By: Adarsh Vijayakumaran
The year 2008 is synonymous with catastrophe in the economic history. The bankruptcy of Lehman Brothers and the collapse of Merrill Lynch reduced the world economy to watching itself plummeting to rock-bottom. After credit default swaps and pre-packaged subprime loans in the United States led to an International stock market crash, market-watchers noticed a discreet $800+ billion financial system emerging into the narrow void of technology and finance. This was the advent of cryptocurrencies and Bitcoin (“BTC”), the world’s first decentralized digital currency. The extraordinary returns that these “alegal” creatures of blockchain technology generated have led to a frenzy of investment, giving birth to multiple crypto exchanges, hedge funds, and tokenization.
But is the Indian law equipped to deal with these instruments of digital finance? Specifically, how do the laws governing debtor-creditor relationships apply to cryptocurrencies? This article tries to assess the position of cryptocurrencies in the traditional financial system. We explore the scope of the Insolvency and Bankruptcy Code, 2016 (“IBC”) in its application to crypto assets. We consider whether a creditor can be allowed to take possession of the crypto wallet of the defaulting debtor. Further, we try to examine whether a token holder has a right as a creditor to secure his deposits? And finally, we analyze the issues that an Interim resolution professional (“IRP”) will face in the restructuring of these assets.
Where do cryptocurrencies fall in the line of traditional finance?
In March 2019, the Supreme Court of India in its famous judgment IAMAI v. RBI, declared the Reserve Bank’s prohibition on banks allowing cryptocurrency withdrawals as unconstitutional. While the Supreme Court has made a detailed analysis of cryptocurrencies, it is worthy to note that neither the court nor the RBI was able to decide on a category of financial instrument in which to place cryptocurrencies. It is true that “Currency” as defined under the Foreign Exchange Management Act and pursuant to section 28A of the RBI Act do not include cryptocurrencies. It is also true that neither the Securities Contract Act, 1956 under section 2(h) nor the Forward Contract Regulation Act, 1952 has made any mention of crypto. This being the case, where do cryptocurrencies fit in?
The legal character of cryptocurrencies has always been controversial. In the United States, certain cryptocurrencies that have characteristics of ICOs (e.g. $NEO, $EOS) are treated as securities. At the same time, BTC and other tradable fungible assets like Ethereum (“ETH”) are categorized as commodities. Interestingly, scholars have even gone ahead to classify cryptocurrencies into utility, hyper utility and research-based assets fixing each of them in its hybrid domains. Luckily, in the Indian scenario, The Sales of Goods Act, 1930(“CST”) defines a “good” under section 2(7) to include all of movable property like stock, shares, and even commodities. This broad definition encompasses even crypto, no matter its categorization as a security or a commodity.
Can insolvency law be applicable for cryptocurrencies?
The Insolvency and Bankruptcy Code, 2016 (“IBC”) strives to resolve issues related to default in repayment in a time-bound process. In an insolvency proceeding, the actors are generally a creditor, debt—a claim or a liability, and corporate debtor. Whenever a default occurs, the creditor, with the help of the adjudicating authority and the appointed insolvency professional, takes control of the debtor’s property. They then restructure it to resolve the payment default. To understand whether a cryptocurrency asset has any scope of being part of this whole transaction we consider the meaning of each of these terms.
Section 3(10) of IBC defines creditor to include any person to whom a debt is owed. This debt could either be financial or operational. As per section 5(21) of the IBC, operational debt comprises goods and services. Now assume a person loans a 10 BTC to a corporate debtor. As BTC is an operational debt (because it belongs to the broad category of “goods”), the corporate debtor will be liable to pay when a default occurs. Now that liability is established, how can the restructuring of its property be done when all of it is stored in a crypto wallet? As per 3(27) of IBC, property includes money, goods, land or actionable claims located inside or outside India. Therefore, when a default is established, the adjudicating authority can order for restructuring. While doing so, an insolvency professional can, under section 18(f), collect information related to the debtor’s “assets” and take control of them, whether they are goods or intangible assets. Thus, regardless of the specific categorization of cryptocurrencies, they remain an asset that becomes a subject of the IBC’s restructuring process.
