What Happens to My Cryptocurrency & NFTs in Bankruptcy?

Cryptocurrency and NFTs are the subject of much media discussion lately. Less often discussed is the role that either can play in a Michigan Chapter 7 or Chapter 13 bankruptcy case.

This Article will discuss what cryptocurrency, cryptocurrency markets, and NFTs actually are. It will then discuss how and why the ownership of these assets need to be disclosed in a Detroit bankruptcy case.

Finally, the Article will explore the extent to which ownership of cryptocurrency and NFTs can complicate either form of consumer bankruptcy—and what a good Michigan bankruptcy attorney can help you to do about it.

First, the definitions.

 

What Is Cryptocurrency?

 

Cryptocurrency or cyber-currency is a system of monetary exchange that exists exclusively in electronic form. There is no paper money involved. There is no gold reserve in any fixed location underpinning the value of the currency.

Instead, it is an independent financial system that allows those possessing the cryptocurrency to exchange units from a series of decentralized nodes scattered throughout the internet.

That is, cryptocurrency functions through the use of so-called blockchain technology.

This “blockchain” is an electronic “ledger” that exists in multiple locations and in duplicate form simultaneously throughout the internet. Decentralized servers store these “ledger records,” allowing the ownership and the value of the currency to be verified by anybody, anywhere, anytime.

Because of the simultaneous nature of the information storage involved, the information cannot be altered. Any review of that item in any of the duplicate copies of the electronic ledger will reveal the same information about that item.

Thus, cybercurrencies like Bitcoin rely upon this blockchain technology to hold value at all. Without the simultaneous value verification capability, the system would collapse into confusion.

The value of cybercurrencies reported in the media is, therefore, just a reading of this electronic ledger.

The appeal and original purpose of Bitcoin and other cybercurrencies is the decentralized nature of the valuation system. It does not rely upon a government. It does not rely upon the Federal Reserve. It does not rely upon banking institutions.

For some, this has a “libertarian” appeal that fits neatly into a certain personal, political mindset.

For others, it’s a shaky system that could benefit from a healthy dose of regulation and oversight.

As of this writing, the latter viewpoint is beginning to prevail.

 

What Is an NFT?

 

An “NFT” is a “non-fungible token.” However, this doesn’t say much, does it?

An NFT is a digital asset. It is a “token,” or an item of property that exists only virtually, in the so-called “metaverse.” It is, in essence, computer code accompanied by a valuation quote on a decentralized digital ledger much like cybercurrency, described above.

They are often digital art or digital objects available for purchase or trading on virtual reality platforms like Second Life or other auction websites.

NFTs have no inherent value. It is not like a stock, which represents the value (however dubiously) of a real-world corporation. The value of an NFT is, purely, exactly what people are willing to pay for it.

That said, NFTs and NFT marketplaces have suffered some very well-publicized issues regarding authentication, ownership, and fraud. They are volatile in terms of value, subject to wild swings up and down again.

Further, other questions regarding the contractual bases for and intellectual property legal frameworks under which an individual can claim to “own” an NFT created by a third party artist.

If you pay $50 (or $500,000!) for a digital image of a cartoon monkey—what have you actually bought? Legally?

These are questions that can feed into the complexity of a Michigan Chapter 7 or Chapter 13 bankruptcy case.

 

Cryptocurrency and NFTs in Michigan Bankruptcy

 

Whatever the value of cryptocurrency or an NFT, it is beyond dispute that these do represent property ownership interests that must be disclosed and valued in Chapter 7 and Chapter 13 bankruptcy cases in Michigan (and elsewhere).

All assets and claims of ownership, even if uncertain or contingent upon some future event occurring (such as the winning of a lawsuit), must be disclosed as assets in your bankruptcy petition schedules.

Right alongside your furniture, clothing, real estate, vehicles, gun collection, and bank account balances, you must list any cryptocurrency or NFT ownership.

Further, just as you are required to provide a value for, say, your used car, you must also provide a “good faith” fair market valuation of cryptocurrency or NFT property ownership interests.

Why must you do this?

You must list and value all assets in Chapter 7 and Chapter 13 bankruptcy proceedings because relief from your debt is a governmental benefit offered under US law only to those who are “good faith debtors.”

A “good faith” debtor is one who (among other things) is not attempting to discharge debts legitimately owed to her creditors while maintaining ownership of luxury-level goods.

You cannot, for example, expect to retain ownership of a McLaren 720s Spider while asking the Bankruptcy Court to relieve you of your obligation to pay your credit card balances.

Likewise, you cannot take all of your cash, dump into a cryptocurrency account, and then claim to be broke. This would not be what the US Congress had in mind when it confined eligibility for bankruptcy to “honest” or “good faith” debtors.

 

Cryptocurrency, NFTs, and Creditor Repayment in Bankruptcy

 

Importantly, you must also list your cryptocurrency, NFTs, and other assets because their value will determine whether your creditors are repaid anything out of your bankruptcy and, if so, how much.

In particular, you must list your assets because, whether you do or not, they are automatically included in something called “the Bankruptcy Estate” when you file your case.

