Crypto winter disputes: Navigating the intersection of crypto, arbitration and insolvency
Shearman & Sterling, Hong Kong
Carey Olsen, Singapore
The advent of a ‘crypto winter’ in early 2022, characterised by a sharp decline in the value of cryptocurrency assets and significant market volatility, has caused major crypto hedge funds, exchanges and lenders to experience financial distress with several entering insolvency proceedings. Since arbitration is the dispute resolution forum of choice in many crypto-related contracts, with the Hong Kong International Arbitration Centre (“HKIAC”) arbitration rules being particularly popular, the coming months are likely to see an increase in the number of parties seeking to arbitrate disputes against financially distressed crypto companies.
This article first provides an overview of the current state of the crypto disputes landscape, which arises at a novel intersection of crypto, arbitration and insolvency. It then looks at the type of legal and practical factors that may be relevant to a creditor in deciding on a dispute strategy when faced with a financially distressed crypto company, including in the context of arbitration and liquidation proceedings.
Impact of the ‘crypto winter’ on the dispute landscape
In early 2022, the onset of a ‘crypto winter’, the equivalent of an equities’ bear market, saw the financial outlook for many crypto companies rapidly deteriorate. Crypto assets, which comprise the major asset of many crypto companies, lost approximately US$ 2 trillion in value since their 2021 peak. The collapse of Terra, a high-profile USD 40 billion ‘stable’ cryptocurrency project, in May 2022 only compounded the negative sentiment permeating the crypto sector.
What is already clear is that the crypto winter has caused a fundamental shift in the crypto disputes landscape in 2022, with the number, variety and complexity of crypto disputes increasing as creditors scramble to recover unpaid debts and other liabilities across multiple jurisdictions. Major crypto hedge funds, exchanges, lenders and other market participants have experienced significant financial difficulties and been left teetering on the edge of insolvency. Indeed, several have already teetered over that edge.
In June, for example, liquidators were appointed in the British Virgin Islands (BVI) over Three Arrows Capital (3AC), a crypto hedge fund incorporated in the BVI with operations in Singapore, that reported assets totalling USD 18 billion earlier this year. In the same month, the crypto exchange CoinFLEX initiated a USD 84 million HKIAC claim against an individual known as “Bitcoin Jesus” for an allegedly unpaid debt arising from a margin call. Subsequently, CoinFLEX filed for restructuring in a Seychelles court seeking to resolve the shortfall arising from that debt.
In July, a Singapore-based trader filed a USD 2.4 billion ICDR arbitration claim against 3AC in respect of loans as well as parallel emergency arbitration proceedings requesting that unsecured funds be placed in escrow. Certain of these proceedings were then temporarily stayed following a request from 3AC’s liquidators. Also in July, in what has been described as cryptocurrencies’ ‘Lehman Brothers moment’, the cryptocurrency lender Celsius Network entered bankruptcy in New York.
With the crypto sector having become increasingly interconnected in recent years via complex relationships between crypto participants and increased lending and leverage (e.g., through decentralised finance (DeFi)), these collapses and others like them have a ripple effect that will be felt for some time as companies are progressively impacted by the spreading financial contagion. Disputes will therefore continue to arise.
Resolving ‘crypto winter’ disputes
In a dispute with a financially distressed crypto company, a creditor’s strategy may be informed by the following factors:
- what claim(s) does the creditor have (e.g., a debt claim, a proprietary claim or other cause of action)? With respect to debt claims, is the debt already due under the contract or has an event of default occurred under the loan agreement? Is the debtor likely to dispute the claim?
- what is the current financial status of the crypto company and are there likely to be claims by other creditors?
- does the creditor have any security over assets or rights against third parties that it can enforce effectively (e.g., parent company guarantees)?
Ascertaining the financial status of a crypto company may be easier said than done. With many crypto companies incorporated in offshore jurisdictions, where publicly available filings and company records can be limited, it may be difficult to obtain reliable information. Furthermore, even where such records are available, information on a company’s crypto asset holdings may be outdated given the ease with which such assets can be transferred. While certain information about crypto assets may be discernible from the relevant blockchain (e.g., transactions), this will often not suffice to provide a complete financial picture. Some crypto businesses are also not run like traditional companies, perhaps taking inspiration from crypto’s decentralised nature, which can further complicate the matter.
