Last summer, the crypto industry experienced a significant downturn. Precipitated by interrelated factors in the traditional economy and the crypto sector, the industry’s distress has caused a drop in cryptocurrency prices and several high-profile insolvencies.
Notably, crypto firms Voyager Digital, Celsius Network, and Three Arrows Capital have all filed for Chapter 11 or similar proceedings.
This crash affected many individual cryptocurrency holders. As insolvencies progress, courts can clarify open insolvency law issues related to crypto.
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He drew attention to the need to resolve longstanding regulatory uncertainty in space with deeper controls. And it could produce clearer rules for the crypto industry.
Starting in late 2021 and continuing into this year, cryptocurrency prices have fallen from all-time highs to much lower levels. Between November 2021 and June 2022, the price of bitcoin – widely seen as a proxy for the crypto market – fell from an all-time high of over $68,000 to just under $20,000, where it sits. still today.
The roots of this crash go back to the early days of Covid-19. As central banks and governments enacted relief packages to ease economic turmoil, asset prices soared across multiple sectors, including cryptocurrency. In 2022, however, these stimulus programs have begun to wind down.
Their end coincided with Russia’s invasion of Ukraine and the resulting rise in commodity prices as governments imposed sanctions on Russia.
Fear of a coming recession has spread throughout the economy and technology assets of all kinds have lost value. Crypto assets were not immune to this widespread downturn and their value fell steadily until early 2022.
This decline accelerated in May when the UST stablecoin lost its peg to the US dollar. Stablecoins – a type of crypto asset – seek to maintain a specific value relative to another asset. UST aimed to maintain a value of exactly $1.
But in May, the system that maintained this value failed, users rushed to sell their holdings of UST and sister cryptocurrency Luna, and both coins became completely worthless.
Due to the constant price of UST, cryptocurrency traders have relied heavily on the stablecoin to buy and sell other crypto assets. When this common medium of exchange lost value, users sold other assets to recoup their losses, causing the steady decline in crypto prices to accelerate into a veritable crash.
This slowdown has affected businesses and investors across the sector. Companies with high exposure to UST and Luna were the hardest hit, and their inability to meet their financial obligations had a domino effect on other companies.
When crypto investors learned of this news, they withdrew their investments from crypto exchanges, which led to further price declines and liquidity issues.
Following the crash, crypto exchange Voyager Digital, lending platform Celsius Network, and crypto fund Three Arrows Capital all filed for insolvency. These cases are still pending in US bankruptcy courts and elsewhere.
Need for regulatory and legal clarity
The crypto downturn could ultimately result in clearer rules for the space as courts in these insolvency proceedings resolve open legal issues and regulators consider tighter controls on cryptocurrency in response to the crash.
The insolvency proceedings of Voyager, Celsius and Three Arrows could produce long-sought legal clarity regarding cryptocurrency. As these cases progress, the courts may address and resolve a variety of open legal issues, including:
- If crypto accounts become estate property (or client property) when the custodian enters Chapter 11;
- How bankruptcy claims are assessed when the price of crypto assets fluctuates during a bankruptcy;
- Whether certain cryptocurrencies qualify as a security, commodity, currency, other asset class, or combination, which could impact issues such as automatic suspension exceptions; and
- Where digital crypto assets are legally “located”
A panel of account holders in the Celsius Chapter 11 cases has sought a declaratory ruling that the custodial accounts are not the property of the bankruptcy estate. As these cases progress, the courts may soon resolve this and other similar legal issues.
The industry’s downfall has also caught the attention of US regulators and lawmakers. Since stablecoins create particular economic risks, as evidenced by the impact of the collapse of UST and Luna, regulators are focusing particularly on these assets.
On March 9, President Joe Biden signed an executive order encouraging federal action on cryptocurrency. Among other measures, the order called on the Treasury Department to develop policy recommendations and an oversight regime to deal with the growing crypto industry.
Lawmakers have also set their sights on crypto, and several major bills are being discussed. The Stablecoin Transparency Bill, pending in the Senate, would require any stablecoin issuer to register as a money transfer business, insured depository institution, or new class of business.
Separately, the Responsible Financial Innovation Act, also pending in the Senate, would require stablecoin issuers to maintain traditional assets equal to the value of their coins in circulation, preventing the kind of meltdown that the UST and Luna have known.
And an as-yet-unnamed bill pending in the House of Representatives would allow banks to issue stablecoins and appoint the Federal Reserve as overseer of non-bank stablecoin issuers.
For these reasons, the crypto downturn may lead to clearer rules for the crypto space as courts resolve open legal issues and regulators impose new controls.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Ronit J. Berkovitch is a partner in the restructuring department of Weil, Gotshal & Manges, where she represents debtors, creditors, lenders, investors and purchasers of assets in all aspects of distress situations.
John Marinelli is an associate in the restructuring department of Weil.
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Crypto Slowdown Will Bring Legal And Regulatory Clarity
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