Token holder’s right
Next, we consider whether a token holder can claim his tokens back from an Exchange that is going bankrupt? The difficulty of this question became evident when Mt. Gox, the largest cryptocurrency exchange until 2014, went bankrupt. The exchange went downhill when hackers allegedly misappropriated 744,800 BTC from Mt. Gox in 2014. The Mt. Gox restructuring proceeding began in Japan as a regular insolvency filing. But, it quickly turned into a civil rehabilitation proceeding when the appointed trustee similar to the insolvency resolution professional under section 267 and 268 of IBC sold massive amounts of BTC leading to a bear market. Though, Japanese proceedings require the “trustee” to sell company assets, the court later allowed a civil rehabilitation suit in 2017 after looking into the merits of the request from the petitioners, thereby allowing the trustee to distribute tranches of BTC to the creditors in its proprietary form rather than in fiat.
In the case of McVicker v. Gigawatt Inc., the United States court had to decide if the rights of Gigawatt token holder under the US Bankruptcy Code. While giving its decision the US court noted that
“The White Paper described a WTT Token as an Ethereum token representing the right to use the Giga Watt processing center’s capacity, rent-free for 50 years, to accommodate 1 Watt’s worth of mining equipment power consumption.…“
The court observed that these are the characteristics of a utility token, and this being the case the token holders cannot be considered as a member to the company and any equity invested appears to be the services proffered by the utility token.
However, in the bankruptcy case of Envion AG, the Swiss court had to determine (i) whether ICO investors are shareholders or creditors and (ii) how investors should be paid distributions given the EVN Subscription Agreement issued at the time of the ICO prescribing that any repayments to investors are to be made in ETH. The court observed that the investors in EVN ICO are not shareholders as the subscription agreement itself provided that the investors did not have any shareholder right, and therefore, the investors were decided as creditors. Further, the court observed that since all the bankruptcy claims in Switzerland are required to be filed in Swiss francs, the token holders would have to convert their claim from ETH to Swiss francs.
From the above, it should be noted that there is no uniform method of including a cryptocurrency into a particular class of assets. The difference in the approach adopted by different courts indicates that the claims made by the creditors have to be decided on a case to case basis by both applying domestic insolvency laws and the object that the debtor-creditor relationship sought to achieve.
As noted by Vlad Zamfir,
“There are lots of layers of crypto that you can only break into with the requisite knowledge. It’s ok that not everyone knows how the sausage is made, if everyone knows how to eat it safely.“
Challenges for Interim Resolution Professionals
There is no doubt that restructuring of crypto-assets is going to be a tedious task for insolvency resolution professionals. The first problem a resolution professional will face is determining the existence of the asset. Even if the public key of an asset is determined, the debtor’s full cooperation will be required in availing his private key so that the insolvency professional can seize property and restructure it. Often, the token holders store their assets in a private wallet offline. This makes it more challenging for the creditor to determine where the asset has been stored or to even ascertain whether there is one.
Assume a case where the token holder converts all the debt into BTC and stores it offline, hiding it away. What remedy does the insolvency professional or a creditor have? Moreover, as Mt. Gox’s case illustrates, the integrity of the digital wallet cannot always be guaranteed if the debtor stores crypto in a public exchange. If the exchange gets hacked then the creditors will have to go through multiple class insolvency proceedings to finally establish their claim and restructure the assets. But in this case, if the debtor has borrowed from the creditor in some form of crypto and if the creditor wants the proceeds in crypto itself, then the whole resolution process becomes all the more tedious. It seems unavoidable that the resolution of corporate debts in crypto can only be handled by tech-savvy finance lawyers who can understand both math and the law.
