Cryptocurrencies are digital assets created (mined) using encryption technology to enable secure trading, investing, ownership, currency exchanges and purchases without the use of banks or governments (decentralised). Cryptocurrency is stored in encrypted digital wallets and transactions exist as digital entries in a distributed ledger across a network of users. The ledger is public and known as a blockchain, holding a record of all transactions.
With an increasing amount of individuals and businesses adopting cryptocurrency as both investment and payment options, digital currencies are increasingly forming part of assets in both personal and corporate insolvencies matters. The treatment of these assets in matters of insolvency present complex challenges including identifying and securing any digital assets as well as the process of selling the asset for the benefit of creditors.
With digital currencies here to stay, businesses and individuals alike need to be aware of the financial risks and potential implications in the event of insolvency.
Cryptocurrency in Bankruptcy
As with any other asset, a person’s interest in a cryptocurrency on or after the date of bankruptcy will vest in the trustee as an asset of the estate and may be realised for the interest of creditors. Ownership of any cryptocurrencies must be disclosed to the Bankrupt’s trustee where failure to do so may be deemed an offence under the Bankruptcy Act. In order to secure the cryptocurrency, the Bankrupt must provide the associated public and private keys to the Trustee.
The Trustee will investigate and seek to obtain information from the Bankrupt to confirm whether or not an interest is held in a cryptocurrency. The Trustee may consider reviewing bank statements in order to identify transactions as well as collecting electronic evidence such as emails, browsing history, mobile application access records and computer hardware, to prove ownership.
The Australian Financial Security Authority (AFSA) has a number of processes in place to assist trustees in identifying, classifying and realising digital assets. Learn more here.
Cryptocurrency in Corporate Insolvency
At the commencement of an external administration, a thorough investigation of the company and its affairs will be conducted in order to identify and secure any assets. It is expected that the company will disclose any interest in cryptocurrency from the outset, however, should the administrators suspect that the company is not forthcoming with information, engagement with a broader group of stakeholders may be required.
In doing so, the administrators will aim to determine if there had been any dealings between external parties and the insolvent company where cryptocurrency was used.
Insolvency practitioners can use their powers under the Corporations Act 2001 (Cth) to acquire access credentials to cryptocurrency held by the insolvent company and subsequently secure it in a digital wallet. Along with the other assets of the business, the cryptocurrency will be realised for the benefit of creditors.
Case Studies
Case Study 1
Take for example, Alexandra, who is a bankrupt but earning a reasonable income, decides to purchase $30,000 in Xcrypto (a cryptocurrency) with her savings/income. Over a period of time, she notices the value of Xcrypto is making significant gains on the market and decides to trade on XChange, a trading platform. After some months, she converts the Xcrypto and transfers funds into her savings account, having made a profit of $15,000 from trade.
As the Xcrypto was acquired after Alexandra’s bankruptcy had commenced, and despite being purchased with post-bankruptcy income, the Xcrypto is deemed ‘property’ for the purpose of the Bankruptcy Act. In this case, proceeds from the sale of Alexandra’s Xcrypto, including any gains from trading, will vest in the Official Trustee as an asset of the bankrupt estate.
Case Study 2
Assume Andrew utilises a cryptocurrency exchange platform and chooses to deposit $10,000 worth of a given cryptocurrency in exchange for $5,000 in US dollars (in the form of a loan and repayable in the long-term future).
Why might Andrew do this? Maybe he does not want to lose his cryptocurrency, but has a desire to buy a small car for his daughter or son.
Under the Personal Property Securities Act, if Andrew were to enter insolvency, arguably the platform he used, which is made up of millions of individual depositors, could be required to perfect its security interest against Andrew. This perfection could be achieved by control (but that would largely depend on the terms and conditions of the platform) or by registering their security interest on the Personal Property Securities Register.
Further case studies on how Government bodies, such as the Australian Tax Office regulate cryptocurrency as an asset can be viewed here.
FAQs
Cryptocurrency are digital assets created by blockchain technology which allows the owners to trade, invest, exchange and purchase without the need for a central party (such as a bank).
As with any other asset, a Trustee or Liquidator should be advised immediately on appointment that cryptocurrency is held by the individual or business. Electronic evidence to prove such should also be provided in order to assist the Trustee or Liquidator in promptly identifying and securing the cryptocurrency assets.
Failing to disclose interest in cryptocurrency could be deemed an offence and may result in the Trustee or Liquidator taking further action.
Determining the value of cryptocurrency can be challenging, not least because of the volatility of the market. Trustees or Liquidators trying to evaluate cryptocurrency will require assistance with access to the software used for the given cryptocurrency and the exchange platform on which it is traded.
