John J. Ray, CEO of the FTX debtors will testify tomorrow before the U.S. House Committee on Financial Services at a hearing entitled “Investigating the Collapse of FTX, Part I.”  Sam Bankman-Fried, the former CEO of the FTX Group, is scheduled to appear as well, albeit remotely. 

Mr. Ray’s prepared remarks are available online and are a worthwhile read to learn more about the controls and governance failures at FTX, as well as Ray’s restructuring plan. 

Specific deficiencies at FTX Group identified by Ray, among others, include:

  1. Senior management access to systems that stored customer assets, without controls to prevent senior management from redirecting those assets;
  2. The ability of the Alameda hedge fund to borrow funds held at FTX.com for its own trading without effective trading limits;
  3. Commingling of assets;
  4. Lack of documentation for nearly 500 investments made by the FTX Group;
  5. Absence of audited or reliable financial statements; and
  6. Absent of independent governance of the FTX Group.

Mr. Ray described his restructuring plan as having five key objectives:

(1) implementation of controls, which is underway;

(2) asset protection and recovery, which has so far resulted in securing over $1 billion in digital assets to protect against the risk of unauthorized transfers;

(3) transparency and investigation, including working with U.S. and foreign regulatory and law enforcement authorities to gather evidence to help determine the events leading to the collapse of the FTX Group;

(4) efficiency and coordination among the various FTX insolvency proceedings occurring globally;

(5) maximization of value for all stakeholders through either a reorganization or sale of various assets of the FTX Group, including investments and digital assets.

Mr. Ray’s prepared remarks also shed light on the rationale for including FTX US in the US Chapter 11 petition.  Mr. Ray states “because FTX US was not operated independently of FTX.com. Chapter 11 protection was necessary both to avoid a ‘run on the bank’ at FTX US and to allow [my] team the time to identify and protect its assets.”  Mr. Ray also describes specific facts he and his team have been able to determine regarding commingling of assets, FTX Group expenditures, and loans and payments to FTX Group insiders, in excess of $1 billion.

The hearing begins at 10:00 AM ET on December 13, 2022, and can be viewed online here.

BlockFi Inc. and eight of its affiliates followed the paths of crypto platforms Voyager, Celsius and FTX by filing for bankruptcy protection.  The case, commenced in the District of New Jersey, on November 28, 2022, is off to a fast start. BlockFi filed a plan of reorganization on the first day of its case. The plan proposes a standalone restructuring but allows the company to toggle to a sale of all or substantially all of the company’s assets. The company had its first day hearing in New Jersey on November 29th and expressed an interest in exiting bankruptcy expeditiously.  

BlockFi’s financial advisor pointed out in a “first day” declaration that, while the company’s downfall came as a result of FTX contagion, it does “not face the myriad issues apparently facing FTX.”  The declaration highlights BlockFi’s efforts to lead the digital assets industry in compliance and transparency in an obvious attempt to distinguishing itself from FTX. BlockFi’s liquidity crisis was, at least in part, due to its exposure to FTX through financing provided by FTX US, loans the company advanced to Alameda, and cryptocurrency held on FTX’s platform.  BlockFi was also heavily exposed to Three Arrows Capital, the crypto hedge fund that collapsed earlier this year. Three Arrows was one of the company’s largest borrower clients and its failure led to the FTX rescue financing.  Based on testimony of the hearing, it seems that BlockFi had lent approximately $680 million to Alameda and has approximately $355 million frozen at FTX.

In its schedule of largest unsecured creditors, BlockFi listed a $729 million unsecured claim on account of an indenture (although does not mention any bonds in the declaration).  It also listed a $250 million unsecured loan from FTX US (which is purportedly subordinated to customer obligations) and an undersecured “institutional loan” in the amount of $21.67 million.  The remaining claims were identified as client claims and the customers were not identified.

In conjunction with the US cases, BlockFi International Ltd., a Bermuda company, filed a petition with the Supreme Court of Bermuda for the appointment of joint provisional liquidators.  It is fair to expect that a Chapter 15 proceeding will be commenced in New Jersey once the liquidators are appointed.

Shoba Pillay, the Examiner appointed in Celsius’ bankruptcy cases, filed her interim report on November 19, 2022.  The Celsius Examiner’s report provides some important insight into a crypto-exchange’s operational and risk management failures which may provide investors and creditors some insight into what to expect in FTX.

The initial report provides important insight on the financial management at Celsius and treatment of various types of customer accounts. Given Celsius’ management of the different accounts, and the commingling of assets between and among them, “customers now face uncertainty regarding which assets, if any, belonged to them as of the bankruptcy filing” as explained by the Examiner. Her report is extremely thorough and can be accessed here. We highlight a few high-level observations from the report below.