In addition to these, another problem that an insolvency professional would face includes liquidation of these assets. One should note that not all crypto assets are liquid. In the cryptoverse, there are coins that are highly liquid such as BTC, ETH, Litecoin, and then there are less liquid coins such as TSL, XVG, etc., also known as the Shitcoins, whose market prices could rise and fall massively from even a minute change in the buyer-seller relationship. Suppose the holder has stored his assets in any of the non-liquid cryptos that are highly volatile. Even a moderate sale of these assets would produce a butterfly effect and negatively impact the market, affecting the capacity of all the other token holders. Therefore, an IRP during the restructuring will have to give due caution to these factors.
Moreover, another big hurdle that both the creditor and the IRP would equally face is finding a solution when the token held by the debtor has been updated to some other version. For example, if a bug is found in the blockchain, or if some crypto has been stolen, the community will fork the chain into a newer version making the older one obsolete. In 2016, ETH was split into Ethereum and Ethereum Classic when a flaw in the DAO project was found.
Finally, the most difficult problem an IRP professional would face would be when the tokens or exchanges are registered beyond the borders of the nation. Cryptocurrencies are intended to be borderless solutions for payment systems. Such currencies are used by people worldwide. Whenever a default occurs, it is apparent there will be stakeholders from at least 15+ jurisdictions. Though section 18(f)(i) allows an interim resolution professional to take control of the assets in a foreign country, the practicalities associated with it are going to be extremely difficult when the IRP of one jurisdiction has to come into an agreement with that of another in a highly disordered space of conflict of laws. Moreover, to recover assets, cooperation of numerous non-parties such as exchanges, wallet service providers, token providers, and banks will be required.
There is no doubt that the coming of decentralized finance has disrupted the world economy in unimaginable ways. The projects like Defi, IEOs etc. have brought an increased momentum in user numbers that were once confined to the tech nerds and crypto-geeks. In India, the announcement of crypto-hedge funds such as Quadarch have already raised too much optimism from the part of crypto newbies. At a time of this ascending transcendence, it will be interesting to see how Indian policymakers—courts and regulators—will join the play to change the face of the debtor-creditor relationship.
While India’s Draft Bill on Cryptocurrency has dampened this optimism, the passage of this bill is still unlikely. A draft ban could only give way for gigantic loopholes for the default creditors to protect themselves from the insolvency proceeding. Countries like Russia, the United States, and Japan have already made fundamental policy changes in regulating crypto. It is not too late for India to join this excellent opportunity and take the lead in this journey to be among the path breakers. India can do this by either separate collateral classification for crypto or by expanding the meaning of securities, commodities and properties from the existing framework to include crypto. But whatever the alternative, a complete ban will aggravate the issue, not solve it.
Nevertheless, the world is witnessing a tremendous change in the understanding of global finance and its future. The rapid pace with which the global institutions like FATF and World Bank are introducing newer policy proposals on crypto may likely herald the creation of a global framework one day. But given the possible size of the Indian market, India’s treatment of cryptocurrencies will be crucial in determining the future of both decentralized finance and fintech.
 B.A.LLB (Hons.) student at the National University of Advanced Legal Studies, India.
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See, e.g., Nishanth Kumar & Hema Parmar, How bitcoin frenzy has helped crypto hedge funds reap 1,100% gains in 2017, Bus. Standard, (Jan. 17, 2018), https://www.business-standard.com/article/markets/how-bitcoin-frenzy-has-helped-crypto-hedge-funds-reap-1-100-gains-in-2017-118011700183_1.html.
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Id. at 28-29 & 43.
See Vijay Pal Dalmia, Arbitrage of Cryptocurrencies or Virtual Currencies Such As Bitcoin, Ripple or Litecoin Etc In India, http://cryptocurrencylaw.co.in/expertise-detail.php?category=CryptocurrencyLaws&&expertise=arbitrage-of-cryptocurrencies-or-virtual-currencies–such-as-bitcoin-ripple-ethereum-or-litecoin-etc-in-india—legal-status-in-india653604 (last visited Sept. 10, 2020).
