In Canada, in order to make out a claim for the return of property in bankruptcy, the person claiming that property must be able to identify that property with specificity which, as it turns out, is pretty hard to do with bitcoins.Peter Nicholls/Reuters
Some people think that bitcoin is the next Facebook for the guys who would have invented Facebook but, with the recent bankruptcies of bitcoin miners CoinTerra and Aquifer and the 2014 bankruptcy of the bitcoin exchange Mt. Gox, things don't look so great for bitcoin proponents these days. Part of this is driven by the fact that bitcoin isn't the quite as liquid and stable as its proponents once said.
But another reason is that bitcoin seems to be not just a financially awkward investment, but a legally awkward one. If you parked bitcoins in Mt. Gox – the world's largest bitcoin exchange, which declared bankruptcy and "lost" 850 million bitcoins in 2013 – you may have discovered over the last year that you're subject to Japanese bankruptcy law, that you are an unsecured creditor in the bankruptcy, and that, even if you found the lost bitcoins, you'd be subject to some ugly tax rules.
This is kind of a downer for bitcoin true believers. To a great many bitcoin loyalists, traditional money is a government mandated fiction backed by decree – or fiat, if you will. For those of you who feel this way, gold is the traditional cash alternative (though does a shiny rock of limited commercial use really merit such high standing?). Those who find gold technologically unsophisticated and have a libertarian bent may have turned in their bullion bars for bitcoins.
As a formal matter, bitcoins are "slots" in a digital ledger, the number of which increases at a fixed but declining rate, based on the amount of computing power needed to solve increasingly difficult mathematical equations used to verify bitcoin transactions. Those who verify these transactions are called "miners" and are rewarded with more bitcoins for their efforts.
These transactions operate somewhat like cash in that they travel from party to party directly, without a financial intermediary, and are therefore somewhat difficult to trace. Also, because of their fixed supply, bitcoins are deflationary, so (empirical evidence notwithstanding) bitcoin proponents believe the price of bitcoin will go up in near perpetuity.
This is a serviceable explanation, but it doesn't tell you exactly what bitcoins are. Are they currency, like the dollars you turned into gold, or are they property, like that gold you turned into bitcoins? And what are the consequence if bitcoin is treated as one or the other?
For those of you who didn't invest in bitcoins, this point seems awfully academic. But for those of you who deposited large numbers of bitcoins on Mt. Gox, this question has probably been weighing on your mind a lot lately. Mostly because what investors thought was a nifty financial technology has turned out to be a complete legal oddball.
I like to imagine that when first buying bitcoins on Mt. Gox, bitcoin investors felt that they were part of some brave new post-nation state frontier. Bitcoins were not authorized by states and were traded directly from person to person through electronic means. The truth is somewhat less romantic: bitcoins would be stored on computers and computers were physically located in places; the "cloud" is actually Mt. Gox's mainframe in Tokyo, and its main operating entity is located and incorporated in Japan.
So, when Mt. Gox went broke, it was no surprise that aggrieved creditors attempted to launch class action suits alleging fraud on the part of Mt. Gox in a variety of jurisdictions, including Canada. And, it was equally not a surprise when, last fall, Justice Newbould declared that Japan would be designated as the "foreign main proceeding" for the Mt. Gox bankruptcy, thereby staying (or pausing) the class action lawsuit in Canada. U.S. courts reached the same decision under Chapter 15 of the U.S. bankruptcy code.
It's a bummer for the class action litigants to have their lawsuit postponed for a process in a jurisdiction half a world away. Indeed, creditors have tried to find all sorts of, um, unique solutions to deal with the Japanese bankruptcy process. Still, while that decision may have been a downer, it's not like things would look much sunnier for Mt. Gox creditors if bankruptcy proceedings took place in Canada. Ask the Mt. Gox creditors who had been hoping that the exchange's quasi-miraculous discover of 200 bitcoins in March of last year would maybe lead to the return of their individual bitcoins.
But suppose courts were to treat bitcoin like property (or commodities), as Japan already has and as the U.S. appears to be leaning toward doing. In Canada, in order to make out a claim for the return of property in bankruptcy, the person claiming that property must be able to identify that property with specificity which, as it turns out, is pretty hard to do with bitcoins.
In order to accurately identify bitcoins for a property claim in a Canadian bankruptcy court, Mt. Gox's creditors would have to be able to point to the specific bitcoins they owned based on the bitcoin's cryptological description, and then point to a contract with Mt. Gox that describes those precise bitcoins as belonging to that person. And then, since bitcoin is intangible, that agreement would have to be registered under the Personal Property Security Act to perfect the interest, a legal status that, in bankruptcy law, generally ranks above merely having an interest in property.
Insofar as I can tell, no one had those agreements with Mt. Gox. Instead, those bitcoins got thrown into a pot to be distributed among all of bitcoin's unsecured creditors on a pro-rata basis.
Also note that perfecting an interest in something like bitcoin makes prophylactic measures hard – if a creditor can't perfect her bitcoin security, that security is no security at all. Similarly, if one's interest in bitcoin were considered an undifferentiated interest in a commodity, it's very likely that they would simply be lumped in with other unsecured creditors. And even if a creditor were to register a security interest in bitcoin, that security interest would make it harder to use bitcoin as currency – the registration would likely have to be released each time a bitcoin was used to pay for goods.
Not that a claim for currency would help bitcoin creditors either. Such a claim would be reduced to the monetary value of the bitcoins on the date of bankruptcy so, if the remaining bitcoins were ever found (which would probably cause bitcoin prices to rise despite increasing supply) creditors would be unable to take advantage of the appreciation in the value of the property.
Of course, any recovery in bankruptcy presupposes the recovery of further bitcoins, which looks like an unlikely event. Deposit insurance would have protected creditors in the event of a bankruptcy, but, unsurprisingly Mt. Gox did not have deposit insurance, nor are bitcoin exchanges mandated to have insurance.
Finally, if a creditor ever were to get her bitcoins back, the CRA would treat bitcoin transactions as though they were barter exchanges, meaning that a person trying to ditch her bitcoins could see a taxable gain when she tries to use her bitcoins to buy, say, anything but bitcoins. Which – property or currency – is increasingly looking like the best position of all.
Adrian Myers is a lawyer at Torkin Manes LLP.