  • Earn Program. Pursuant to its “Earn” program, customers purported to lend cryptocurrency to Celsius in exchange for certain “rewards” plus the return of their principal. The terms of use, while changing over time, were largely consistent with respect to Celsius’ ownership of all cryptocurrency deposited. While each customer’s account reflected the amount of each digital asset deposited (plus rewards), Celsius did not have individual wallets holding those assets. Instead, when amounts were deposited by a customer they would be swept into one or more “Main” wallets that pooled many customers’ assets. Celsius accessed those accounts at its discretion for purposes of funding its many investments — needed to generate its customers’ expected returns. When needed, Celsius effectuated withdrawals related to the Earn program by transferring assets from any one or more of its many commingled Main wallets to its customers’ external wallets.
  • Custody Program.  This program was launched in April 2022 in response to investigations then underway by various state regulatory authorities. The program was designed to allow the company a mechanism to maintain relationships with unaccredited customers in the US, purportedly holding their assets in “custody” without the benefit of rewards. Generally, all deposits of US customers following April 15 would go to Custody accounts (and accredited customers could then move them to an Earn account). The terms of use with respect to Custody accounts were clear — title remained with the customer (although they also identified bankruptcy risks). Hastily developed however, the Custody program did not provide customers with individual wallets that segregated assets.  Instead, the company sought to maintain an aggregate level of deposits in commingled wallets (as expressly permitted by the terms of use) that roughly matched the assets held in such program. When first deposited by a customer, assets would be directed to the company’s Main wallets at which time it lost any ability to trace an assets to a customer. From Main wallets, assets were periodically, and manually, transferred to Custody wallets. The aggregate amount contained in these commingled Custody wallets did not necessarily correspond to the aggregate customer balances allocated to them. Reconciliations occurred from time to time. When a shortfall existed, Celsius would transfers coins from a number of sources into Custody wallets to regain balance. In the days leading up to the filing, the swings in liabilities to customers with Custody accounts and the amounts maintained in the Custody wallet swung by millions of dollars in value. The Examiner reports that the deficit reach $45 million by June 28th. When it came to withdrawals to Custody customers, Celsius effected transfers, not from Custody wallets, but instead from wallets located in a different workspace.
  • Withhold Accounts. Celsius was unable to offer Custody accounts to users in nine states due to regulatory issues. For customers in those states, the company purported to maintain Withhold accounts as a temporary substitute. These funds were unavailable for either Custody accounts or the Earn program, and customers were advised to withdraw them. Unfortunately, customers could not withdraw funds through the Celsius app but rather need to contact customer care. In the interim, rather than be treated similarly to Custodial accounts, assets supposedly held in Withhold accounts were held in the Main wallets and available for use by Celsius as those in the Earn program.

Based on the Examiner’s initial report, it appears that Celsius’ ability to match the cryptocurrency deposited by a customer, whether in an Earn account, Custody account or Withdrawal account, was non-existent shortly following deposit and that assets were commingled with other Debtor assets for a short period of time.  While certain customer accounts were being tracked by accounting ledgers, the facts revealed by the Examiner’s report will provide the Bankruptcy Court with additional factual guidance in determining whether account holders can claim that their assets were being held in trust or “constructive trust.”    In other non-crypto bankruptcy cases,  whether or not trust funds can be identified or traced after such funds have been commingled (sometimes using a technique called the “intermediate balance rule”) helps to determine how much a beneficiary can actually recover.   Under this standard, if the amount of the commingled deposit equals or exceeds the amount claim to be in trust, then a constructive trust may be imposed. The Examiner’s report provides important factual backdrop for that rapidly approaching litigation, the outcome of which will certainly have dramatic consequences of customers’ ultimate recoveries.

Relatedly, while an examiner has yet to be appointed in the FTX case, it will be important to monitor and understand the severity of record keeping and segregation failures by FTX and the impact it will have on their account holders and creditors.

Crowell’s Crypto Digest asked Chainalysis, Inc., the world’s first and largest blockchain analytics provider, to give us a brief overview of the transformative compliance and investigation tools they can provide to financial institutions and legal counsel. The following post was graciously prepared by the Chainalysis team. Crowell & Moring is both a user of Chainalysis tools and legal services provider to Chainalysis.

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Blockchain technology is commonly described as providing a completely anonymous mechanism for transacting, which often leads to criticism that it facilitates illicit activity without accountability. However, with the right data and tools, the blockchain can provide greater transparency and traceability than is available in traditional finance. Since 2014, Chainalysis has been providing law enforcement, compliance professionals, and lawyers with the data and tools they need to manage risk and investigate suspicious activity within the cryptocurrency ecosystem.      