Where the creditor has the benefit of an arbitration agreement, arbitration can offer a viable method for pursuing a claim against a crypto company. The international enforceability of arbitral awards pursuant to the New York Convention, combined with arbitration’s procedural flexibility, renders it particularly well suited to resolving crypto disputes, which are inherently cross-border in nature.
Another relevant and important feature of arbitration is the availability of interim measures, such as freezing injunctions, which may be necessary to prevent assets from being dissipated. Since crypto assets can be transferred in a matter of seconds, the arbitration process may be frustrated if interim measures are not put in place to prevent this. Parties may be able to obtain interim measures ex parte from national courts or, alternatively, from an emergency arbitrator appointed by the arbitral institution. In jurisdictions like Hong Kong, Macao and Singapore, mechanisms exist to enforce emergency arbitrator decisions before the courts. Given the volatility of crypto assets, parties may try to argue that crypto assets should be converted into a more stable currency to preserve their value until the arbitration has been concluded.
In a situation where a financially distressed crypto company could enter insolvency (as considered further below), time may be of the essence in obtaining an arbitral award. Unlike national courts, it is rarely possible to obtain ‘summary judgment’ from an arbitral tribunal. Obtaining a final award often takes many months, or years. However, methods exist to expedite arbitration proceedings. For example, the HKIAC, SIAC and ICC Rules all include expedited procedure mechanisms designed to allow a party to secure an award (e.g., within 6 months). Key features of expedited proceedings can include the referral of the dispute to a sole arbitrator (instead of a three-person tribunal), shortened time limits, limits on the number and length of submissions, absence of discovery or disclosure (or limited document production), dispensation with a hearing (with the tribunal deciding only ‘on the papers’), and the rendering of awards with reasons in summary form.
In terms of threshold, expedited proceedings are generally available either by agreement of the parties, or when the amount in dispute does not exceed a certain limit (the range typically being between USD 2 million and USD 4.5 million, depending on the set of arbitration rules). Interestingly, under the HKIAC and SIAC rules, expedited proceedings are also available if the arbitral institution is persuaded that the case is one of ‘exceptional urgency’. A serious risk of a respondent party entering insolvency might justify applying the expedited procedure.
Notwithstanding arbitration’s suitability as a method for resolving crypto-related disputes, initiating an arbitration may not always be the best or most cost-effective course of action. For example, arbitration proceedings may be stayed if a moratorium comes into effect (considered below) and securing an arbitration award may not improve the creditor’s legal position as compared to unsecured creditors where the company becomes insolvent before any award can be enforced. If insolvency proceedings are commenced, it will be necessary to consider the law of the seat of arbitration and the contract, as well as the laws applicable to the insolvency proceedings, to determine the impact of those proceedings on an arbitration. Complicated situations can arise, particularly in cross-border contexts where there are parallel proceedings with the respective jurisdictions of arbitral tribunals and courts being governed by different laws.
Many crypto companies are incorporated in offshore jurisdictions. These include, for example, 3AC; it is therefore useful to look more closely at the mechanisms for liquidation available in the Cayman Islands and BVI, which may be of interest to parties faced with a financially distressed crypto company even where they have the benefit of an arbitration agreement.
As an initial matter, both the Cayman Islands and BVI have abundant experience dealing with issues specific to crypto companies; in particular, the BVI Court has expressly confirmed that cryptocurrencies are "assets" for purpose of the BVI Insolvency Act 2003 and allowed liquidators to convert crypto assets (such as Bitcoin and Ether) into US dollars and USDT (which is a cryptocurrency pegged to the US dollar). Areas of uncertainty nevertheless remain with regard to how crypto assets could be realized and distributed to creditors in the liquidation process, which will likely be considered by courts over the coming months as more liquidations of crypto companies work their way through the court system.
Practical issues for a creditor to bear in mind before going down the liquidation route include that:
- a creditor applying for liquidation of the debtor company is seeking a collective remedy on behalf of itself and all other creditors; it is therefore different from an arbitration claim by the creditor to merely recover its own debt from the debtor company;
- where an independent liquidator is ultimately appointed to collect, preserve, and distribute a company's assets, any individual creditor will have little control over the process; and
- if the liquidation proceedings are commenced on the basis of a disputed debt, such proceedings may be stayed or struck out if the issue of whether the debt is in fact owed by the company falls to be determined by arbitration (i.e., the parties have agreed to submit such a dispute to arbitration).