Once secured, the asset is realised as quickly as possible in order to mitigate market volatility risks. Should the cost of realising the asset be too onerous and not commercially viable, then no further action may be taken.
Should the cryptocurrency be realised, the funds from sale will be used to settled debts owed to creditors.
Treatment of cryptocurrency will be different in each administration and depend particularly on if it is being used for trading, as an investment or purely for purchase of goods and services.
As with any other asset, should cryptocurrency be acquired on or after the date of bankruptcy, the debtor’s interest will vest in the Trustee as an asset of the estate (with some exemptions). The bankrupt is required to advise the Trustee at the commencement of the administration whether or not an interest is held in cryptocurrency.
The bankrupt will be required to provide all access credentials in order to allow the Trustee to identify and secure the cryptocurrency in a digital wallet.
Should cryptocurrency be acquired by a bankrupt with his or her income, the trustee may seek to clarify the purpose of the purchase in order to identify whether or not it vest as an asset in the bankrupt estate. If the intent of purchase was to use the cryptocurrency as a substitute to legal currency (for example to purchase or sell goods and services), then this may not be the case. The trustee will make a determination based on the outcome of the investigation.
Where the bankrupt is a high income earner, the trustee will review account statements and transactions periodically over the course of the bankruptcy in order to identify any cryptocurrency investments. Where transactions are discovered, the trustee will aim to ascertain the purpose of the investments, the intended use of the cryptocurrency, and whether it should vest as an asset in the bankrupt estate.
In a corporate insolvency scenario, insolvency practitioners can use their powers under the Corporations Act 2001 (Cth) to acquire access credentials to cryptocurrency held by the insolvent company and secure it in a digital wallet. Along with other assets of the business, the cryptocurrency will be realised for the benefit of creditors.
Engagement with a broader group of stakeholders may also be required in order to determine if there had been any dealings with the insolvency company where cryptocurrency was used. This may result in the Liquidator identifying unfair preference payments and clawing back funds.
Cryptocurrency being used in business activities need to be accounted for in the same way as any other asset. Should the business receive cryptocurrency in exchange for goods or services, the value of the cryptocurrency (in Australian dollars) must be included as part of the ordinary income of the business. Reputable exchange platforms can be used to obtain a fair market value of the cryptocurrency.
Having this data recorded accurately is particularly important should a business enter into insolvency.
Regardless of the purpose behind cryptocurrency transactions, whether for investment, personal or business use, clear and accurate records must be kept of each transaction.
The following cryptocurrency transaction details should be recorded and kept:
- date of transactions
- value of the cryptocurrency (in Australian dollars) at the time the transaction takes place
- the purpose of the transaction
- the other party involved in the transaction
This will allow a Trustee or Liquidator to accurately assess the situation in the event of insolvency.
There are tax implications associated with acquiring or utilising cryptocurrency, those of which vary depending on the situation. The Australian Taxation Office has made it clear that any person acquiring or disposing of cryptocurrency must keep accurate records of all transactions.
A capital gains tax (CGT) event occurs when cryptocurrency is disposed of. Examples of disposal include:
- selling or gifting cryptocurrency
- trade or exchange of cryptocurrency (include one currency for another)
- converting cryptocurrency to a currency of legal tender (such as Australian dollars)
- using cryptocurrency to obtain goods and services
In this case, some or all of the gain may be taxed. It is important to note that while a digital wallet may contain different types of currency, each is classified as a separate CGT asset.
Learn more about the tax treatment of cryptocurrencies here.
Cryptocurrency can be claimed by a trustee as it is a digital asset that may be sold for profit or gain, similar to shares.
Super payments received before bankruptcy are claimable by a trustee. Assets purchased with super funds prior to bankruptcy (such as a house or car) are also claimable.
Lump sum payments received during or after bankruptcy, or assets purchased with those funds, are unable to be claimed by a trustee.
There are certain exceptions to this. To learn more, speak to one of our experts on 1800 246 801.
By law, bankrupts cannot be a trustee of a SMSF. The bankrupt must notify their trustee immediately if they have a SMSF and cease acting in such a capacity, notifying the ATO within 28 days.
In the event of bankruptcy, the fund may need to restructured or revert to a small APRA fund. Alternatively, the assets may be realised and transferred into a retail fund with the SMSF to be wound up.
To learn more about how a SMSF is treated in bankruptcy, read our article here.
Blockchain is a decentralised system of recording transactions encrypted via a distributed ledger. This allows for information (financial and non-financial) to be stored accurately and securely through encryption. Blockchain technology is used as a way to store data while cryptocurrency is a medium of exchange.