How do we do it? Using machine learning, dedicated forensic experts, and an extensive customer network, Chainalysis continually attributes cryptocurrency addresses and transactions to real-world entities, enabling law enforcement, governments, and others to trace the flow of crypto between counterparties.

The dataset is used tactically, to identify and disrupt illicit activity, and strategically, for an intelligence function to understand emerging risks and threats. Where are ransomware attackers cashing out? How are scammers defrauding victims? Which darknet markets are growing fastest? Chainalysis’ massive collection of designated data has been used to solve some of the most high-profile cases in cryptocurrency’s history. Working with Chainalysis, government agencies have recovered over $9 billion of funds from hacks, scams, and other illicit activities facilitated by convertible virtual currency.

Blockchain analytics also power valuable compliance tools to detect and prevent money   laundering and other forms of financial crime. Chainalysis’ compliance and due diligence resources are used by financial institutions and crypto-native businesses to reduce risk and illicit activity and to meet regulatory and risk-management requirements related to anti-money laundering (AML), counter-terrorism financing (CTF), and sanctions exposure. FinCEN, the Financial Action Task Force, and the Office of Foreign Assets Control (OFAC) all recommend blockchain analytics to account for the dynamic AML risks present in cryptocurrency and to screen for any possible nexus to sanctioned entities.

For that reason, Chainalysis is the blockchain analytics tool used by OFAC and many other US   government and law enforcement agencies. In OFAC’s sole source letter, they write, “Chainalysis’ use by key industry, US Government, and foreign partners necessitates OFAC’s use of the same tool to be able to collaborate easily and seamlessly with these partners in investigations and anti-money laundering and terrorist finance inquiries.” Annex B of the Department of Justice’s (DOJ) June 2022 Report discusses successful examples of cross-border collaboration to disrupt crypto-currency related cybercrime. The Report specifically mentions Colonial Pipeline, AlphaBay/Hansa, BTC-e, Silk Road, NetWalker Ransomware Disruption, Hydra Market, and the Twitter Hack. Chainalysis worked with law enforcement to trace and solve each of these cases.

An investigation is only as successful as its prosecution, and a recent case out of the Northern District of Georgia, United States v. Felton, sets a precedent that blockchain analyses can be used in much the same ways as texts, emails, and other forms of electronic evidence.  Increasingly, attorneys are utilizing blockchain analytics to improve outcomes for their clients, and better collaborate with law enforcement and government agencies.

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Crowell has direct experience using Chainalysis data that was integral to the tracking, tracing, and ultimately seizing for a client over USD 10 million of stolen cryptocurrency. The currency flows and related data allowed Crowell to prove to the US Secret Service, DOJ, several overseas trading platforms, and ultimately a US federal court, that certain funds were stolen and must be returned to the victim of a crime. In another ongoing Crowell representation, Chainalysis data and analysts were also critical in uncovering what appears to be a large-scale cryptocurrency Ponzi scheme with a significant number of victims.

FTX has warned its investors, customers and the crypto-world that they may have to file for bankruptcy protection without rescue financing to address its immediate liquidity crisis. Unlike the bankruptcy cases of Celsius and Voyager, FTX’s case, should it file, will likely involve many institutional investors with secured and unsecured claims. These institutional investors are now having to take steps to limit their exposure in the face of such uncertainty while considering the consequences of an FTX filing. While history rarely repeats itself, it does rhyme quite often, and lessons learned from Lehman’s epic bankruptcy in dealing with securities trades, loans, swaps, repos, customer property and dozens of other structured transactions may be useful guidance.  Of course, adding the novelty and complexity of digital assets and absence of regulatory clarity, an FTX case could be a tangle of confusion.

The legal questions that investors will face include:

  1. How will my digital assets or investments be classified in an insolvency proceeding?
  2. In a US Bankruptcy proceeding, do any traditional safe harbors apply which would allow termination, liquidation and set-off of claims?
  3. How will my claims or assets be valued?
  4. What should a counterparty do with any collateral they hold?
  5. What are the risks of withdrawing my digital assets today (assuming I still have access)?
  6. Do I have any legal recourse against management in connection with my potential losses?

This is a gut check moment for institutional investors in the cryptocurrency space and may be the first real test of how market, counterparty and legal risk management should respond to these types of events in digital asset investing and trading.