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See, e.g., Cryptocurency Regulations Around The World, KYC Chain, (Jan. 21, 2020), https://kyc-chain.com/cryptocurrency-regulations-around-the-world/; see generally Countries where Bitcoin is banned or Legal in 2020, Crypto News, https://cryptonews.com/guides/countries-in-which-bitcoin-is-banned-or-legal.htm (last visited Sept. 1, 2020).
See generally David Hamilton, Investing in EOS everything you need to know about, Securities (Oct. 20, 2020), https://www.securities.io/investing-in-eos-everything-you-need-to-know/; Jay Derenthal, NEO Announces formation of security token consortium, Securities, (Jul. 19, 2020), https://www.securities.io/neo-announces-formation-of-security-token-industry-consortium/.
See generally Helen Partz, BTC and ETH are commodities while XRP’s status is unclear, CFTC says, Coin Tel., (Jan. 14, 2020), https://cointelegraph.com/news/bitcoin-and-eth-are-commodities-while-xrps-status-is-unclear-cftc-says#:~:text=Bitcoin%20and%20Ether%20are%20commodities,CFTC%20Chairman%20Heath%20Tarbert%20believes.&text=Bitcoin%20(BTC)%20and%20Ether%20(,Trading%20Commission%20(CFTC)%20said.
See generally Clean App, Token Taxonomy Frameworks, Medium, (Mar. 20, 2019), https://medium.com/cryptolawreview/token-taxonomy-frameworks-de968bf2605c.
See The Sales of Goods Act, 1930, §2(7) https://www.indiacode.nic.in/handle/123456789/2390?locale=en (Oct. 5, 2020, 1:00 AM).
See, e.g., Vedanta Agarwal, GST Application in Cryptocurrencies Classification & Taxability of Bitcoins, Tax GURU (Jul. 8, 2020), https://taxguru.in/goods-and-service-tax/indirect-tax-applicability-cryptocurrency-classification-taxability-virtual-currency-bitcoins.html.
See Insolvency and Bankr. Bd. of India, Understanding the Insolvency and Bankruptcy Code, (2016), https://www.ibbi.gov.in/uploads/publication/190609_UnderstandingtheIBC_Final.pdf (last visited Sept. 1, 2020).
Id. at 20.
The Insolvency and Bankruptcy Code, 2016, §3(10), (Access), http://egazette.nic.in/WriteReadData/2016/169882.pdf.
Insolvency and Bankr. Bd. of India, Understanding the Insolvency and Bankruptcy Code 8 (2016), https://www.ibbi.gov.in/uploads/publication/190609_UnderstandingtheIBC_Final.pdf (last visited Sept. 1, 2020).
See generally Singh & Associates, Default under Insolvency and Bankruptcy Code, 2016, Mondaq, (Aug. 25, 2017), https://www.mondaq.com/india/insolvencybankruptcy/623536/default-under-insolvency-bankruptcy-code-2016.
Insolvency and Bankruptcy Code, 2016, Gazette of India, pt. II sec. 18(f) (May 28, 2016), https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf.
See, e.g., Matthew Beedham, The brief history of Mt. Gox, the $3B Bitcoin tragedy that just won’t end, The Next Web (Mar. 14, 2019), https://thenextweb.com/hardfork/2019/03/14/a-brief-history-of-mt-gox-the-3b-bitcoin-tragedy-that-just-wont-end/.
See generally Piper Alderman, The long shadow of Mt. Gox, Lexology, (Mar. 7, 2019) https://www.lexology.com/library/detail.aspx?g=8f5d2de6-58f8-4706-811a-7e62a5a126f7
See, e.g., James Mckay, Bitcoin: What is the crash of 2014, tell us about the 2018 bear market?, Mckay Rsch., (Oct. 16, 2019), https://www.mckayresearch.com/post/2018/05/30/bitcoin-what-can-the-crash-of-2014-tell-us-about-the-2018-bear-market.
See Alderman, supra note 27.
