What Happens to Cryptocurrency During Bankruptcy?

If you are a crypto investor or Web 3.0 enthusiast, filing for bankruptcy raises many questions about what you can keep and what needs to go toward debt repayment. Read our blog for more information about bankruptcy, cryptocurrency, and what crypto investors should know before filing.

What Is Cryptocurrency?

Investing is not limited to property or the stock market anymore. Now, prospective investors can put their money toward a new future where currency is not regulated by any government and increases in value exponentially. Cryptocurrency is an unregulated form of currency based on blockchain technology and is entirely virtual.

The Blockchain

To understand crypto, it is important to have a basic understanding of blockchain technology. The blockchain is a database network that stores data in blocks chained together with code. In many ways, the blockchain is like a game of telephone. During telephone, one person creates a message and passes it on from person to person until the last person in the line says the message aloud.

In the blockchain, data is passed from one block to another. Each block has a designated storage capacity and when it reaches maximum capacity, new data is passed on through the chain to the next block and so on. All information stored in the blockchain is encrypted meaning it stays private unless a person has the encryption key.

Drawbacks

Cryptocurrency is stored on the blockchain, and investors have wallets that store their crypto and are only accessible by a unique one-of-a-kind key. One of the drawbacks of cryptocurrency is that because it is not backed by a government entity, there is only a finite amount available to investors. There are no treasury departments to “print” more crypto.

While crypto is a valuable investment opportunity, the ebbs and flows can be detrimental to some investors leaving them with no choice but to file for bankruptcy. So, what happens to cryptocurrency during bankruptcy? Keep reading to find out.

Chapter 7

When filing for bankruptcy, crypto investors could encounter loses during Chapter 7. Chapter 7 bankruptcy, also known as liquidation, involves assigning a trustee to the debtor so they can manage the liquidation of the estate. During this process, all the debtor’s property (including investments) into exempt and nonexempt property.

Exempt property is everything necessary to maintain a standard of living. This means that if the debtor commutes to work, they may be able to keep their car. Whatever is not necessary for maintaining a standard of living is typically put into the nonexempt category. Property that is nonexempt will be subject to liquidation.

For trustees, the challenge in cases is determining when the debtor began investing and how many transactions were made. When filing for bankruptcy the de tor must provide a comprehensive account of all of their assets including investment yields. However, in many cases, crypto transactions are not included in the Schedule or Statement of Financial Affairs. Because of this, the trustee must trace all transactions and review bank statements from Coinbase/BTC.

The difficulty with this process is that crypto transactions can be hard to uncover there is the risk that the debtor could be hiding assets within the web of the blockchain. The worst thing a debtor can do is hide assets from the bankruptcy court. It is always best to provide too much information than not enough.

Risks of Filing for Bankruptcy

For investors, there could be a lot to lose when filing for bankruptcy. In most cases, investment yield may not be exempt from liquidation. On the other hand, investment yield could also exempt the debtor from Chapter 7 altogether.

If a debtor has too much disposable income, they may not pass the means test and qualify for Chapter 7. Instead, they may file for Chapter 13 reorganization which would put their disposable income toward their debt. During reorganization, the debtor may be restricted by their ability to continue to trade and make a profit. Making more money while in bankruptcy can raise questions about why the debtor filed for bankruptcy and whether there is something else at play.

Tips for Crypto Investors Filing for Bankruptcy

When filing for bankruptcy, there are many factors that can impact a case. The most important tip for crypto investors is to be as honest as possible about their investments. When the trustee and the court have all the information they need, they can help the debtor resolve their debt without the need for further investigation.

Another thing to keep in mind, is that preparation is key. Filing for bankruptcy is not easy and getting ready to file takes time and lots of planning and preparation. Debtors must provide a plethora of documentation to the bankruptcy court.