FTX’s insolvency will have repercussions on Voyager as well. As has been widely reported, Voyager’s exit from Chapter 11 is premised on the consummation of a sale of substantially all of its assets to FTX US (or West Realm Shires, Inc.).  Very generally, under the transaction FTX US would acquire the cryptocurrency on the Voyager’s platform and pay additional consideration which the company estimated to provide at least approximately $111 million of incremental value.  In its disclosure statement, the company reported that “the FTX US bid can be effectuated quickly, provides a meaningful recovery to creditors, and allows the Debtors to facilitate an efficient resolution of these chapter 11 cases, after which FTX US’s market-leading, secured trading platform will enable customers to trade and store cryptocurrency.” After this week’s news of FTX’s severe liquidity constraints and its own bankruptcy risk, Voyager’s prospects for a quick wind-down, and the associated recovery for customers and other creditors, have dimmed considerably.

It has been reported that Binance was a leading competitor of FTX US for Voyager’s assets. Binance has now backed out of any purported agreement to provide rescue financing to FTX, leaving FTX US’s ability to close on its acquisition in grave doubt. If unable to close, Voyager will surely look to Binance to revisit their interest in the  platform. While this will certainly cause a delay, the framework of Voyager’s plan to exit bankruptcy may hold.

The excitement in the distressed digital assets markets may only be in the early innings.

Crowell’s Crypto Digest sat down with Jorge Pesok, Chief Legal Officer at The HBAR Foundation and former Crowell & Moring attorney.

What is your role at HBAR?

I am the Chief Legal Officer.

How did you come into your current role? How did you get interested in the digital assets space to begin with?

I first got into the industry almost six years ago as an investor. A friend pushed me into it; and I tripled my money within the first month. I was instantly hooked. Prior to me going down the “crypto rabbit hole,” I practiced white collar securities litigation and enforcement defense. It did not take long for me to spot the similarities between the issues that I was already focusing on and those I anticipated would become relevant in the burgeoning crypto industry. As a way to move my practice into the industry, I started writing and publishing articles related to legal issues that I thought the industry should focus on. I got lucky. When regulators started becoming active in the space, my articles became relevant. That is when I started generating clients.

I continued to practice in this space at Crowell and later went in-house at a development shop working on a hybrid-decentralized exchange, Tacen, Inc. However, when the HBAR Foundation was created, they reached out to me because they had a Chief Legal Officer role that they wanted me to fill. Because I had previously worked with Hedera Hashgraph as outside counsel, I had a substantial understanding of their technology and structure which made it an easy decision. So yes, I’ve been in this role from the beginning. As Chief Legal Officer I manage all of the legal work for the Foundation.

Tell us about the HBAR foundation, what is their mission and what is their overall contribution to the crypto ecosystem?

Hedera Hashgraph is layer one platform. It’s carbon negative, extremely fast, Asynchronous Byzantine Fault Tolerant—it’s the future.[1] Our role at the Foundation is to incentivize development and adoption of the Hedera Network.

What current projects are you excited about or have been the main focus of your time and energy?

It’s tough to pinpoint one or two projects that I’m excited about. Since I’ve been at the Foundation, I’ve worked on over 150 grants, meaning that I am aware of at least 150 projects being developed on the platform. One area that I am particularly passionate about—and I’m happy to be a part of an organization that is also passionate about this—is sustainability. We’ve allocated a significant amount of money to promote development in the sustainability space. What we are essentially creating is a marketplace for carbon credits and carbon offsets that are trackable, traceable and auditable. One of the current issues with carbon credits and claiming you’re “carbon negative” or that you’re offsetting your emissions by purchasing these carbon credits, is that the carbon credits themselves are not very auditable. There are a lot of issues with the industry and we’re trying to correct it from the ground up using the Hedera Hashgraph. If successful, we will have created an entire marketplace for the trading, buying, and selling, of carbon credits which I think will lead to a much greener future.

It’s a daunting undertaking, and we’re working with a lot of entities because this exchange is being built from the ground up. We work with grantees that develop the technology, marketplace, and trading platform, on how these tokens are created, and how they’re audited. And at the same time, we’re also working with potential users, participants of the exchange, to understand what they need, what they want to see, and where the pain points are. These discussions are happening on a global scale. We’ll be participating at COP27, if you’re not familiar with that, I believe it was COP22 or COP23 that led to Paris climate accord. This conference continues to push the “green” agenda and how to combat climate change; and, we now have a seat at the table, along with an international body thinking through these issues and how to push forward.

Based upon what you’ve done thus far, the challenges that you’ve faced, and considering your company’s objectives, were there any lessons learned?

I think there’s always room for improvement, especially in this fast-moving industry. When I started at the Foundation, there was a giant backlog of legal work to get through; and, I was a team of one at the time. I had to triage the work and address the most pressing ones first even if it meant that other tasks had to wait.