The nature of a decentralised finance system means verification of transactions do not rely on an intermediary such as a bank. As the system is peer-to-peer, it allows anyone to send and receive payments anywhere, at any time with transactions verified by the network.
An example of a cryptocurrency transaction (in this case, Bitcoin), is set out below:
- Alexandra wants to send Bitcoin to Andrew. To do so, Alexandra sends instructions to transfer Bitcoin from her wallet to Andrew by using an exchange platform such as Swyftx, Binance or Crypto.com. Anyone using the network can view the message containing the instructions from Alexandra.
- Both Alexandra and Andrew will need to wait for the transaction to be confirmed. Depending on the cryptocurrency used, this confirmation process could take anywhere from a few seconds to a few hours.
- The pending transaction is sent to the network for confirmation. This task is performed by miners, which are a group of computers that maintain the network. The transaction is grouped together in a block with other pending transactions and then transformed into code.
- Miners compete to find the code which will verify the transaction.
- Once the code has been solved, the transaction is verified and added to the blockchain.
- Anyone with a copy of the blockchain (in reality, every computer on the network), will receive an updated version with the new block added.
- At this point, Andrew will be able to see the Bitcoin from Alexandra in his wallet.
Learn more about cryptocurrencies and how transactions work here.
Blockchain creates an encrypted record of the critical information in a transaction which cannot be modified. This information is stored across a network of computers as opposed to a single storage location as is traditionally the case. When a new transaction takes place, a block is created and sent to each node in the network for validation and verification.
Once verified, the block is added to the existing blockchain and the update of this is distributed across the entire network, with the transaction effectively complete.
The nature of the process means that critical information, whether financial or other, can be stored in a way which cannot be altered, thereby preventing fraud and unauthorised activity.
The process also provides greater transparency and traceability as an audit trail is created, documenting each asset and the steps it has taken along a journey. This has wide ranging implications across not just financial services, but any industry where there are concerns around counterfeiting or fraud.
One significant benefit of blockchain technology is that it does away with the need for an intermediary or central authority to authenticate transactions.
In order to do so, cryptographic keys are used to identify users and provide access to their account. Users have both a private key (unique & secret to a given user) and a public key (which is widely distributed).
The private key is, in essence, a user’s digital signature which is used to verify the origin of a transaction from a particular user. The private key can be verified by using the matching public key (which is known to anyone on the network).
As an example of all this in practice:
- Tom wants to send 1 coin (of a particular cryptocurrency) to Alex. Using his private key, Tom can sign a message with details of the transaction which contains the amount he would like to send and Alex’s public key.
- This message is the broadcast to the network. Anyone on the network can now use the public key to verify the transaction is coming from the legitimate account owner, in this case, Tom. The network solves complex mathematical equations to confirm the validity of the transaction.
- Once the transaction is confirmed as legitimate, it is grouped together in a block with other, recent transactions. This information is encrypted.
- The block is added to the existing blockchain and the update is registered across the network.
- Alex then receives the coin from Tom and the transaction is deemed complete.
In The News
Recent cryptocurrency related insolvency matters in the news:
- Troubled exchange MyCryptoWallet bites the dust after barrage of complaints
- MyCryptoWallet collapses, liquidators appointed
- $20m Cryptopia heist: Liquidators wheel out the heavy artillery
- The search is on for $50m in lost cryptocurrency after two Australian exchanges collapse
- Failed crypto company collapses owing $21m
- Cryptocurrency platform for sale
Our Experience
SV Partners has developed an in-depth understanding of the complexities and regulations impacting the industry through first-hand experience dealing with cryptocurrency businesses and exchange platforms facing financial difficulties, stress or insolvency.
Our team have gained knowledge around the specific requirements that businesses and stakeholders face through our engagement in a variety of matters of varying scope and complexity.
To find out how we can assist, contact Matthew Hudson or Andrew Allemand from our cryptocurrency team on 1800 246 801 or email us at contact@svp.com.au
How can SV Partners help?
Our industry experience has allowed us to develop expert skills and apply them across small and large scale matters of varying complexity across the sector. Our close relationships with trusted external industry experts means we can call on additional resources where required and are able to assist with any engagement.
We take a collaborative approach to our work, partnering with business owners to address all concerns in a given situation and take a measured approach in our evaluation and options for moving forward. We make sure to consider individual circumstances and all contributing factors when assessing each situation.
We are well placed to assist with all cryptocurrency matters. In addition to our metro offices, we maintain a strong regional focus in South Australia, Queensland and New South Wales with offices in Adelaide, Mackay, Rockhampton, Sunshine Coast, Toowoomba, Gold Coast, Wollongong, Newcastle, Dubbo and Tamworth.