Associate Professor of International Law - ESSCA

In an increasingly digitalised world, the European Union has taken a step forward with the publication of the 'MiCA' Regulation (Markets in Crypto-Assets) in 2023, establishing a pioneering legal framework for crypto-assets. This framework not only defines crypto-assets as digital representations of value or rights that can be electronically transferred and stored using Distributed Ledger Technology (DLT), but also seeks to address unprecedented legal and economic challenges arising in the context of economic crises.

Amidst an economic crisis, navigating the legal complexities surrounding these assets presents unprecedented challenges. Identifying viable solutions becomes imperative in ensuring stability and resilience within the crypto-asset landscape.

What happens in the event of insolvency?

Media often highlights the dramatic collapses of trading and storage platforms for crypto-assets, such as the cases of FTX in the United States or Mt. Gox in Japan, which vanished in 2014. However, the connection between economic crises and crypto-assets extends beyond these illustrations. Financial strains can affect any sector and economic entity that holds such assets on its balance sheet.

The critical issue, particularly during a company's insolvency, revolves around clarifying ownership rights to crypto-assets. This poses a legal challenge demanding careful consideration.

Hence, it is crucial to develop a precise comprehension of the legal and economic aspects, especially within a landscape where the complexity of the crypto-asset market is compounded by diverse storage methods.

In the maze of economic functions developed by crypto-asset service providers (CASPs), each crisis episode adds a critical dimension. Responses to the solvency challenge not only vary depending on national jurisdictions but also crucially rely on regulatory rules and national private law frameworks.

The three main areas of consideration regarding the intersection between crypto-assets and solvency include:

  • (1) Legal treatment of crypto-assets,
  • (2) Evaluation of these assets,
  • (3) Specific cross-border challenges in insolvency scenarios.

These three challenges are examined in more detail in this article.

Legal treatment of crypto-assets: unraveling the complexity

Examining the legal treatment of crypto-assets in insolvency proceedings is akin to navigating a labyrinth. At every twist and turn, fresh legal inquiries surface. Central to this challenge is a fundamental question: are crypto-assets acknowledged as objects of ownership under national law?

The extension of ownership rights varies significantly from one jurisdiction to another, contingent upon how each national legal system addresses intangible digital objects like these assets. Determining a crypto-asset's status as property— i.e., whether it embodies ownership rights—transcends regulatory rules. It represents a crucial aspect of national private law.

Regarding insolvency proceedings, if crypto-assets are not recognised as property, it is challenging to ascertain if they are part of the debtor's estate or constitute a creditor's collateral. The determination varies based on national rules and custodial arrangements in each jurisdiction.

In certain jurisdictions, such as France, the United States, the United Kingdom, and Brazil, these assets are generally deemed intangible movable property that can be acquired. Consequently, they may be seized and distributed to creditors during insolvency proceedings. In French private law, crypto-assets are regarded as incorporeal movable property of a fungible nature (e.g., Nanterre Business Court, 26 February 2020, n° 2018F00466), except for non-fungible tokens (NFTs).

However, in other jurisdictions, elucidating legal standing can pose practical challenges, notably in nations that do not attribute the same ownership effects to intangible assets within their private law systems. Traditionally, that is the case for German and Japanese legal regimes. In such instances, formulating precise rules to address these nuances becomes imperative.

Crypto-assets, encompassing both native tokens and tokenised assets, are intangible property. They should not be treated as commodities but rather as property akin to those safeguarded by intellectual property laws. These assets should be recognised as objects of ownership, whether they represent value or rights, and serve as collateral in contractual transactions. In practice, the level of fungibility will also dictate the extent of these rights: the less fungible, the more legally-protected the investor or creditor can be.

Still, in many jurisdictions, new legal rules must be established to govern the circulation and negotiation of crypto-assets. For example, cryptographic keys are necessary to exert control over these assets, a factual legal concept prevalent in common law jurisdictions, which differs from the notion of possession in civil law countries (see principle 6 of the Unidroit guidelines on digital assets and private law).

The control over keys does not signify ownership of the asset. Therefore, the saying "not your keys, not your coins"[1] is legally inaccurate. Private law defines the framework for tokenised economic relations. Transferring a crypto-asset does not always imply a legitimate change of ownership, as seen in cases of fraud or theft. The legal classification is independent of the factual ability to return the asset to its rightful owner.

For instance, crypto custody should not entail a transfer of ownership from the consumer-investor to the CASP. Custody involves exerting control over the asset, which carries the associated legal obligations of a custodian. In the case of the custodian's bankruptcy, the investor possesses personal or real rights against the crypto intermediary, depending on the asset's fungibility as defined in the correspondent private laws.

Challenges in evaluating crypto-assets during financial crises

The second key aspect is another complex puzzle. Crypto-assets pose challenges in determining their value during insolvency proceedings, impacting the interests of creditors. In asserting their collateral, creditors have the duty to obtain the best reasonably achievable price. Generally, this does not involve delaying execution in the hope of higher values. However, the inherent volatility of these markets can pose substantial challenges for all stakeholders involved.

National insolvency rules govern the allocation of responsibilities among stakeholders in various scenarios, such as distressed company sales. Additionally, they establish criteria and methods for converting asset prices into the official currency.

In the European Union, member States should expedite the harmonisation of their insolvency laws. In addition to advancing the Capital Markets Union goals, this harmonisation aims to streamline asset recovery from liquidated estates and ensure equitable distribution among creditors, impacting crypto-asset proceedings too.

Borderless Blockchain: The Intricacies of Cross-Border Cooperation in Crypto-Asset Disputes

The third aspect involves cross-border cooperation in the crypto-assets realm, which operates on DLT, extending beyond single jurisdictions.

The complexity related to the storage of these assets does not make the task easier. If controlled by the owner (for example, in cold storage) and fraud is detected, insolvency practitioners should ensure their access to the private key. If held in custody by foreign CASPs, it may require international judicial cooperation. In any case, the burden of proving the existence of these assets generally falls on the creditors.

In complex crises, multiple courts may claim jurisdiction based on national laws; for instance, English courts argue that crypto-assets reside where the owner is domiciled (e.g., Ltd v Persons Unknown and D'Aloia v Persons Unknown). Differing court approaches promote arbitration, prompting stakeholders to seek proceedings elsewhere.

Seeking Legal Certainty: Reforms for a Tokenised Economy

During crises, the legal complexities of crypto-assets extend beyond regulatory rules to include country-specific private laws. Homogenisation efforts, such as those proposed by MiCA, may face implementation obstacles on a national scale.

This article highlights issues regarding legal treatment, evaluation challenges, and technology's global nature of crypto-assets. An unstable legal landscape negatively impacts product design and investor decisions involving these assets. Looking ahead, legislative reforms addressing tokenised relations' private law aspects are needed worldwide, alongside sector-specific rules under MiCA at the European level.

[1] "Not your keys, not your coins" (NYKNYC) is a widely recognized and popular phrase in the cryptocurrency community, emphasizing the importance of managing your private keys to truly possess your coins (not in the legal sense).

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