June 27, 2016
Authored by: Justin Sabin and Mark Duedall
What a difference a week makes! On June 17, 2016, bitcoin was trading at more than $750. Five days later, as polls showed the Brexit vote leaning heavily to “remain,” bitcoin dropped as low as $585. After the vote to leave the European Union became final, the British Pound, the Euro, the Chinese Yuan, and global stocks dropped precipitously. Bitcoin, on the other hand, spiked to more than $676, and was trading in the $660s on Friday. Could this mean bitcoin is being perceived as a new safe-haven asset?
A Brief Background on Bitcoin Generally
Bitcoin often is described as a “digital currency.” On a more technical level, bitcoin is a digital asset within a peer-to-peer computer network payment system created in 2008 by an anonymous cryptographer going by the pseudonym Satoshi Nakamoto. Because the computer network uses open-source, peer-to-peer software, no truly central authority administers and oversees transactions, and no government controls or backs the digital “currency.” Instead, users or “nodes” on the network verify transactions by solving complex computer algorithms. The verified transactions are then recorded on a public ledger (called the blockchain) for all to see. Because transactions employ lengthy key codes rather than traditional personally-identifiable information, users can trade bitcoin quasi-anonymously.
Because bitcoin lacks government or centralized control, conceptually it is accessible to anyone with an internet connection and eliminates many of the transaction costs associated with traditional currency trading. For the same reasons, however, it can be highly volatile. At the inception of the network in 2009 and through 2012, a single bitcoin was worth mere pennies. In 2013, amid a financial crisis and the seizure of bank accounts in Cyprus, holders of Cypriot accounts began buying massive amounts of bitcoin, which drove the price of bitcoin to more than $260 for the first time. By November 2013, the value of bitcoin peaked at $1,242. The price of bitcoin declined thereafter amid hacking scandals, the insolvency proceeding of Mt. Gox (bitcoin’s then largest exchange), and negative perceptions created by the high-profile criminal case involving the elicit online marketplace known as Silk Road. Despite its volatility over the last seven years, however, bitcoin has endured and shows no signs of disappearing.
Bitcoin as a Safe Haven?
Bitcoin’s sharp rise after the Brexit vote appears to evidence a new confidence in bitcoin as a safe haven. Investment professionals, however, have been extremely reluctant to give bitcoin such status. One recent research note observed that calling bitcoin a safe haven “obfuscates the fact that bitcoin is a high-risk and volatile investment” and ignores that “bitcoin’s correlation to other traditional safe-haven assets has fluctuated significantly.” Instead, bitcoin can be viewed as “something entirely different that does not fit into the normal buckets that investments are typically bracketed into.”
The inability to categorize bitcoin into a traditional “bucket” is equally visible in the legal context, and perhaps particularly in the bankruptcy context. In a recent widely-circulated decision, for example, a bankruptcy judge concluded that bitcoin is not currency for purposes of a trustee’s recovery of avoidable transfers. See In re Hashfast Technologies LLC, No. 15-3011DM (Bankr. N.D. Cal. Feb. 19, 2016). The case involved a “bitcoin mining” computer company that paid 3,000 bitcoin to an individual to promote the company’s products. After the company’s bankruptcy filing, a trustee was appointed. The trustee sought the return of the value of the bitcoin paid to the promoter. The total value of the bitcoin in question had increased from $363,861 at the time of payment to nearly $1.3 million as of the Feb. 19, 2016 ruling.
The arguments on each side were predictable. The promoter argued that the company intended to use the bitcoin as currency and that the trustee should be able to recover only the value of the bitcoin at the time of the payment. The trustee, on the other hand, argued that the bankruptcy estate should be able to recover the fully appreciated value of the bitcoin as a commodity. The bankruptcy court did not fully resolve the issue. Rather, it concluded solely that “bitcoin are not United States dollars,” and left for another day the question of whether the trustee could recover the value of the bitcoin at the time of payment or the subsequent appreciated value.
As the Hashfast case demonstrates, the current legal framework is still deciding whether bitcoin fits into any familiar “buckets” or whether Congress or the judiciary will have to create new ones. Characterizing bitcoin as a commodity versus a currency, versus some other property right, is just one example of the many issues bitcoin presents in a financially distressed situation. In short, the legal outcomes, particularly in bankruptcy, currently lack any degree of predictability.
From a legal perspective, bitcoin does not appear to share the features of traditional safe-haven investments such as government bonds or stable fiat currency. Whether traders treat it as a safe haven, however, ultimately will be the true test. Over time, their collective decisions may give rise to bitcoin as an alternative safe haven, or those decisions may bring a wave of novel legal issues to our federal bankruptcy courts. In either case, insolvency professionals would do well to keep their eye on this growing and rapidly evolving field.