Are there interesting projects or grantees that stick out in your mind? Something that might be a game changer?

Yes, I just mentioned sustainability, but we have different funds focused on different verticals. I don’t know if you’ve seen recently, but LG has announced that now certain LG TVs are going to come with an integrated NFT marketplace where you can purchase an NFT and display it on your TV. And that’s all built on Hedera. That’s really exciting. There’re tons to be excited about. I’m very bullish for 2023 and on because right now everybody’s building. In 2023 we’ll see a lot of the development that is happening now come to market, and I’m very excited about it.

What specific legal issues have you been grappling with?

There are many, the crypto industry is filled with legal uncertainty. And there are a lot of potential regulations/regulators to think about on a daily basis. You can take your pick from the cornucopia of acronyms, SEC, CFTC, DOJ, FinCEN, IRS, and so on. However, I think it is all interesting. That’s why I love the space. It keeps me on my toes and makes me stay on top of the recent developments.

Is there any specific area that piques your interest whether NFTs, DeFi, or other platforms? Or is there some other particular trend that you are interest in?

So, I’ve been in the industry for a while. What I get excited about are use-cases coming to market. When blockchain technology or crypto came about, there were some basic use cases like remittance—for example, it takes a lot of money to send funds internationally because you have to go through an intermediary. It’s a complex process but I believe Distributed Ledger Technology can fix that. It’s one of those core use-cases that maybe does not get as much attention as it should. I’m excited about seeing some of these core issues being tackled. I also think that there’s a lot of excitement with regard to the metaverse, a digital world. I think there’s going to be a lot done with that. However, I think a lot of good can happen right now just by tackling the basics. For example, why do I still have to pay a thousand dollars for a title search when I purchase or sell a property? If it is verified on the blockchain, super easy.

How do you or would you use outside legal counsel? How can outside legal counsel help you grow and achieve your specific goals?

I rely heavily on outside counsel. We have tons of legal issues for a legal team of now two. There is no way we could cover it all without relying on excellent outside counsel to support in the drafting of grants, to support in the structuring of a tax perspective, to keeping us apprised of all the latest and greatest in the regulatory space, and so on. I view outside counsel as part of my team. It expands my team from beyond two to however big the law firm is, or law firms because I use multiple.

Do you have any predictions for the digital assets space?

My prediction, at least in the short term, is that the industry will continue to face a bear market but will come out of it much more mature and garner more retail and institutional adoption. I also predict turbulence. But any time you’re creating disruptive technology or disruptive products, you’re going to have some turbulence.

[1] Asynchronous Byzantine Fault Tolerance (ABFT) is a property of Byzantine fault tolerant consensus algorithms, which allow for honest nodes of a network to guarantee to agree on the timing and order of a set of transactions fairly and securely.

In an earlier post we discussed the bankruptcy filing of Compute North Holdings, Inc., a bitcoin miner felled by high electricity costs and falling cryptocurrency prices (see here). It may be followed shortly by another miner, Core Scientific, Inc., which announced on October 26, 2022 that it has similarly been severely impacted by rising electricity costs and the price of bitcoin. It also noted increases in the “global bitcoin network hash rate” as well as ongoing litigation with Celsius Networks and its affiliates. The company, whose stock is listed on NASDAQ under the symbol CORZ, is engaged in a battle with Celsius regarding the latter’s failure to pay certain “utility tariffs” purportedly owing in relation to the hosting of Celsius’ mining equipment at Core Scientific’s data centers, among other things. In a filing earlier this month in Celsius’ bankruptcy case, Core Scientific asserted that it was “losing approximately $1.65 million per month subsidizing Celsius’s business.” A hearing on Core Scientific’s demand that Celsius pay these administrative expenses, among other things, has been scheduled for November 9, 2022 in Celsius’ case.  Core Scientific may have commenced its own case by that time. 

In its 8-K, Core Scientific announced that it will be unable to make certain upcoming payments under financing arrangements. Such failure may lead to defaults under its other indebtedness, including two series of convertible notes. They have hired restructuring advisors and announced that alternatives include the filing for bankruptcy. As of the date of the 8-K, the company was holding 24 bitcoins and approximately $26.6 million in cash. 

Meanwhile, Compute North Holdings’ case has progressed rapidly.  The company is engaged in a sale process and has scheduled an auction to begin on November 1, 2022.

We will provide further updates as on these matters as circumstances warrant. 

