How Do a Crypto Platform’s Terms of Service Affect Asset Ownership in Bankruptcy?

Concept

The intersection of a cryptocurrency platform’s Terms of Service (ToS) and bankruptcy law delineates a critical, and often unforgiving, boundary for asset ownership. When a user deposits digital assets onto a platform, the legal nature of that deposit is defined by the contractual agreement to which they consent, frequently through a “clickwrap” process. This agreement dictates whether the user retains full, unencumbered ownership of their assets or if they are, in effect, transferring title to the platform in exchange for a service.

In the event of a platform’s insolvency, this distinction becomes the central determinant of whether a user’s assets are treated as their own property, to be returned in full, or as assets of the bankruptcy estate, positioning the user as an unsecured creditor with a high probability of recovering only a fraction of their holdings. The language within the ToS, therefore, is not mere boilerplate; it is the legal foundation upon which the security of a user’s assets rests.

Recent bankruptcy proceedings involving major cryptocurrency platforms have brought this issue into sharp focus, establishing legal precedents that underscore the paramount importance of the ToS. The case of Celsius Network, in particular, serves as a watershed moment. The court’s ruling in this case hinged on the explicit language of the platform’s ToS, which granted Celsius “all right and title” to the assets deposited in its interest-bearing “Earn” accounts. This transfer of ownership was deemed a valid and enforceable component of the contract the users had accepted.

Consequently, the assets in these accounts were classified as the property of the Celsius bankruptcy estate, available to be distributed among all creditors, with the original depositors relegated to the status of unsecured creditors. This outcome highlights a fundamental principle ▴ the promise of a yield on deposited assets often necessitates the platform’s ability to use those assets, a right that is typically secured through the transfer of ownership in the ToS.

The contractual language of a crypto platform’s Terms of Service is the primary determinant of asset ownership in a bankruptcy proceeding.

The legal framework for determining asset ownership in these cases is rooted in established principles of contract law and the Bankruptcy Code. Section 541 of the Bankruptcy Code defines the property of the estate as “all legal or equitable interests of the debtor in property as of the commencement of the case.” The central question, then, is whether the user’s deposited assets fall within this definition. The answer is found in the ToS. If the ToS establishes a custodial relationship, where the platform is merely holding the assets for the user’s benefit without the right to use them, the assets are likely to be considered the user’s property and excluded from the bankruptcy estate.

Conversely, if the ToS creates a debtor-creditor relationship, where the user has effectively loaned their assets to the platform, the assets become the property of the estate. The Celsius case and others have demonstrated that courts will meticulously analyze the specific language of the ToS to determine the nature of the relationship between the user and the platform, with profound implications for the user’s ability to recover their assets in a bankruptcy.

Strategy

A strategic analysis of a crypto platform’s Terms of Service requires a discerning eye for the nuances that differentiate a custodial arrangement from a transfer of ownership. The most critical distinction lies in the type of account being offered ▴ “earn” or interest-bearing accounts versus “custody” or non-interest-bearing accounts. This distinction is not merely a matter of nomenclature; it reflects a fundamental difference in the legal relationship between the user and the platform, and, consequently, in the risk profile of the assets deposited.

The “earn” Vs. “custody” Dichotomy

“Earn” accounts, which offer users a yield on their deposited assets, are inherently riskier from an ownership perspective. To generate a return, the platform must have the ability to utilize the deposited assets, such as by lending them to other users or staking them in proof-of-stake protocols. This operational necessity is typically reflected in the ToS, which will often include language that grants the platform title to and ownership of the assets.

The Celsius case provides a stark illustration of this principle. The platform’s ToS for its “Earn” accounts explicitly stated that users were transferring ownership of their assets to Celsius, a provision that the court upheld, with devastating consequences for the depositors.

“Custody” accounts, on the other hand, are designed for the simple storage of digital assets and do not offer a yield. The ToS for these accounts should, in theory, reflect a purely custodial relationship, where the platform is acting as a bailee, holding the assets for the user’s benefit. The language in the ToS for a custody account should explicitly state that the user retains full ownership of the assets and that the platform does not have the right to use, lend, or hypothecate them.

The bankruptcy case of BlockFi provides a contrasting example to Celsius. In the BlockFi case, a court ruled that assets held in the platform’s non-interest-bearing wallet accounts were not the property of the bankruptcy estate, offering a glimmer of hope for users of custody services.

The type of account, “earn” or “custody,” is a primary indicator of the level of ownership risk, with “earn” accounts carrying a significantly higher risk of asset loss in a bankruptcy.

The Peril of Commingling

Even in a custodial relationship, the practice of commingling assets poses a significant threat to user ownership. Commingling occurs when a platform mixes customer assets with its own funds or with the assets of other customers in a single omnibus account. This practice, while common among centralized exchanges for operational efficiency, can make it exceedingly difficult to trace and identify a specific user’s assets in the event of a bankruptcy.

If a user’s assets cannot be definitively traced, they are at a much higher risk of being treated as part of the general bankruptcy estate, even if the ToS purports to establish a custodial relationship. The ability to demonstrate that assets are held in a segregated, uniquely identifiable wallet is a powerful defense against an ownership claim by a bankrupt platform.

