Part Two of Bankruptcy Safe Harbors, the CLARITY Act, and Lessons from FTX and Celsius
The Digital Asset Gap
The safe harbors were designed for traditional financial instruments; however, digital assets like Bitcoin and Ethereum do not fit neatly into any of the categories the Bankruptcy Code protects. When crypto exchanges and lending platforms collapsed in 2022, there was no clear legal framework for how digital assets should be treated in bankruptcy. The Bankruptcy Code was never designed to answer questions like “Who actually owns the Bitcoin a customer deposited on a crypto exchange?” The answers to those questions turned out to have enormous consequences, as demonstrated in the 2022 bankruptcies of FTX and Celsius.
FTX, once the third-largest cryptocurrency exchange in the world, filed for Chapter 11 bankruptcy in November 2022 after a sudden liquidity crisis. At the time of filing, FTX.com held only 0.1% of the Bitcoin that customers believed they had deposited. Although the court-approved plan ultimately provided 98% of customers (those with claims of $50,000 or less) with 118% recovery of their claim value, plus interest, claim values were calculated as of the filing date, when Bitcoin traded at approximately $16,080. Customers received the dollar value of their holdings—not the assets themselves – limiting their ability to realize sizable gains that otherwise could have been realized had the assets been recognized as their own. A customer who deposited one Bitcoin received approximately $21,903 (118% of $16,080 plus interest), even as Bitcoin surged to dramatically higher prices. Meanwhile, hedge funds that purchased distressed claims for cents on the dollar reaped enormous returns.
Celsius Network froze customer withdrawals in June 2022 and filed for Chapter 11 the following month with approximately $4.7 billion in customer assets, including digital assets deposited in Celsius’s “Earn” accounts that the Bankruptcy judge ruled were property of the bankruptcy estate, not property of the customers, leaving those customers with significant losses as general unsecured creditors – losses that could have been avoided under the proposed CLARITY Act bankruptcy safe harbor provisions.
Safe Harbor Proposals Under the CLARITY Act
Congress attempted to address this gap in the CLARITY Act. The proposed law would have brought certain digital assets within safe harbor protections of the Bankruptcy Code, providing that a “purchase, sale, or loan of, a margin loan or other extension of credit on, or a repurchase, reverse repurchase, or other transaction involving, a unit of a digital commodity occurring with a commodity broker, stockbroker, financial institution, financial participant, or securities clearing agency shall be deemed to be— (1) a commodity contract for purposes of— (A) sections 362(b)(6), 362(o), 546(e), 553, 556, 561, and 562 of title 11, United States Code; . . . . (2) a margin payment for purposes of section 548(d)(2)(B) of title 11, United States Code. The availability of such safe harbor provisions likely would have protected customers who had deposited billions of dollars with the Celsius exchange by requiring it to maintain such funds as separate property of the customers, rather than treating them as property of the estate – treating the customers as general creditors.
The CLARITY Act did not receive the necessary 60 votes to pass a cloture vote on September 15, which would have allowed the measure to move forward to consideration by the full Senate. Its future is now uncertain, particularly with midterm elections approaching.
What Happens Without the CLARITY Act?
Without federal legislation, the current patchwork of uncertainty persists: There is no federal bankruptcy framework designed for digital assets; courts will continue deciding ownership on a case-by-case basis, often based on platform terms of service that most customers never read; customers of future failed platforms could face the same fate as Celsius Earn account holders – unsecured creditors with no priority, despite believing they were simply depositing assets for safekeeping; digital commodity transactions lack the safe harbor protections traditional financial instruments enjoy, creating potential systemic risk; the SEC retains broad discretion to classify digital assets as securities, while the CFTC’s authority remains limited. Regulatory turf battles continue; institutional adoption of digital assets continues without clear statutory guardrails.
Why This Matters for Your Business
Even businesses not directly involved in cryptocurrency should pay attention. The principles at stake – who owns what when a financial intermediary fails, and what protections exist – apply broadly. As tokenized assets, stablecoins, and blockchain-based financial infrastructure become mainstream, these questions will touch every industry. Companies that hold digital assets on third-party platforms, accept cryptocurrency as payment, or invest through funds with digital asset exposure all face the risk that the legal safety net they expect simply may not exist.
The gap between traditional bankruptcy safe harbors and the absence of digital asset protections has created a two-tier system. Until Congress acts, businesses must rely on careful structuring, rigorous due diligence on platform terms, and experienced legal counsel to protect their interests.
Cullen and Dykman LLP continues to monitor legislative and regulatory developments affecting digital assets, bankruptcy, and financial markets. For more information about how these issues may affect your business, please contact the attorneys in Cullen and Dykman’s Corporate, Finance, and Bankruptcy practice groups.
This advisory does not constitute legal advice. Nothing herein creates an attorney-client relationship between the sender and recipient. If you have any questions, please feel free to contact R. Patrick Quinn at (516) 357-3826 or via email at PQuinn@cullenllp.com, Matthew G. Roseman at (516) 296-9106 or via email at MRoseman@cullenllp.com, Michael H. Traison at (312) 860-4230 or via email at MTraison@cullenllp.com, or Howard Poon at (212) 510-2231 or via email at HPoon@cullenllp.com
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Cullen and Dykman’s Bankruptcy and Creditors’ Rights practice offers clients a unique perspective into the issues involved in complex bankruptcy proceedings in a wide range of industries. We have represented secured creditors, debtors, unsecured creditors’ committees, and individual unsecured creditors in Chapter 11 cases filed throughout the country, and we are skilled in resolving issues among various constituencies in complex Chapter 11 proceedings. We also have significant experience in out-of-court workouts, restructurings and bankruptcy litigation, and we have secured favorable results for our clients in complex bankruptcy cases throughout the country.
About Cullen and Dykman’s Distributed Ledger Technology Practice
Cullen and Dykman’s Distributed Ledger Technology practice advises financial institutions, corporate clients, and real asset stakeholders on the legal and regulatory implications of distributed ledger technology (DLT) and digital asset adoption. As blockchain-based infrastructure becomes increasingly integrated into banking, lending, payments, and asset ownership, we help clients implement these technologies within established legal and supervisory frameworks.