Secured lenders who include personal property assets as collateral in lending transaction structures have long relied upon the regularity and clarity of the Uniform Commercial Code (“UCC”) provisions which provide a roadmap for creation, perfection and enforcement of security interests in personal property. Revisions made to the UCC since 2000 have recognized and incorporated concepts to address changes in marketplace reality driven by technological advances.  The creation of cryptocurrencies, however, has posed challenges to entrepreneurial lenders and their counsel who desire to reach a level of comfort that a perfected security interest in a cryptocurrency can be achieved within the existing UCC framework.  The mere fact that a new Article 12 of the UCC, tentatively entitled “Controllable Electronic Records”, is in the early stages of adoption in state legislatures is proof enough that current law is at best inadequate to address issues peculiar to digital asset classes, including cryptocurrencies. The Wyoming legislature amended its version of UCC Article 9 effective as of July 1, 2019 with the intent of permitting perfection by control for cryptocurrencies (by controlling the applicable private key, including through a multi-signature arrangements) without addressing significant legal, practical and policy issues addressed in the proposed new Article 12 and its conforming amendments to other UCC articles.  It is presently unclear if Wyoming will follow other jurisdictions in adopting the Article 12 regime.

Secured lending against cryptocurrencies as collateral is but one of the topics addressed by the proposed UCC revisions.   Lenders who are currently taking  cryptocurrencies as collateral and their counsel have followed two basic approaches to achieve security interest perfection to the extent possible under current law:

Approach 1: The cryptocurrency is transferred to a securities intermediary, the securities intermediary agrees to treat the cryptocurrency as a “financial asset” which is then credited to the borrower’s “securities account” held at the “securities intermediary,” and the securities intermediary, the borrower and the lender enter into a control agreement as to the “securities account” and the “securities entitlement”; or

Approach 2: The lender files a UCC financing statement indicating the cryptocurrency/general intangible as collateral, the borrower provides the lender with the private key, and the lender transfers the cryptocurrency into its own public address or “wallet”. Note that absent the filing of the financing statement, the lender will be unperfected; having the cryptocurrency in the lender’s “wallet” alone does not perfect the security interest. Often, lenders may have no option under current law other than to perfect via Approach 1 as borrowers may be apprehensive about transferring the cryptocurrency to the lender and having a public record by filing of a financing statement tying the borrower to ownership of cryptocurrency, especially if the public address or amount of cryptocurrency is disclosed in the financing statement.  

Neither of these approaches, however, provides the securities intermediary or the secured party with any legal or practical assurance that the borrower owns the cryptocurrency free of other claims, nor that the securities intermediary will acquire the cryptocurrency free of other claims. Under the current version of Article 9 of the UCC there is also no way to ensure priority of the security interest without obtaining a release or subordination from all other secured parties, even if they are disclosed.  While the Wyoming non-uniform UCC amendments offer some additional protections, these uncertainties cannot be fully resolved under the current state of the law.

Therefore, lenders may need to simply rely on representations and warranties from the borrower as to its ownership of the cryptocurrency being free and clear of liens and other adverse claims encumbrances. In addition, in order to provide some comfort to the lender until the law catches up with the marketplace, the lender may need to engage in a factual diligence process to protect itself from other claimants to the cryptocurrency that may exist at the time of the transfer to the securities intermediary or the filing of the financing statement, such as examining the on-chain transactions and inquiring about the prior owners and prior public addresses of the cryptocurrency being used as collateral. In practice, while not fully resolving these concerns, some lenders have required borrowers to incorporate a borrowing entity in Wyoming to utilize Wyoming’s amendments to Article 9 to make use of the perfection by control rules available in that jurisdiction.

The revisions to the UCC, once enacted, will as a legal matter, create uniform rules for perfection of “controllable electronic records” (a new asset class that includes digital assets broadly defined and most, but not all, cryptocurrencies) via a “control” regime aligned to the peculiarities of this new asset class and rules that will either cut off prior claims or that will give the secured lender with control a priority over other claims.  These revisions are more clear and robust than the non-uniform Wyoming amendments. Wyoming, for example, provides for a cut off of prior claims only after two years following perfection by filing provided the secured party does not have actual, as opposed to constructive, notice of an adverse claim during  two-year window. Unlike the very familiar account control agreements for deposit accounts and securities accounts currently in use where parties can look for the magic language that imparts “control” to the secured party, the new Article 12 paradigm will  require careful analysis to determine if in fact the asset in question is a “controllable electronic record” and whether it is meets the newly developed tests for “control” of a “controllable electronic record” set out in the new Article 12. It is unlikely that a “form” document like an account control agreement will be the one size fits all mechanic to gain perfection by “control” for this asset class.

