with "almost all securities transactions,"65 including the redemption of preferred stock, redemption of commercial paper, or transfers of securities.66 A "securities contract" includes any "contract for the purchase, sale, or loan of a security . . . ."67 "Security" is defined quite broadly to include notes, stock, bonds, and any "other claim or interest commonly known as 'security,'" but does not include "currency."68 A "stockbroker" is an entity that transacts with "customers" and "is engaged in the business of effecting transactions in securities" on the account of others or with members of the public.69 A "financial participant" is any entity that, at the time it enters into a securities contract or any time in the 15-month period prior to the bankruptcy filing, has at least $1,000,000,000 worth of securities contracts in the aggregate (or at least $100,000,000 in "mark-to-market" value on such contracts).70

It is an open question as to whether a given cryptocurrency is properly considered a security, a commodity, a currency, or something else. The Securities Exchange Commission, for example, has not adopted a universal position on whether "cryptocurrency" writ large is a security, but instead has analyzed individual cryptocurrencies and tokens on a case-by-case basis.71 So while it does not consider Bitcoin to be a security, for example, the SEC believes that the Ripple token is (and recently succeeded in arguing that the LBC token, is in fact, a security subject to the Securities Act of 1933).72 By contrast, the Commodities and Futures Trading Commission appears to be of the view that many popular cryptocurrencies like Bitcoin and Ethereum are commodities.73

To the extent that it can be shown that a given cryptocurrency should be treated as a security, then customers of and lenders to large crypto platforms seeking the protection of section 546(e) would seem to be on solid footing. The agreements governing retail lending programs such as Celsius' Earn program clearly are contracts for the "loan" of cryptocurrency, which would make them "securities contracts" by definition. Transfers made in connection with the liquidation of DeFi loans (assuming those loans are not themselves securities contracts-which they might be) would also seem likely to fall under the extremely broad definition of "settlement payment" that has been adopted by courts in recent years.74 In addition, platforms like Voyager and Celsius appear to qualify either as financial participants (based on the magnitude of crypto assets that were on deposit and enrolled in their programs prepetition, which were well in excess of the statutory $1 billion threshold) or as stockbrokers (as they effectuated transactions in cryptocurrency on their customers' account).

If, instead, it is determined that cryptocurrencies are not in fact securities, then counterparties may nonetheless argue that other safe harbors protect their transfers from avoidance, such as those applicable to commodity contracts and forward contracts.75


1 For example, the Voyager debtors note in their disclosure statement that, as of April 3, 2022, Voyager had assets on platform of approximately $5.64 billion. By June 6, 2022, however, the amount of Voyager's assets on platform had decreased materially (in part due to market decline and in part due to customer withdrawals) to $3.39 billion. See First Amended Disclosure Statement Relating to the Second Amended Joint Plan of Voyager Digital Holdings, Inc. and Its Debtor Affiliates Pursuant to Chapter 11 of the Bankruptcy Code, In re Voyager Digital Holdings, Inc., Case No. 22-10943 (MEW) (Bankr. S.D.N.Y. Oct. 17, 2022) (the "Voyager Disclosure Statement"), at 46. With respect to the Celsius debtors, the first day declaration reports that, the day before the petition date, consolidated assets and liabilities resulted in a deficit of $1.19 billion. See Declaration of Alex Mashinsky, Chief Executive Officer of Celsius Network LLC, in Support of Chapter 11 Petitions and First Day Motions Docket No. 23, at 7.

2 Paige Tortorelli, Kate Rooney, Érica Carnevalli, "Celsius co-founders pulled out millions of dollars in assets before crypto firm froze client withdrawals" (Oct. 6, 2022), https://www.cnbc.com/2022/10/06/celsius-executives-withdrew-millions-before-freeze-on-customer-funds.html.

3 The Voyager debtors established a special committee of the board of directors to look into, among other things, potential avoidance actions to be brought against directors, officers, and other insiders, but it is unclear that ordinary course preference actions were part of the special committee's mandate. Regardless, the debtors believe that no "valid Avoidance Actions exist against Account Holders because any transactions with Account Holders were completed in the ordinary course of business consistent with past practices." Voyager Disclosure Statement, at 52.