Consolidated Class Action Complaint for Violation of the Federal Securities Laws, McVicker v. Giga Watt Inc., No. 2:18-cv-00103-SMJ Silver Miller, https://www.silvermillerlaw.com/wp-content/uploads/2018/11/2018-10-24-DE-22-CONSOLIDATED-CLASS-ACTION-COMPLAINT.pdf (last visited Sept. 1, 2020).
Id. at ¶75.
See, e.g., Lee Pascoe, Crypto assets as property of the insolvent estate, Norton Rose Fulbright, (January 2019), https://www.nortonrosefulbright.com/en/knowledge/publications/39f45394/cryptocurrency-and-insolvency-2018-the-year-in-review#:~:text=A%20fundamental%20issue%20for%20determination,part%20of%20an%20insolvent%20estate.&text=Even%20though%20cryptocurrency%20is%20clearly,inclusion%20within%20a%20bankrupt%20estateaccessed.
@VladZamfir, twitter, (Aug. 26, 2020, 5:06 PM), https://twitter.com/VladZamfir/status/1298584522146152449.
See What is Public-key Cryptography?, Global sign, https://www.globalsign.com/en-in/ssl-information-center/what-is-public-key-cryptography (last visited Oct. 1, 2020). (A Public Key is a complex cryptographic code that is shared in the blockchain in order to facilitate transactions between the parties).
See Connor Freitas, Why private keys are important and how to keep crypto safe?, Currency, (Nov. 24, 2019), https://currency.com/why-private-keys-are-important-and-how-to-keep-crypto-safe (A Private Key is a complex form of cryptography that allows its user to access their cryptocurrency and thereby giving ownership of their funds on the specific address.).
See infra note 44 (Since the integrity of an exchange wallet has a greater chance of being compromised, the trend is now in moving crypto-assets to private wallets.).
See generally GBT, Private Wallet VS Exchange Wallet, Medium, (Aug. 20, 2019), https://medium.com/grabityio/crypto-wallet-private-wallet-vs-exchange-wallet-feat-planet-wallet-61b29942439c#:~:text=Since%20the%20users%20have%20the,trading%20purposes%20within%20the%20exchanges.
Since the stakeholders of the assets can be from anywhere, an insolvency proceeding can be initiated in any of the countries concerned, provided their domestic law permit for the same. In 2018, following the theft of 17 million NANO from an Italian Exchange Bitgrail, a class action suit was filed in the United States District court for Eastern District of New York. See llya Kokorin, Hacked Insolvencies of Crypto Exchange, Leiden L. Blog, (Jul. 25, 2018), https://leidenlawblog.nl/articles/hacked-insolvencies-of-crypto-exchanges.
The case of Mt. Gox is a reminder on what will happen to the market if selling specific crypto-assets at bulk quantity happens. In order to avoid possible losses for other stake holders, it is essential that a proper resolution plan be drawn before the assets are sold keeping in mind that whatever the plan be it should only cause the loss to other asset holders not involved in the proceeding at minimum; See, e.g. Saumya Vaishampayan, Bitcoin Prices fall 4.5% on Mt. Gox Bankruptcy, Mkt. Watch (Feb. 28, 2014, 9:00 AM), https://www.marketwatch.com/story/bitcoin-prices-fall-45-on-mt-gox-bankruptcy-2014-02-28.
 Liquidity of crypto-assets indicates the ease with which it can be traded without affecting its price. In order to trade with such ease, market volume of the specific crypto-asset must be very high. But that is not the case all the time. See Paybis, infra n.46.
See, e.g., Top Crypto spot Exchanges, Coin Mkt. Cap, https://coinmarketcap.com/rankings/exchanges/liquidity/ (last visited Sept. 5, 2020).
Forking refers to the splitting of the chain in which the cryptocurrencies run into two divergent paths. See Saul Bowden, What is a Cryptocurrency Fork?, Commodity, https://commodity.com/cryptocurrency/what-are-forks/ (last visited Aug. 21, 2020).
