Crypto Downturn Will Bring Legal & Regulatory Clarity – Bloomberg Law | Jewelry Dukan

Last summer, the crypto industry experienced a significant downturn. Triggered by interrelated factors in the traditional economy and the crypto sector, the industry’s plight caused a crash in cryptocurrency prices and several high-profile bankruptcies.

Notably, crypto firms Voyager Digital, Celsius Network, and Three Arrows Capital have all filed for Chapter 11 or similar proceedings.

This crash has hit many cryptocurrency retailers. As the insolvencies progress, courts can clarify open insolvency law issues in connection with crypto.

It has drawn attention to the need to resolve longstanding regulatory uncertainty in this area through more thorough controls. And it could bring about clearer rules for the crypto sector.

Steady decline

Starting in late 2021 and into this year, cryptocurrency prices fell from all-time highs to much lower levels. Between November 2021 and June 2022, the price of bitcoin — widely viewed as a proxy for the crypto market — plummeted from an all-time high of over $68,000 to just under $20,000, where it remains today.

The roots of this crash go back to the earliest days of Covid-19. As central banks and governments enacted bailout programs to ease economic turmoil, asset prices soared across several sectors, including cryptocurrency. In 2022, however, these stimulus programs began to expire.

Their demise coincided with the Russian invasion of Ukraine and a consequent spike in commodity prices as governments imposed sanctions on Russia.

Fears of an imminent recession spread throughout the economy, and tech assets of all kinds fell in value. Crypto assets couldn’t escape this broad downturn, and their values ​​fell steadily through early 2022.

This decline accelerated in May when stablecoin UST lost its peg to the US dollar. Stablecoins – a type of crypto asset – try to maintain a certain value relative to another asset. UST aimed to hold a value of exactly $1.

But in May, the system maintaining this value failed, users rushed to sell their holdings of UST and sister cryptocurrency Luna, and both coins became completely worthless.

Due to UST’s constant price, cryptocurrency traders have largely relied on the stablecoin to buy and sell other crypto assets. As this common medium of exchange lost its value, users sold other assets to offset their losses, causing the previously steady decline in crypto prices to accelerate into an all-out crash.

This downturn impacted companies and investors across the sector. Companies with significant exposure to UST and Luna were hit the hardest, and their inability to meet their financial obligations created a domino effect on other companies.

Upon hearing this news, crypto investors withdrew investments from crypto exchanges, leading to further price declines and liquidity issues.

As a result of the crash, crypto exchange Voyager Digital, lending platform Celsius Network and crypto fund Three Arrows Capital have all filed for bankruptcy. These cases remain pending in US bankruptcy courts and elsewhere.

Need for regulatory and legal clarity

The crypto downturn may ultimately result in clearer rules for space as courts resolve outstanding legal issues in these bankruptcy cases and regulators consider tighter controls on cryptocurrency in response to the crash.

The Voyager, Celsius, and Three Arrows bankruptcies could bring long-awaited legal clarity to cryptocurrency. During the course of these cases, courts may address and resolve a variety of outstanding legal issues, including:

  • Whether crypto accounts become property of the estate (or client property) when the trustee enters Chapter 11;
  • How bankruptcy claims are valued when crypto assets fluctuate in price over the course of a bankruptcy;
  • Whether certain cryptocurrencies qualify as securities, commodities, currencies, another asset class, or a combination thereof, which could impact issues such as exceptions to automatic suspension; and
  • Where Digital Crypto Assets Are Legally “Located”

A committee of account holders in the Celsius Chapter 11 cases has sought a declaratory judgment that custodial accounts are not owned by the estate. As these cases progress, courts may soon resolve these and other similar legal issues.

The industry slump has also caught the attention of US regulators and lawmakers. Because stablecoins pose particular economic risks — as the fallout from the UST and Luna collapses have demonstrated — regulators are particularly focused on these assets.

On March 9, President Joe Biden signed an executive order encouraging federal action on cryptocurrencies. Among other things, the order called on the Treasury Department to develop policy recommendations and an oversight regime to address the growing crypto sector.

Legislators have also targeted crypto, and several major bills are under discussion. The proposed stablecoin transparency bill pending in the Senate would require every stablecoin issuer to register as a money-transmitting entity, insured depository entity, or a new business category.

Separately, the Responsible Financial Innovation Act, also pending in the Senate, would require stablecoin issuers to hold traditional assets at the value of their outstanding coins to prevent the collapse experienced by UST and Luna.

And a yet-unnamed bill pending in the House of Representatives would reportedly allow banks to issue stablecoins and appoint the Federal Reserve to oversee non-bank stablecoin issuers.

For these reasons, the crypto downturn may result in clearer rules for the crypto space as courts clarify open legal issues and regulators impose new controls.

This article does not necessarily represent the opinion of the Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Information about the author

Ronit J. Berkovich is a partner in the restructuring department of Weil, Gotshal & Manges, where she represents debtors, creditors, lenders, investors and asset purchasers in all aspects of distressed situations.

John Marinelli is an Associate in Weil’s Restructuring Practice.

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