Strategic Review of Terms of Service

A strategic review of a crypto platform’s ToS should focus on several key provisions:

• Ownership and Title ▴ The ToS should be scrutinized for any language that suggests a transfer of ownership or title to the platform. Phrases such as “grant,” “transfer,” “all right and title,” or “ownership rights” are red flags.
• Use of Assets ▴ The ToS should clearly define the platform’s rights and restrictions regarding the use of deposited assets. For custody accounts, the ToS should explicitly prohibit the platform from using, lending, or hypothecating the assets.
• Segregation of Assets ▴ The ToS should specify whether customer assets are held in segregated or omnibus accounts. Language that guarantees the segregation of assets provides a much stronger ownership claim for the user.
• Risk Disclosures ▴ The platform’s risk disclosures, often found in a separate document or a dedicated section of the ToS, can provide valuable insights into the platform’s own assessment of the ownership risks. Coinbase’s 10-Q filing, in which it acknowledged the risk that custodially held assets could be considered part of the bankruptcy estate, is a case in point.

The following table provides a comparative analysis of key ToS provisions for hypothetical “earn” and “custody” accounts:

Execution

The execution of a strategy to mitigate ownership risk in the event of a crypto platform bankruptcy requires a deep understanding of the legal and regulatory frameworks that govern digital assets. This includes a working knowledge of the Uniform Commercial Code (UCC), as well as the evolving guidance from regulatory bodies such as the Securities and Exchange Commission (SEC) and the New York Department of Financial Services (NYDFS).

The Uniform Commercial Code and Digital Assets

The UCC, a comprehensive set of laws governing commercial transactions in the United States, is increasingly being applied to the digital asset space. Two articles of the UCC are particularly relevant to the issue of asset ownership in a crypto bankruptcy:

• Article 8 ▴ This article governs the holding of securities and other financial assets through intermediaries. While it was not originally drafted with cryptocurrencies in mind, some legal scholars and courts have argued that it can be applied to digital assets held by a custodian. Under Article 8, if a crypto platform is deemed a “securities intermediary” and the customer’s assets are treated as “financial assets,” the customer would retain a property interest in the assets, even if they are commingled.
• Article 12 ▴ This is a new article that has been proposed to specifically address the transfer of property rights in digital assets. It provides a clearer legal framework for perfecting security interests in and establishing ownership of cryptocurrencies and other digital assets. The adoption of Article 12 by states will provide much-needed legal clarity and will likely strengthen the ownership claims of users who hold their assets in true custodial arrangements.

The following table outlines the key provisions of the UCC that are relevant to crypto asset ownership:

Regulatory Guidance and Best Practices

Regulatory bodies are also taking a more active role in addressing the risks of crypto asset custody. The NYDFS, for example, has issued guidance for crypto custodians that emphasizes the importance of clear and conspicuous ToS that explicitly state that the customer retains ownership of the assets. The guidance also calls for the segregation of customer assets and prohibits custodians from using customer assets for their own purposes.

The SEC has also weighed in on the issue, with its Staff Accounting Bulletin 121 (SAB 121) recommending that companies that custody crypto assets for customers disclose the risk that those assets could be subject to the claims of creditors in a bankruptcy. This disclosure requirement has led to the inclusion of the now-infamous “bankruptcy risk” language in the 10-Q filings of publicly traded crypto companies like Coinbase.

The evolving legal and regulatory landscape is providing greater clarity on the issue of crypto asset ownership, but it also underscores the need for users to be vigilant in protecting their assets.

A Proactive Approach to Risk Mitigation

Given the current legal and regulatory landscape, a proactive approach to risk mitigation is essential for any individual or institution that holds digital assets on a third-party platform. This includes the following steps:

1. Thoroughly review the ToS of any platform before depositing assets. Pay close attention to the provisions on ownership, use of assets, and segregation of assets.
2. Choose platforms that offer true custodial services. Look for platforms that explicitly state in their ToS that they are acting as a custodian and that the user retains full ownership of the assets.
3. Whenever possible, hold assets in a non-custodial wallet. This is the most secure way to hold digital assets, as it gives the user full control over their private keys and eliminates the risk of a third-party custodian going bankrupt.
4. Stay informed about the evolving legal and regulatory landscape. The law in this area is still developing, and it is important to stay up-to-date on the latest court rulings and regulatory guidance.

By taking these steps, users can significantly reduce their risk of losing their assets in the event of a crypto platform bankruptcy. The ultimate responsibility for protecting one’s assets lies with the individual, and a thorough understanding of the legal and contractual risks is the first and most important line of defense.

Reflection

The legal and financial frameworks that govern the ownership of digital assets are in a state of rapid evolution. The recent spate of cryptocurrency platform bankruptcies has exposed the vulnerabilities of a system that has, for too long, operated in a regulatory gray area. The cases of Celsius, BlockFi, and others have served as a harsh but necessary wake-up call, forcing a reckoning with the fundamental question of what it means to “own” a digital asset in a world of centralized intermediaries.

The “Systems Architect” understands that the Terms of Service are more than just a legal document; they are the source code of the relationship between the user and the platform. They define the protocols, the permissions, and the parameters of the system. A failure to understand this code is a failure to understand the system itself, and a failure to understand the system is an invitation to catastrophic failure.

The path forward requires a new level of sophistication from all market participants. Users must become more discerning consumers of financial services, capable of parsing the legalese of a ToS and understanding the subtle but profound differences between a custodial and a debtor-creditor relationship. Platforms, in turn, must embrace a new standard of transparency and accountability, designing their systems and their contracts with the explicit goal of protecting customer assets. And regulators must continue to develop a clear and consistent legal framework that can provide certainty and stability to this nascent but increasingly important asset class.

The ultimate goal is to build a more resilient and trustworthy digital asset ecosystem, one in which the promise of decentralization is not undermined by the risks of centralization. This will require a concerted effort from all stakeholders, a willingness to learn from the mistakes of the past, and a commitment to building a future in which the ownership of digital assets is not a matter of legal ambiguity but a matter of mathematical and contractual certainty.