Broken hearts - digital assets in insolvency: practical aspects for insolvency practitioners

Posted: 10/02/2025

Introduction

Digital assets, including cryptocurrencies and non-fungible tokens (NFTs), have seen exponential growth. With the continued adoption and expanding personal ownership of digital assets, they will increasingly become a regular part of insolvency proceedings. This is true whether they are assets to be realised in the insolvency or if an insolvent company operates a digital asset-related business, such as the high-profile crypto exchange insolvencies of FTX and Three Arrows Capital.

Digital assets in an insolvency raise various practical issues which every insolvency practitioner (IP) needs to prepared for so that they can identify, secure and realise them promptly, or potentially be left exposed to criticism and claims by creditors. 

Digital assets are ‘property’ 

It is now established in case law that digital assets are considered ‘property’, a status soon to be confirmed in UK statute once the Property (Digital Assets etc) Bill, introduced on 11 September 2024, is passed. The UK Insolvency Act 1986 (IA1986) has always defined ‘property’ more broadly than the traditional definition. Consequently, digital assets form part of the assets of a company or individual that an IP is under a duty to realise. An IP cannot properly discharge this duty without considering the presence of digital assets.

Identifying digital assets

If an IP fails to identify and realise digital assets it could expose them to claims by creditors for failing to comply with their duties. Some directors and bankrupts may avoid disclosing the existence of digital assets particularly if they believe the IP is not knowledgeable about this asset class.  Given the ease by which digital assets can be transferred, the IP should act promptly to identify any digital assets.  This may include the following steps:

• Send letters to the cryptocurrency exchanges - Although there are over 700 cryptocurrency exchanges, IPs should at least consider writing on day one to a short list of the main exchanges such as Binance, Coinbase, Bybit and Kraken to request confirmation as to whether the company or individual owns any wallets on the exchange. The major exchanges are becoming more cooperative but they may still require a court order particularly if they are outside the jurisdiction. Others may not engage at all.  
• Question the directors, bankrupt or other related parties - It should be standard practice to include in the questions for directors or bankrupt individuals whether they own or have owned any digital assets and to request the relevant information to enable the IP to promptly access and secure those assets. The information requested should include the public and private keys for all wallets and the ‘seed phase’ which is a sequence of 12 or 24 random words that allows a party to access or recover their digital assets if they lose their device or forget the private key. In addition, they should seek confirmation as to whether the wallet(s) are ‘hot wallets’ (ie connected to the internet) or ‘cold wallets’ (ie not connected to the internet such as a USB).
• Use the IPs powers to request information from third parties – Under UK insolvency laws, IPs can request information from third parties under section 236 or section 366 of the IA1986 in relation to companies and individuals, respectively.
• Identify signs of digital assets from the books and records – IPs should be vigilant for signs of digital assets in the books and records of a company or individual. The private key to access a wallet, which is a 12 or 24 alphanumeric code, or seed phrase, could be written on a piece of paper or stored in computer files. There may also be financial transactions linked to digital asset exchanges, miscellaneous QR codes, an internet search history that reveals references to digital assets, apps on mobile phones or storage devices such as a USB stick containing cold wallets.

Securing and realising digital assets

If the IP has identified evidence of digital assets, the next stage is to secure and realise those assets before the they can be transferred by another party that may also have access to the wallet. 

• Freezing and third party disclosure order – If the IP does not have access to the wallet and there is a risk of dissipation, it may be necessary to apply to the court for a freezing order. This order can be issued against ‘persons unknown’ and is often combined with a third-party disclosure order. Given the various jurisdictions where exchanges are based, a worldwide freezing order is likely required. Considering the time it can take to obtain such an order, IPs should consider contacting the exchange holding the digital assets, as they may cooperate by placing a temporary freeze on the wallet.
• Transfer the digital assets from the wallet – If the IP has the private key to access the wallet, the IP should take immediate steps to secure any digital assets in the wallet given that it will not be known if other parties also have the private key to access the wallet. IPs should already be considering how they would hold any digital assets recovered. This could be by holding it in a cold wallet created by the IP but this has risks associated with it for the IP as the cold wallet will also need to be secured and be adequately insured. IPs should check whether their existing insurance policy would be sufficient (which is unlikely) and, if not, explore insurance cover with a specialist provider now given that it can take time to arrange. 
  Alternatively, the IP could utilise the services of a professional custodian. An insured custodian can mitigate some of the risks for the IP, particularly in handling the transfer of digital assets. This transfer can be vulnerable to hacks, especially since fraudsters might anticipate a wallet transfer due to the insolvency. Given the time required to onboard a custodian, IPs should consider making arrangements in advance.
• Avoidance actions – If the digital assets have been transferred to another party, it may be possible to bring claims to avoid those transactions on the basis that they are a transaction at an undervalue or transaction defrauding creditors. However, given the volatility of digital assets it may be difficult to determine if there was an undervalue.   

Valuation and distribution

• How assets are held – The IP will need to establish if any digital assets are held on behalf of a creditor or form part of the general assets of the estate.  If assets have been mixed, the traditional rules on tracing will apply but the precise nature of the particular digital asset may impact that analysis.
• Sale or distribution in specie – If there is a significant amount of digital assets, for instance where the IP is dealing with an insolvency of a cryptocurrency exchange, an in specie distribution may be appropriate on the basis it cannot be readily or advantageously sold.
• Converting to fiat currency – If the digital asset is to be converted to fiat currency, an IP should consider obtaining expert advice on the timing of any sale given the volatility. It may be necessary to sell in tranches to reduce the impact on the value.
• Creditor and court approval - To avoid the risk of criticism from creditors, an IP may wish to engage with creditors on the disposal and distribution strategy at an early stage as well as seek the approval of the court.

A digital asset debt 

The UK Jurisdiction Taskforce (UKJT) has determined that insolvency proceedings cannot currently be initiated based on a statutory demand for a digital asset debt, as statutory demands must be for a ‘liquidated sum’ expressed as a ‘money sum’, and cryptocurrencies are not yet considered money. However, if the obligation to deliver digital assets is terminated and replaced with a fiat currency obligation, a petition could be possible. Despite this, it should still be possible to use digital asset debts to assess if a company is balance sheet insolvent.

In insolvency, claims for specific quantities of digital assets are provable under Rule 14.1(3) of the Insolvency (England and Wales) Rules 2016, which covers all creditor claims including those sounding in damages, not just those for liquidated sums.

For distribution purposes, debts in foreign currencies must be converted to pounds sterling at a rate determined by the IP by reference to the exchange rate prevailing at the commencement of the insolvency proceedings. If digital assets were considered a foreign currency, creditors would be shielded from market fluctuations post-conversion. However, since digital assets are not yet deemed money, they are also not considered foreign currency, leaving their value subject to market volatility until there is a distribution in the insolvency. This distinction is crucial due to the high volatility of digital asset prices.

Costs

The IP’s fees and disbursements to identify, secure and dispose of digital assets can be significant. This will need to be considered in the IP’s estimate of cost and may make it less attractive to work on a fixed fee basis. The IP will need to consider carefully the benefit to the estate of pursuing the recovery of digital assets. Although litigation funding is potentially available for pursuing claims to recover digital assets, such funding will require a good merits assessment and good chances of recovery.

Conclusion

Even if an IP has not yet had to deal with digital assets in an insolvency, they will have to in due course. Accordingly, IPs should be preparing by reviewing their procedures including whether to get insurance and a digital asset custodian in place now. If an IP is not prepared and digital assets are missed, the IP could be exposed to claims by creditors. 

This article was first published in INSOL World in Q4 2024.

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