4See Celsius First Day Presentation, In re Celsius Network LLC,Case No. 22-10964-mg (Bankr. S.D.N.Y. Jul. 18, 2022), Dkt. No. 45, at 3.

5 11 U.S.C. § 547(b).

6 See 5 Collier on Bankr. ¶ 547.01 at 2 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2022).

7 This 90-day period is extended to one year where the transferee is an "insider" (e.g., director, officer, major shareholder, or close affiliate) of the debtor. See 11 U.S.C. § 547(b)(4)(B).

8 Cullen Ctr. Bank & Tr. v. Hensley (In re Criswell), 102 F.3d 1411, 1415 (5th Cir. 1997).

9 11 U.S.C. §§ 101(5), (10), (12).

10 See 11 U.S.C. § 547(f).

11 Lawson v. Ford Motor Co. (In re Roblin Indus., Inc.), 78 F.3d 30, 34 (2d Cir. 1996).

12 11 U.S.C. § 547(b).

13 Begier v. IRS, 496 U.S. 53, 58 (1990). This again potentially tees up the metaphysical question of when a transfer pursuant to a smart contract is made.

14 Tr. of Hrg., In re Celsius Network LLC, No. 22-109640-MG (Bankr. S.D.N.Y. Jul. 18, 2022), at 37:21-22.

15 Celsius Terms of Use (Last Revised: Sept. 29, 2022), https://celsius.network/terms-of-use.

16 Id.

17 Although arguments would no doubt be raised by defendants, including potentially with respect to the enforceability of the terms of use as a clickwrap agreement under New York law.

18 Celsius Terms of Use, https://celsius.network/terms-of-use.

19 See Declaration of Stephen Ehrlich, Chief Executive Officer of the Debtors, in Support of Chapter 11 Petitions and First Day Motions, In re Voyager Digital Holdings, Inc., Case No. 22-10943 (MEW) (Bankr. S.D.N.Y. Jul. 6, 2022), ECF No. 15 (the "Ehrlich Declaration"), at ¶ 24.

20 See Declaration of Alex Mashinsky, Chief Executive Officer of Celsius Network LLC, in Support of Chapter 11 Petitions and First Day Motions, In re Celsius Network LLC, Case No. 22-10964 (MG) (Bankr. S.D.N.Y. Jul. 14, 2022), ECF No. 23 (the "Mashinsky Declaration"), at ¶ 63.

21 See generally Adam J. Levitin, Not Your Keys, Not Your Coins: Unpriced Credit Risk in Cryptocurrency, 101 Tex. L. Rev. (2022) (forthcoming).

22 See Mashinsky Declaration, at ¶ 58.

23 See Adam J. Levitin, Not Your Keys, Not Your Coins: Unpriced Credit Risk in Cryptocurrency, 101 Tex. L. Rev. (2022) (forthcoming), at 7. As of the date of this article, the ownership of custodial accounts remains a live issue in the Celsius bankruptcy, with an ad hoc group of account holders having filed an adversary complaint seeking a declaratory judgment as to the ownership of crypto assets deposited into custody accounts. See Complaint for Declaratory Judgment,Adv. Pro. No. 22-01142 (MG), Dkt. No. 1.

24 For a discussion of how security interests in crypto assets can be perfected, see Geoffrey R. Peck, et al., Security Interests: Bitcoin and Other Crypto Currency Assets, Practical Law Finance (Feb. 2, 2022), http://us.practicallaw.tr.com/w-017-6122.

