Wallet Provider Insolvency - This Is What Happens to Crypto Assets Held in Custody
One important characteristic of crypto-based assets such as Bitcoin is the decentralized administration, utilizing blockchain or Distributed Ledger Technology (DLT). This allows owners of crypto-based assets to access the relevant assets directly, without using intermediaries. Transactions occur directly through the network user’s confirmation, rather than centrally, using an account holding bank.
Custody - the determining factor in an insolvency
Access to crypto-based assets occurs using a cryptographic access key (private key). Keeping private keys safe is therefore essential when dealing with crypto assets. Loss of the private key means loss of the assets.
For this reason, many users use professional custodial sites (wallet providers), in the expectation that their assets will therefore be better protected. However, this also brings certain risks. The question of who actually owns the assets in a wallet provider’s custody arises in insolvency proceedings, if not before.
When insolvency proceedings are commenced, all assets of the insolvent debtor form a single estate (insolvency estate), which is used to satisfy the claims of creditors. The location of the assets is irrelevant, provided they form part of the property of the insolvent debtor. For movable items, the presumption of ownership is established through possession. For example, equipment or vehicles, which are physically located in the property of the debtor, will therefore in principle be attributed to the insolvency estate. If a third party claims that an item in the debtor’s custody actually belongs to him, then he must enforce his right through the relevant process (a claim for segregation under Article 242 of the Swiss Federal Law on Debt Collection and Insolvency - SchKG). The attribution of crypto-based assets follows in the same way.
If insolvency proceedings are commenced against a crypto wallet provider, the question also arises of which assets are attributed to the insolvent debtor and therefore fall within the insolvency estate, and which are to be surrendered to third parties with a stronger claim. In relation to crypto-based assets the power of disposition, in the form of the private key, is determinative.
A situation where the private key is known only to the customer of the wallet provider and only the customer can access the crypto tokens directly and permit transactions via the blockchain is straight-forward. In this case, there is no third party custody and the crypto assets do not come within the insolvency estate. The same applies to so-called multi-signature wallets, where the insolvent wallet provider does not have sole authority to access the crypto-based assets.
Segregation from the insolvency estate
However, where customers of the wallet provider have no individual access to their crypto assets and the insolvent wallet provider holds all of the keys required to access the assets, the relevant assets will, in principle, fall within the insolvency estate and segregation proceedings must be commenced by customers claiming better title in order to obtain them.
A statutory provision to this effect came into force on 1 August 2021 (Article 242a SchKG). Under this provision, crypto-based assets held by a custodian may be segregated where two conditions are met.
Firstly, the insolvent custodian must have undertaken to make the crypto-based assets available to the customer at all times. Therefore, the custodian must be prohibited contractually from carrying out its own transactions with the underlying assets.
In addition, the underlying assets must be attributable to the relevant customer either individually or, as a minimum, to a specific group. In the latter case it must be clear which proportion of the joint assets are attributable to an individual customer.
Customers of an insolvent crypto asset custodian must bring their segregation claims against the relevant insolvency administrator. It should be noted that costs for the segregation of assets are borne by the claimant and not the insolvency estate. Where the insolvency administrator finds that a claim is not justified, this will need to be enforced through court proceedings.