One potential advantage of a creditor commencing liquidation proceedings is the speed with which the offshore courts may proceed to grant a requested relief. Taking the recent 3AC liquidation as an example, an application by the creditors on 24 June 2022 resulted in a hearing by the relevant BVI court on 27 June 2022 and an order of appointment of joint liquidators on the same day. Liquidation proceedings can also bring the benefit of a moratorium on claims and other proceedings, in particular if provisional liquidators are appointed in the interim. In the Cayman Islands, the appointment of provisional liquidators brings into effect a moratorium. In the BVI, the appointment of provisional liquidators does not automatically trigger a moratorium; nevertheless, it is likely that the court would be prepared to further exercise its power in favour of granting one.
In circumstances where a crypto company is facing suits and arbitration proceedings in multiple jurisdictions (which is often the case given the geographical scope of its businesses), it is often necessary for liquidators to apply for recognition and enforcement of a stay in the courts of relevant foreign jurisdictions. The 3AC joint liquidators accordingly made a petition in New York under Chapter 15 for Recognition of Foreign Main Proceeding and Related Relief [within that state’s laws] and obtained a stay against the commencement and continuation of proceedings against 3AC's assets.
It is also relevant to note that the Cayman Islands' restructuring regime is undergoing a significant development that has come into effect on 31 August 2022. Under the new regime, companies are allowed to explore restructuring under the supervision of a court-appointed company restructuring officer and the moratorium will arise from the time that the company applies for such restructuring officer to be appointed. It would be interesting to see how this new restructuring regime may be employed by crypto companies to resolve their imminent financial difficulties.
While 2021 saw only a trickle of crypto disputes heading to arbitration, the crypto winter may see this turn into a torrent in 2022 and 2023. There is no one solution that fits all creditors. Navigating through the myriad issues that can arise at the intersection of crypto, arbitration and insolvency will require creditors and their lawyers to rapidly implement creative strategies to realise a successful outcome, which may involve seeking interim measures and initiating or participating in arbitrations and/or insolvency proceedings across multiple jurisdictions.
For example, Binance’s user terms have provided for HKIAC arbitration with a Hong Kong seat.
“Bitcoin Jesus” faces HKIAC claim (Global Arbitration Review, 11 July 2022): https://globalarbitrationreview.com/article/bitcoin-jesus-faces-hkiac-claim.
 CoinFlex Crypto Exchange Files for Restructuring in Seychelles (Bloomberg, 10 August 2022): https://www.bloomberg.com/news/articles/2022-08-09/crypto-exchange-coinflex-files-for-restructuring-in-seychelles#xj4y7vzkg.
Crypto fund collapse produces billion-dollar claim (Global Arbitration Review, 21 July 2022): https://globalarbitrationreview.com/article/crypto-fund-collapse-produces-billion-dollar-claim.
However, in jurisdictions where crypto-currencies are banned or heavily regulated, arbitral awards may be at risk of being denied enforcement or aside-aside by national courts on ‘public policy’ grounds. For example, in Mainland China where crypto-currencies are prohibited, a court in 2020 set-aside an award on public policy grounds in an arbitration administered by a PRC arbitral commission concerning a crypto-currency dispute (See Gao Zheyu v Shenzhen Yunsilu Innovation Development Fund Enterprise (LP) and Li Bin (2018) Yue 03 Min Te No. 719).
Section 22B of the Hong Kong Arbitration Ordinance (Cap 609); Articles 20, 44 and 45 of the Macanese Arbitration Law (Law No 19/2019); Sub-sections 2(1) and 12(6) of the Singapore International Arbitration Act (Cap 143A)..
See SIAC Rules 2016, Article 5. HKIAC Rules 2018, Article 42; ICC Rules 2021, Article 30..
Philip Smith and Jason Kardachi (in their capacity as joint liquidators of Torque Group Holdings Limited) v Torque Group Holdings Limited (in liquidation) BVIHC (COM) 2021/0031.
In the matter of Three Arrows Capital Limited BVIHC (COM) 2022/0119.