As digital assets like cryptocurrency and NFTs (non-fungible tokens) become more mainstream, more people are wondering what might happen to these assets if they face bankruptcy. For years, personal and business bankruptcy has primarily dealt with traditional assets such as real estate, cash, and stocks. But, the rapid rise of digital assets presents a new frontier in bankruptcy law that leaves many with questions. Understanding how cryptocurrency and NFTs are treated in bankruptcy cases can help you prepare, safeguard your assets, and make informed decisions if financial hardship looms.
In this post, we’ll dive into what happens to digital assets in bankruptcy, explore how they’re valued, and review strategies to protect your digital wealth during difficult times.
Understanding Digital Assets in Bankruptcy: Cryptocurrency, NFTs, and More
Digital assets have added a new layer of complexity to bankruptcy cases. Traditionally, bankruptcy cases only had to deal with tangible assets such as real estate, liquid assets like cash, and financial instruments including stocks and bonds. However, digital assets have introduced a new type of property that may or may not fit neatly into existing legal frameworks. Cryptocurrency, for example, can function as currency or an investment asset, while NFTs often represent ownership of unique digital items, from artwork to virtual land.
Cryptocurrency is a decentralized digital currency that exists primarily on blockchain technology, and NFTs, also stored on blockchains, represent ownership of a specific digital item, such as art or collectibles. With both types of assets, ownership is recorded on a blockchain, meaning they are managed outside of traditional banking systems. Their decentralized nature also means they can be moved or stored outside the reach of traditional financial institutions, making them somewhat elusive when it comes to bankruptcy law.
The rise of digital assets has forced the legal system to adapt. Courts and legal professionals now consider whether digital assets fall under the property or are something different altogether. As a result, it's essential for anyone holding cryptocurrency or NFTs to understand how these assets might be viewed in bankruptcy proceedings.
Are Digital Assets Considered Property? Key Legal Definitions and Implications.
One of the first questions that comes up in a bankruptcy involving digital assets is whether they are considered property. In the eyes of bankruptcy law, property typically includes anything that the debtor has an ownership interest in, whether it be tangible or intangible. Courts, so far, have largely treated cryptocurrency as property rather than as currency. NFTs, likewise, are generally considered assets rather than mere representations of digital items. This means both are typically included as part of the debtor's estate when they file for bankruptcy.
Because they’re treated as property, cryptocurrency and NFTs are generally subject to liquidation or reorganization under bankruptcy laws, similar to how physical assets or stocks would be. In a Chapter 7 bankruptcy, this could mean the sale of digital assets to pay creditors. In a Chapter 13 case, these assets may factor into the repayment plan, potentially requiring the debtor to assign a value to them or liquidate some assets as part of the plan to pay creditors.
For individuals holding significant digital assets, this legal treatment highlights the importance of accurately valuing and reporting these assets in bankruptcy proceedings. Misrepresenting the value or existence of digital assets could lead to legal consequences such as fines, penalties, or even criminal charges, so it's crucial to be transparent and informed.
How Are Cryptocurrency and NFTs Valued During Bankruptcy Proceedings?
The valuation of cryptocurrency and NFTs during bankruptcy is a complex and sometimes contentious process. Unlike traditional assets, whose values are generally stable or can be easily appraised, digital assets are highly volatile. Cryptocurrencies, for example, can experience daily price fluctuations, and NFTs have no standardized valuation method, as they are often unique and market-dependent.
During bankruptcy proceedings, cryptocurrency is usually valued at its market price on the date of filing. This means if the price of a specific cryptocurrency was high at the time of filing, it could increase the amount the bankruptcy trustee considers part of your estate. However, if prices drop significantly after filing, it may still complicate liquidation processes.
The valuation of NFTs can be even more complex. NFTs are non-fungible, meaning their value is based on their uniqueness and market demand. In many cases, trustees may bring in appraisers or use third-party valuations to estimate the NFT's value at the time of filing.
Courts and trustees generally try to assign the most reasonable and current value possible for digital assets, but it is an evolving area of law that is likely to change as digital asset markets mature. For now, the key is understanding that both cryptocurrency and NFTs will likely need to be valued and reported accurately.
Steps to Safeguard Your Digital Assets if Bankruptcy Looms
If you anticipate the possibility of filing for bankruptcy, taking proactive steps can help protect your digital assets. While these strategies won’t make your assets “untouchable,” they can help you retain some control over your wealth and potentially reduce your liabilities in the process.
1. Maintain Accurate Records
It’s essential to keep comprehensive and up-to-date records of your digital assets, including purchase dates, transaction histories, and valuations. In bankruptcy, these records will support accurate reporting and valuation, minimizing potential disputes with trustees and creditors.
2. Use Secure Storage Solutions
Consider transferring your digital assets to secure, reputable wallets or storage platforms. Cold storage (offline wallets) is generally more secure than hot wallets (online), as it reduces the risk of hacking or unauthorized access. However, you must keep records of your storage choices, as these assets will need to be disclosed in bankruptcy proceedings.
3. Monitor Market Fluctuations
Since digital assets are highly volatile, monitoring market trends can help you better anticipate how much of your estate they might represent. If values are low, it may be beneficial in terms of a bankruptcy filing, as your estate valuation may be lower. However, be cautious in timing your decisions solely based on market prices, as this could be perceived as an attempt to manipulate your financial situation, which may be viewed as fraudulent by the courts.
4. Consult a Financial Advisor
Working with a financial advisor who understands digital assets can help you make strategic decisions about your portfolio. An advisor can guide you on the best ways to diversify or potentially liquidate some assets if you foresee financial hardship, providing you with additional resources and flexibility during challenging times.
5. Be Transparent with Your Legal Team
Transparency with your bankruptcy attorney or legal team is crucial. The more they know about your assets, the better they can protect them within the boundaries of the law. Concealing digital assets can lead to severe penalties, including fines, asset forfeiture, and even imprisonment. Therefore, it's vital to have open discussions with your legal team about your holdings and options.
Why Legal Support Is Essential for Managing Digital Assets in Bankruptcy
Digital assets add a layer of complexity to bankruptcy cases that few people can handle alone. With limited precedent, rapidly changing regulations, and the technical nature of valuing and managing digital assets, having legal support can be crucial. A bankruptcy attorney with experience in digital assets can guide you through the necessary disclosures, help ensure you’re valuing your assets accurately, and work to protect as much of your estate as possible.
A skilled bankruptcy attorney can also help you understand the evolving nature of bankruptcy law as it pertains to digital assets, ensuring that you remain compliant and that your interests are represented fairly. In addition, they can guide you through the practical aspects of bankruptcy, from valuing assets to understanding potential tax implications.
Having legal support during bankruptcy doesn’t mean giving up your assets—it means navigating the process strategically and with as little stress as possible. Contact Buchalter & Pelphrey at (321) 320-6088 or fill out our online form to book a consultation.