25 See In re AFA Inv. Inc., No. 12-11127, 2016 WL 908212, at *2 (Bankr. D. Del. Mar. 9, 2016).

26 See, e.g., Money for Nothing: The Treatment of Bitcoin in Section 550 Recovery Actions, Mary Maginnis, 20 U. Penn. J. of Bus. L. 485, 505 (2017); The bankruptcy estate and cryptocurrency, Jack Haake, 15 No. 1 Westlaw Journal Bankr. 01 (May 17, 2018); cf. In re Waterford Wedgwood USA, Inc., 500 B.R. 371, 383 fn. 8 (Bankr. S.D.N.Y. 2013) (for valuation of purportedly fraudulent transfer, foreign currency converted to dollars based on exchange rate at the time of transaction).

27 See In re Int'l. Ski Service, Inc., 119 B.R. 654, 658-59 (Bankr. W.D. Wisc. 1990) (collecting cases holding that, when determining the "value" of property transferred for the purposes of Bankruptcy Code section 550(a), value is determined by reference to "market price at the time of the transfer") (quotation omitted). The question as to whether Bitcoin is a currency or commodity was raised in a relatively recent California bankruptcy case, but the parties settled prior to determination of the issue by the bankruptcy court. See generally Kasolas v. Lowe (In re Hashfast Technologies LLC), No. 15-AP-03011 (DM) (Bankr. N.D. Cal. Jun. 17, 2016), at ECF No. 52.

28 See, e.g., In re AFA Inv. Inc., No. 12-11127, 2016 WL 908212, at *2 (Bankr. D. Del. Mar. 9, 2016) ("Whether a transfer meets the test of section 547(b)(5) requires the formulation of a hypothetical chapter 7 distribution of a debtor's estate as it existed on the petition date. Because the Defendant received 100% of what it was owed for the Transfers, the Court need only find that the Defendant would have received less than 100% in a hypothetical chapter 7 liquidation.") (internal citations and quotations omitted); In re CIS Corp., 195 B.R. 251, 262 (Bankr. S.D.N.Y. 1996) ("§ 547(b)(5) analysis is to be made as of the time the Debtor filed its bankruptcy petition."); In re Connolly N. Am., LLC, 398 B.R. 564, 580 (Bankr. E.D. Mich. 2008) ("The Court must assess the value of the claim as it existed on the bankruptcy petition date."); see also 11 U.S.C. 502(b) (claim amounts determined "in lawful currency of the United States as of the date of the filing of the petition . . . .").

29 In re Cavalier Indus., Inc., No. 01-0900, 2002 WL 975868, at *4 (Bankr. E.D. Pa. Apr. 16, 2002) (internal citations omitted) (emphasis added).

30 See Tr. of Hrg., In re Celsius Network LLC, No. 22-109640-MG (Bankr. S.D.N.Y. Aug. 16, 2022), at 35:5-8 (Mr. Sussberg: "The company is not seeking to dollarize claims on the petition date and give people back a recovery in fiat. That's just not what we are going to do.").

31 There may also be adverse tax consequences for customers that receive a distribution in fiat currency, as such customers could potentially be forced to realize a taxable gain on the underlying cryptocurrency asset.

32 5 Collier on Bankr. ¶ 550.02a (collecting cases) (emphasis added).

33 Id.

34 Matthew N.O. Sadiku, et al., Smart Contracts: A Primer, 5 J. of Scien. & Eng. Research 538, 539 (2018).

35 Note that, in the case of DeFi lenders whose loans are subject to a smart contract, the timing of the transfer likely will not matter to the extent they have a perfected security interest in cryptocurrency; again, secured creditors as a rule cannot obtain preferences to the extent of their collateral.

36 11 U.S.C. § 547(e)(1)(B).

37> See 5 Collier on Bankr. ¶ 547.08, at 1.

38 This principle is closely related to the Latin maxim nemo dat quod non habet, or "no one can give what he does not have." See "nemo dat quod non habet," Oxford Reference (retrieved Oct. 20, 2022, from https://www.oxfordreference.com/view/10.1093/oi/authority.20110803100228794).