On September 22, 2022, Compute North Holdings, Inc. and certain affiliates filed bankruptcy in the Southern District of Texas in Houston.  The company describes itself as “a leader in data centers, focused on delivering sustainable, cost-effective infrastructure for customers in the blockchain, cryptocurrency mining and distributed computing space.”  See Declaration of Harold Coulby, Chief Financial Officer and Treasurer of the Debtors (Doc. 22). It owns and operates three operating facilities that provide remote computing capacity and has rights to two others that remain in development. Its main business lines include (i) hosted cryptocurrency mining services, (b) bitcoin mining, and (c) cryptocurrency equipment sales. See Id.

The company attributes its predicament to a severe liquidity crisis that constrained its ability to complete development of two facilities that had begun prior to the distress that has marked the digital assets markets in 2022. In particular, it points to the drop in bitcoin prices to levels almost 75% below its peak in late 2021 and the doubling of costs for electricity required for bitcoin mining. See Id. The company also encountered extreme difficulties with one of its lenders, Generate Lending, LLC (“Generate”), the lender on a $300 million credit facility. Following a number of alleged defaults under the facility, among other things, Generate effectively ceased control of a non-debtor subsidiary that indirectly owns two critical facilities, including the so-called “crown jewel.” The company says that it had disputed the existence of the alleged defaults and remains in discussions with Generate regarding financing. See Id.    

With regard to its mining operation, the company says that it maintains cryptocurrency wallets which contain customer “subaccounts or subwallets” — the mining gear that is awarded bitcoin “could belong to a customer.” The wallets are maintained on the Genesis and Bitstamp exchanges. See Id. Given the opacity in this largely unregulated environment, it is unclear whether there will be any dispute regarding the ownership of bitcoin maintained in those wallets.

Like Voyager and Celsius before them, the company filed bankruptcy without arranged financing. The case will be funded at the outset with the company’s limited unrestricted cash (approximately $8.7 million).Also similar to those cases, the company plans to pursue a dual path process, either a sale of the business as a going concern or a stand-alone plan.  See Id.  

We will continue to provide updates as circumstances warrant.

Crowell’s Crypto Digest Blog sat down with MakersPlace’s Head of Legal and Trust and Safety, Kayvan Ghaffari, to learn about the NFT marketplace and the current legal landscape regarding NFTs.

What does it mean to be the Head of “Trust and Safety”?

Trust and safety revolve around ensuring the platform is secure and safe, and ensuring that whoever interacts with the website has a trusting relationship with the platform.

To me, it involves four buckets.

One, is content moderation. Essentially, how are we thinking about the content that is being provided on our platform? We are thinking through these murky issues to make sure people are safe and that there is nothing inherently wrong, illegal, or harmful on our platform.

Second, is fraud. How do we prevent fraud and scams from occurring on our platform? This is a big issue in the art world and also the digital assets space. We want to make sure we have a reputable platform that people engage in.

Third, is cybersecurity. How do we maintain our infrastructure and secure it?

Finally, intellectual property. How do we approach potential IP theft? All of these encapsulate trust and safety at a high level.

How did you come into your role at MakersPlace?

MakersPlace was a client of mine when I was at Crowell. What I did for them for the most part was IP due diligence. They would send artistic works from creators before they were launched and I would look at them and see if there were any IP issues. I was really fascinated by this work. There’s a lot of IP issues around art, including licensing, copyright, and trademark issues.

I never anticipated being an art lawyer. Working with any startup is a fascinating opportunity. They don’t take no for an answer and you are required to think creatively about a solution. Regardless of where they are located in the world, they have this ethos of “break it and then fix it.” As a lawyer, you’re saying “alright, here’s a set of items you want to achieve, I can’t tell you, ‘you can’t do this.’” That doesn’t work, because the startup will go to another law firm. Instead, I find ways to mitigate that risk and look at the startup’s risk tolerance. You don’t get that same issue with large institutional clients. With startups, you’re forced to reckon with that. From that perspective, it always fascinated me and interested me – it’s something I always enjoyed in my career. When they asked me to take this role, it was a hard decision, but it was an opportunity to flex my creativity and I couldn’t say no to it. I have a chance to operate at the cutting edge of IP issues. 

What’s the mission of MakersPlace?

Our company is called MakersPlace, a place of makers. Our goal is to empower creators and to give them a platform to speak. We want to connect these creators with collectors who value and appreciate that art and expression. We haven’t wavered from this mission. This is evident by the fact that we have not deviated from being a curated marketplace. It’s also why in our smart contracts there’s a built-in royalty flow where an artist will gain royalties for any secondary sale of that particular art in perpetuity. This is a revolutionary system for creators. This has never happened before in the “traditional” art world.

