When Bankruptcy Regulates Crypto: The Good, the Bad, and the (Really) Ugly

Without an established oversight regime, crypto winter has turned bankruptcy courts into accidental regulators of the digital asset market.

In the wake of Terra/Luna’s collapse in May 2022, followed by FTX’s spectacular demise a few months later, the crypto industry has become a heavy user of Chapter 11 bankruptcy. BlockFi, Celsius, Core Scientific, FTX/Alameda, Genesis Global, Prime Trust, Three Arrows Capital, Voyager — former linchpins of the crypto ecosystem — have all ended up filing. There have been bruising court battles. The legal costs have been staggering. Millions of customers have suffered enormous economic damage, hardship, and disillusionment.

Yesha Yadav is the Milton R. Underwood Chair, Associate Dean, and Professor of Law at Vanderbilt Law School. Robert Stark is Chair of the Bankruptcy and Restructuring Practice Group at Brown Rudnick LLP. This op-ed, part of CoinDesk’s “State of Crypto Week” is based on the longer article, “The Bankruptcy Court as Crypto Market Regulator,” here.

With bankruptcy courts taking control of some of crypto’s biggest firms and examining the market’s workings, it is worth asking whether this substitute regulatory regime is working, or whether its intervention is adding to the uncertainty facing the market.

How crypto bankruptcies are different

First, a little context. Most financial firms are, outside of bankruptcy, supervised by government regulators, like the Securities and Exchange Commission, Commodity Futures Trading Commission or the Federal Reserve. Bankruptcy works in tandem with the regulators, with bankruptcy focusing primarily on reworking the balance sheet and regulators continuing to monitor the company’s business practices. If all goes well, the company leaves bankruptcy in a sound financial position and without any objections voiced by regulatory supervisors.

This has not been the experience for crypto insolvencies. The digital asset industry has been allowed to mature without a dedicated regulatory framework, resulting in runaway risk-taking, opaque business practices, and suspect governance. More to the point, bankruptcy courts have found themselves largely on their own, sifting through the wreckage of 2022’s crypto winter without any regulatory support.

Courts have been forced to rely on the Bankruptcy…