39 UCC §§ 2-401(1)-(3).

40 UCC § 3-203(a); see UCC § 4-215(a).

41 See, e.g., Matter of O.P.M. Leasing Services, Inc., 46 B.R. 661, 667 (Bankr. S.D.N.Y. 1985) (applying New York law).

42 Barnhill v. Johnson, 503 U.S. 393, 399 (1992).

43 Allegheny, Inc. v. Basic Packaging Systems, Inc.(In re Allegheny, Inc.), 86 B.R. 466, 471 (Bankr. W.D. Pa. 1988) (applying either Ohio or Kansas law).

44 See, e.g., In re Aspen Data Graphics, Inc., 109 B.R. 677, 682-83 (Bankr. E.D. Pa. 1990) (applying Pennsylvania law); In re Coco, 67 B.R. 365, 369 (Bankr. S.D.N.Y. 1986) (collecting cases and noting that "the escrow cases are uniform in holding that it is the debtor's deposit of funds into escrow and not the award of judgment or subsequent release of the funds that is the controlling transfer for preference purposes.") (emphasis in original).

45 In re Coco, 67 B.R. at 369.

46 Id. (quoting Matter of Newcomb, 744 F.2d 621, 626 (8th Cir. 1984)) (internal quotations omitted).

47 M. Sadiku, 5 J. Scien. & Eng. Research at 539.

48 See id.

49 W.S. § 34-29-103(e)(i)(B).

50 See 11 U.S.C. § 547(g).

51 As further explained infra.

52 11 U.S.C. § 547(c)(2).

53 H.R. Rep. No. 595, 95th Cong., 1st Sess. 373-74 (1997).

54 See 5 Collier on Bankr. ¶ 547.04, at 9 (collecting cases).

55 Id. at 10.

56 See Wood v. Stratos Product Dev., LLC (In re Ahaza Sys., Inc.), 482 F.3d 1118 (9th Cir. 2007).

57 See Celsius Terms of Use, § 4(D), https://celsius.network/terms-of-use ("You may terminate any loan to Celsius at any time, and request that Celsius return the borrowed Eligible Digital Assets and deliver any Rewards accrued from the Earn Service, by transferring such Eligible Digital Assets and Rewards to your external Virtual Wallet"); Decentralized Finance and the Power of Smart Contracts, Anna Gotskind, Duke Research Blog (Dec. 13, 2021), https://researchblog.duke.edu/2021/12/13/decentralized-finance-and-the-power-of-smart-contracts/ (describing self-executing and automatic nature of smart contracts powering DeFi loans).

58 See, e.g., In re Forex Fidelity Int'l., 222 Fed. App'x 806, 809 (11th Cir. 2007).

59 See Voyager Disclosure Statement, at 52.

60 See 11 U.S.C. § 547(c)(9). This amount is subject to adjustment every three years.

61 See Ehrlich Declaration, at ¶ 63.

62 See Mashinsky Declaration, at ¶ 9.

63 H.R. Rep. No. 97-420, at 1 (1982), as reprinted in 1982 U.S.C.C.A.N. 583, 583.

64 11 U.S.C. § 546(e).

65 Mervyn's, LLC v. Lubert-Adler Group IV, LLC (In re Mervyn's Holdings, LLC), 426 B.R. 488, 499 (Bankr. D. Del. 2010); see 11 U.S.C. 546(e).

66 See 5 Collier on Bankr. ¶ 546.06bi (collecting cases).

67 11 U.S.C. § 741(7).

68 11 U.S.C. § 101(49).

69 11 U.S.C. § 101(53A).

70 11 U.S.C. § 101(22A).

71 Lydia Beyoud, Allyson Versprille, "Why the Crypto World Flinches When the SEC Calls Coins Securities," Bloomberg (last updated Sept. 22, 2022), https://www.bloomberg.com/news/articles/2022-07-29/why-crypto-flinches-when-sec-calls-coins-securities-quicktake.

72 See Memorandum and Order, SEC v. LBRY, Inc., No. 21-cv-260-PB (D.N.H. Nov. 7, 2022), Dkt. No. 86.

73 Id.

74 See In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411, 417-23 (2d Cir. 2014).

75 See 11 U.S.C. § 546(e)

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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