What’s exciting you right now at MakersPlace?

The first thing that comes to mind is O(V.)Erturned.This month-long exhibition featured women creators. The idea behind this came after the Supreme Court overturned Roe v. Wade. We as a company took issue with that decision and we issued a public statement condemning the decision. So, we wanted to empower women voices and amplify them. We had a curated exhibition, just of women creators, where we donated all of our commissions to Planned Parenthood, the ACLU Reproductive Freedom Project, and the Brigid Alliance. Each week we had a Twitter Spaces with some of our women creators. It was such a remarkable, moving, powerful experience to hear these women and hear about their inspiration and their thoughts on the Supreme Court’s decision. Hearing the raw vulnerability of these creators was so moving.

What are the goals of MakersPlace moving forward?

We want to really lean in and maintain our message of being a curated digital marketplace for leading artists.  In many ways, we want to be premier destination of digital art. We want people to think about and be proud of owning a beautiful piece of digital art. It is art. It’s just using another medium – a new technology – to communicate that art. We want to become the go-to for art. And we want to be able to cultivate that community of collectors who value and appreciate it in a material way.

And, as a I mentioned earlier, trust and safety is a big deal, MakersPlace is taking and making strides to lean in on trust and safety. We want to be totally transparent about issues that are happening on the platform, and being transparent on what our views are on content and moderation. I want to ensure that anyone that spends any money at MakersPlace can trust that they are receiving the value for what they spent money on.

On the flip side, what are some challenges that are on the horizon?

The biggest challenge is the unknown. The regulatory uncertainty is challenging. We don’t know who is going to regulate us. What they are going to regulate us with. We don’t know how everything is going interplay with laws in other countries. We’re starting to see hints of it, but it will be interesting to see how it all plays out. In many ways, it’s helpful to be regulated because it creates some certainty.

Of note, the SEC recently announced that they are doubling the size of their digital assets division and for the first time the SEC has identified NFTs as an area of focus.

In general, how would you use outside counsel and how can outside legal counsel be helpful to MakersPlace?

There are a few things that outside counsel can do to help MakersPlace and any NFT company.

First, monitoring what laws are happening. What’s the noise on the ground? What is the SEC saying? What is the CFTC saying? What is Congress saying on NFTs? This all goes to what regulations will be applicable. I think law firms need to keep their ears to the ground and immediately notify companies like MakersPlace about any developments and, critically, to provide insight on how it may affect us.

Outside counsel would also be helpful in IP litigation. Or any litigations. The non-digital art world is full of litigations both in terms of IP litigation but also a “who owns it?” litigation, what is the commission split, breach of contract stuff. I suspect we’ll start to see additional activity in that domain in the next few years. Scam and fraud are happening a lot in this ecosystem as well. It’s not just isolated to NFTs and crypto. It happens all the time outside of this space.

Most importantly, and lastly, when I’m asking outside counsel for advice, I’m asking, “what should I do?” I’m not asking for a recitation of the law. Take the law and tell me what to do with it. First and foremost, I’m paying you to tell me what to do first. I don’t necessarily need or want a memo or full-blown analysis of the law. I need lawyers to give me solution and provide a pathway of how we’re going to mitigate those risks.

What predictions do you have for the NFT ecosystem in the next few years?

I think we are starting to see a lot of consolidation of marketplaces. I think people are being smarter about NFTs, and digital assets in general because there have been a lot of rug pulls recently. We’ve launched an education hub on our platform which is designed to actually educate people on NFTs, including on what it takes to become a creator and collector on our platform.

I also think we’re going to see a bifurcation and trifurcation of the industry. We’re going to see companies like OpenSea that are open marketplaces. And we’re going to see curated marketplaces. And we’re also going to see studios that are facilitating creators that will feed into these marketplaces.

Anything else that you want to communicate about MakersPlace and the NFT space?

It’s a young space. If we think about the internet and where it is and how many issues there are, it’s like what my mentors Gabe Ramsey and Warrington Parker would always tell me, “it’s kind of like an adolescent riding a bus.” We kind of know what it is. We kind of have an understanding of its full potential, but we don’t really know, and don’t really have the capacity and the maturity to really understand it. With NFTs, we’re like children driving a bus. It’s an exciting industry that needs to be taken seriously. The industry needs to do a better job of educating people about its capacity and about instilling trust and safety within the industry, and we’re trying to do that through our MakersPlace Education Hub. From an intellectual perspective, there are a lot of opportunities to pave the way and be leaders from a business and artistic perspective. It’s scary, but also really fun. There are so many ways this industry can mature and adapt. I found it both exciting and impactful.