See Laura M., Ethereum vs Ethereum Classic, BitDegree (Sept. 11, 2020), https://www.bitdegree.org/crypto/tutorials/ethereum-vs-ethereum-classic.
 Simon Maynard & Elizabeth Chan, Decrypting Cryptocurrencies: Why Borderless Currencies May Benefit from Borderless Dispute Resolution, Kluwer Arb. Blog (Nov. 2, 2017), http://arbitrationblog.kluwerarbitration.com/2017/11/02/decrypting-cryptocurrencies-borderless-currencies-may-benefit-borderless-dispute-resolution/?print=print.
See, e.g., Carley Brennan, How Cryptocurrencies Help People Move Money around the World, Inside Viasat (Jan. 30, 2019), https://corpblog.viasat.com/how-cryptocurrencies-help-people-move-money-around-the-world/.
KuCoin, which recently faced an alleged hack, has 5 million users across 207 countries. See AIT News Desk, KuCoin Trading Desk Supports Purchasing Cryptocurrencies with CAD, AI Auth., https://aithority.com/technology/cryptocurrency/kucoin-otc-trading-desk-supports-purchasing-cryptocurrencies-with-cad/#:~:text=Established%20in%20September%202017%2C%20KuCoin,Pool%2DX%2C%20and%20loans (last visited May 26, 2020); see also Shiraz Jagati, KuCoin Hack Unpacked: More Crypto Possibly Stolen than First Feared, Coin Tel. (Sept. 30, 2020, 3:00 AM), https://cointelegraph.com/news/kucoin-hack-unpacked-more-crypto-possibly-stolen-than-first-feared.
See generally Aryaja B. Majumdar, Risks of Cross Border Insolvency, 2 India L.J. (2020), https://www.indialawjournal.org/archives/volume2/issue_1/article_by_Aryja.html.
See Mark Rijmenam, How Decentralised Finance will Change the World’s Economy, Experfy, (Mar. 6, 2020), https://www.experfy.com/blog/how-decentralised-finance-change-worlds-economy/.
See Alyssia Hertig, What is DeFi?, Coin Desk, https://www.coindesk.com/what-is-defi (last visited Sept. 10, 2020); see also, Benjamin Vitáris, What is an Initial Exchange Offering (IEO) and how it Differs from ICO?, Crypto Potato, (Jun. 24, 2020), https://cryptopotato.com/what-is-an-initial-exchange-offering-ieo-and-how-it-differs-from-ico/.
See generally Quadarch-Crypto Venture Capital Fund, Crypto Fund Rsch., https://cryptofundresearch.com/qua september darch-crypto-fund/ (last visited Aug. 30, 2020).
PRS Legislative Research: Banning of Cryptocurrency and Regulation of Official Digital Currency Bill (2019).
See e.g., Prasif Bannerjee, Banning Cryptocurrencies in India not a Solution, Mint, (Jul. 30, 2019, 2:18 PM), https://www.livemint.com/news/india/banning-cryptocurrency-in-india-not-a-solution-nasscom-1564476081539.html.
See KYC Chain, supra note 10.
It is evident from the article that crypto can be included under the category of “goods” as defined in the Sales of Goods Act, 1930. However, a separate collateral classification or the expansion of present definition of securities or commodities will help in removing the prevailing uncertainty on the legal recognition of crypto assets in India.
See, e.g., Kevin Helms, FATF Releases Global Standards for Crypto Assets, Bitcoin News, https://news.bitcoin.com/fatf-global-standards-crypto-assets/ (last visited Oct. 1, 2020); see generally Blockchain and Emerging Digital Technology for Enhancing Post 2020 Climate Markets, World Bank Grp., http://documents1.worldbank.org/curated/en/942981521464296927/pdf/124402-WP-Blockchainandemergingdigitaltechnologiesforenhancingpostclimatemarkets-PUBLIC.pdf (last visited Sept. 1, 2020).