Introduction: Why crypto needs special handling in bankruptcy
Cryptocurrency and other digital assets present recurring questions in modern bankruptcies: are deposited tokens the debtor's property or the customers' property; when and how should those assets be valued for claims and plan purposes; and how can trustees, creditors or debtors trace or recover assets that move on public blockchains — often through mixers and cross‑chain bridges? These issues matter in California cases (and nationwide) because the answers determine whether claimants get crypto back in kind, recover only a monetary claim, or obtain nothing at all.
This article explains the practical and legal contours of custody (who owns the coins), valuation (what value counts and when), and tracing/recovery (forensic tools, sanctions risks, and best practices for parties preparing to file or respond in bankruptcy). It emphasizes recent judicial trends and enforcement developments that California debtors, creditors, and trustees should know.
1. Custody and property status: it depends on the relationship and the terms
Bankruptcy courts do not treat all crypto arrangements the same. Courts look to the parties' relationship, the platform's terms of service, applicable state law, and whether assets were held in a custodial or trust-like arrangement at filing. If a platform's contract grants the platform ownership or uses language that transfers title, courts have in key cases found the assets to be property of the debtor's estate; if the arrangement is custodial or an FBO/account structure, courts have sometimes treated the assets as belonging to customers.
For example, in the Celsius chapter 11 cases the SDNY court concluded that certain "Earn" accounts were estate property because Celsius's terms unambiguously gave Celsius ownership and the ability to use deposits; that ruling is a leading example of contract-driven outcomes in crypto bankruptcies.
By contrast, decisions dealing with segregated bank FBO accounts or similarly structured custodial arrangements have recognized that funds held for customers may not be estate property — illustrating that characterization is highly fact- and contract-dependent.
Practical checklist on custody questions
- Review the platform's Terms of Use, Wallet/Account agreements, and any written acknowledgements (ownership language, transfer of title, disclaimers).
- Document whether customer balances were segregated (e.g., FBO bank accounts, segregated on-chain addresses, or internal pooled hot/cold wallets) and whether the platform maintained identifiable ledgers linking customer claims to specific addresses.
- Look for statutory/regulatory regimes that might affect classification (state custodial trust statutes, proposed UCC Article 12, or payment‑stablecoin legislation).
2. Valuation: which date and what method?
Valuation in bankruptcy is not a single fixed rule — Section 506(a) directs courts to choose the valuation date and method in light of the purpose of the valuation and the proposed disposition or use of the property. In practice this means the valuation date for crypto can vary: some contexts (e.g., certain Chapter 7/13 personal property questions) call for petition‑date valuation, while Chapter 11 or cram‑down contexts may permit valuation at confirmation or another date tied to the property's intended use. Courts and practitioners therefore consider the valuation's purpose (distribution, cram-down, settlement, tax reporting) and the volatility of the specific crypto asset.
Because cryptocurrency prices can swing dramatically, parties should be explicit in motions and plan documents about the valuation date and methodology (spot market at X exchange, volume-weighted average price, or an agreed appraisal), and be prepared to justify the choice analytically and with market data.
Practical valuation tips
- State the valuation date and methodology in pleadings and proposed plans.
- Use transparent market data (timestamped exchange VWAPs or on-chain price oracles) and preserve contemporaneous pricing evidence for the chosen valuation date.
- Consider the effect of choice on distributions: petition‑date pricing benefits creditors if prices rose after filing; confirmation/effective‑date pricing may be appropriate when the property will be sold or used later in the case.
3. Tracing, recovery, sanctions and forensic tools
Blockchains are public, which helps tracing, but the on‑chain movement of funds through mixers, bridges, and privacy tools complicates recovery. Large bankruptcies and post-hack recoveries have shown that experienced forensic teams (private‑sector analytics plus cooperation from exchanges and law enforcement) can locate and recover substantial sums — but recoveries require speed, cross‑platform cooperation, and technical skill. Major restructuring teams and trustees have partnered with blockchain analytics firms to build evidentiary transaction graphs and identify custodial exchange on-ramps that can freeze or recover funds.
Enforcement and sanctions risks also affect tracing and recovery. OFAC's designation actions and related litigation (for example litigation addressing Tornado Cash and the scope of designations) highlight that certain privacy or mixer tools present compliance and forfeiture risks for anyone attempting to touch sanctioned addresses or related smart contracts. Courts have considered whether smart contracts or developer groups constitute property interests for sanctions purposes — a development practitioners must watch when tracing or proposing distributions involving mixed or tainted funds.
Common forensic/recovery steps used in bankruptcy
- Engage a blockchain analytics vendor quickly to tag addresses and create transaction graphs.
- Work with exchanges and KYC providers to subpoena and freeze exchange accounts tied to traced wallets.
- Coordinate with U.S. and foreign law enforcement when funds involve alleged criminal conduct or sanctioned actors.
- Document chain‑of‑custody for any recovered funds and seek court approval for sales or distributions of volatile assets.
Practical compliance note
Before attempting to move or liquidate assets, trustees and counsel must consider OFAC, money‑transmission statutes, and other regulatory constraints. Even an otherwise valid recovery can be jeopardized if it exposes the estate to sanctions or money‑laundering liabilities.
4. Practical steps for California debtors, creditors and trustees
For counsel and parties in California bankruptcy proceedings (Central, Northern, Eastern and Southern District practice), the following practical steps reduce litigation risk and maximize recoveries:
- Debtors preparing to file: secure private keys (move estate assets to a new court‑control wallet or implement multi‑sig with neutral custodian), preserve logs/ledgers and export transaction history, and be transparent in Schedules and SOFAs about token holdings and where keys are kept. Have counsel negotiate with proposed custodians or exchanges in advance if a pre‑file transfer is contemplated.
- Trustees/creditors: hire forensic analysts early, seek expedited discovery/subpoenas to exchanges, and file preservation motions where assets are at risk. Consider motions to determine property status early if contract language is ambiguous.
- Avoid risky pre‑petition transfers:
- Use clear valuation mechanics:
These steps combine technical caution (key custody), legal disclosure (Schedules, SOFA and motions), and forensic readiness (vendor engagement) — and they reflect what major cases and restructuring teams have done to preserve value for creditors.
Conclusion & takeaways for California practice
Key takeaways for California debtors, creditors, and counsel: (1) custody labels and contract language often decide who owns deposited crypto — read and litigate the terms; (2) valuation dates vary with purpose — don’t assume petition‑date pricing is automatic; (3) tracing is feasible but requires specialists, cooperation from exchanges, and attention to sanctions/compliance risks; and (4) early technical and legal steps (securing keys, transparent disclosure, and quick forensic engagement) materially increase the chances of recovery or a favorable distribution.
If you or your client hold crypto and are considering a bankruptcy filing, or are a creditor in a crypto‑related insolvency, consult counsel experienced with both bankruptcy procedure and digital‑asset forensics so you can act quickly and avoid losing value to avoidable mistakes.
Selected sources used in this guide: leading bankruptcy rulings and practice analyses on Celsius and platform custodial disputes; valuation guidance under §506; and modern tracing partnerships and OFAC litigation.