The Bankruptcy Estate is the imaginary “house” containing all of your property or claims to property that is created by automatic function of law when you file a Chapter 7 or Chapter 13 bankruptcy case.

The US Bankruptcy Code and, alternatively, Michigan state law include a number of provisions to allow you to protect property within the Bankruptcy Estate, however. These protections are called “exemptions.” There are different exemptions for different types of property, with value caps to certain specific limits.

Some types of property have no exemption directed toward them whatsoever.

Any property not disclosed in your petition schedules cannot be exempted at all.

 

Assets in Chapter 7 Bankruptcy

 

In a Chapter 7 bankruptcy, your assets are liquidated by the Chapter 7 Trustee assigned to your case if they are not exempted from the Bankruptcy Estate.

That is, they are seized and sold off. The resulting proceeds are then used to repay, at least in part, your creditors.

If an asset can be fully exempted, up to its full fair-market value, it has been removed from the Bankruptcy Estate, essentially, and cannot be liquidated by the Chapter 7 Trustee.

 

Assets in Chapter 13 Bankruptcy

 

In Chapter 13 bankruptcy, assets are never liquidated. Your property is safe in Chapter 13 bankruptcy.

However, that does not mean that assets do not need to be disclosed and valued.

To the contrary, there is a direct financial cost to owning property of value beyond the available exemption limits.

A Chapter 13 bankruptcy is not a “liquidation” bankruptcy as is a Chapter 7. Instead, it is a “reorganization” bankruptcy, in which, for 3-5 years, you make a monthly payment to the Bankruptcy Court that the Chapter 13 Trustee assigned to your case then distributes to your creditors in a priority order depending upon the types of debts owed to different creditors.

The class of creditors that is paid last, after all others, are the unsecured, non-priority creditors. These are credit card debt holders, medical debt creditors, former landlords, people who have lent you money on a personal basis, and so on.

Often, in Chapter 13, these creditors receive very close to nothing at all from the Chapter 13 payment plan.

However, if you do own property that cannot be exempted, in full or in part, the dollar value of your non-exempt property must be paid to your unsecured creditors in order for your Chapter 13 plan to be approved by the court.

For example, if you are able to exempt everything you own except for the $95.00 in your Robinhood.com brokerage account, your unsecured creditors must (as a class, not individually) receive $95.00 from your Chapter 13 plan—after everyone else is paid. (Including your own bankruptcy lawyer.)

 

Back to Cryptocurrency and NFTs Now …

 

What does this have to do with cryptocurrency and NFTs?

Simply, such assets are among the types of property that have no exemption available to protect them at all. This is true under either Federal law or Michigan law.

Just as cash balances, bank balances, stock ownership, business ownership, fine art, antiques, and brokerage and investment accounts are unavailable for exemption and protection, likewise is cryptocurrency and NFTs.

Remember the description of “good faith” debtor, above?

The sorts of property ownership interests that have no available exemption are those which Congress determined to be unnecessary to a family’s survival.

You do not need your NFT of a cartoon monkey to put food on the table. If it’s the only thing you own and it’s worth a million bucks, Congress presumed you would understand that liquidating it to buy food for your kids is the proper course of action—not bankruptcy.

It is worth noting, additionally, that this Article has not touched upon the possible intellectual property ownership interests inherent in NFTs in particular.

What did you buy, exactly, when you bought that cartoon monkey image? Just the “original” image, or did you manage to buy ownership of the copyright as well?

Depending on the popularity of that monkey, your value may be compounded if you did.

 

Cryptocurrency or NFTs as Income in Bankruptcy

 

Cryptocurrency and NFTs, like stock or business or rental property interests, can represent something more in a Chapter 7 or Chapter 13 case than an asset-exemption problem.

They are ownership interests that can, depending on the ownership platform, also generate a stream of income.

This could be particularly true if you do own the NFT copyright and the image is widely used.

All income must also be disclosed in either a Chapter 7 or Chapter 13 bankruptcy in Michigan.

In Chapter 7, this will directly affect your Chapter 7 eligibility as an initial matter. The income will need to be disclosed and accounted for in two different parts of the bankruptcy petition, including the dreaded Means Test. (The Means Test is the mathematical formula and accompanying form that determines whether a person is eligible for Chapter 7 bankruptcy based on gross household income.)

In Chapter 13 bankruptcy, your income from all non-Social Security sources will determine the amount of your monthly Chapter 13 Plan payment.

 

Cryptocurrency and NFTs in Bankruptcy: The Bottom Line

 

The bottom line is that the value of your cryptocurrency and NFT holdings can directly impact not just the cost of bankruptcy for you—but the utility as well.

Should you even file? What are the risks?

Do you even own that NFT that you think that you own? Is litigation regarding that particular platform ongoing?

These are questions that only an experienced Michigan bankruptcy lawyer will be able to help you answer.

Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has successfully represented Metro Detroit Chapter 7 and Chapter 13 clients for over 30 years.

If you are considering filing for bankruptcy and own cryptocurrency or NFTs, contact us to schedule your free consultation before making any quick decision on your own.