Treating crypto as property in Hong Kong insolvency regime

By Tang Chong, Helmsman

Hong Kong’s Court of First Instance recently held (in the case of Re Gatecoin (in liquidation) 2023) that cryptocurrency has all the traditional characteristics of a property and is to be properly regarded so.

However, the court did not come to any conclusion on characterising the nature of cryptocurrency; namely, whether it’s a thing in possession (chattel), in action (rights associated with intangible property), or a new middle category property that is neither of the two.

This article analyses the impact of that decision on the city’s insolvency regime.

Q: How are ownership and value of cryptocurrencies determined in insolvency cases?

A: In the context of cryptocurrencies held by an insolvent exchange, ownership can be a complex issue. Factors affecting ownership include: terms of use between the cryptocurrency exchange and the user; how the exchange treated these cryptocurrencies operationally; and whether the exchange pooled or segregated the cryptocurrencies.

Tang Chong Jun, Helmsman
Tang Chong Jun
Executive Director at Helmsman and a Managing Partner at Tang & Co

The issue of ownership determines whether it is the liquidators or users themselves who pursue wrongdoers for cryptocurrency recovery. If it is the former, one further question that can arise is whether any recovered assets are available for distribution to the general body of creditors, or held by the liquidators on trust for each user.

The value of cryptocurrencies, like money or listed shares, is determined by reference to market demand, as published by an exchange. Major cryptocurrencies such as Bitcoin and Ethereum, with values that are in constant flux, can be ascertained at any given point in time, with market information available on various trading platforms.

The value of cryptocurrencies known as stablecoins is tied to fiat currencies or precious metals. More difficult to ascertain is the accepted value of lesser-known cryptocurrencies, which may be illiquid in nature, even if their last-known traded value is published on a trading platform.

Q: What is the current state of Hong Kong regulation regarding the use of cryptocurrencies and insolvency?

A: The cryptocurrency exchange in Hong Kong is currently subject to a licensing or regulatory framework introduced on 1 June 2023 under the jurisdiction of the Securities and Futures Commission (SFC).

Requirements for the operation of an exchange include maintaining a paid-up capital of no less than HKD5 million (USD640,000) and liquid capital as defined in the Securities and Futures (Financial Resources) Rules. At present, there is no specific regulation governing insolvency of cryptocurrency companies. Cryptocurrency exchanges are subject to the usual company insolvency regime, and supervision of the High Court.

Q: What are the challenges faced by insolvency practitioners dealing with cryptocurrencies in Hong Kong?

A: Cryptocurrencies have no physical location. Finding out where these assets are – and which court or law enforcement agency to work with in any particular jurisdiction – is an immense challenge. This is further complicated by the nature of cryptocurrency, with its public and private keys.

In cases where cryptocurrency is not held by a custodian and the private keys are known to only a few individuals who have already absconded, insolvency practitioners will find it hard to “unlock” and realise the value of these wallets without the co-operation of wrongdoers, and this assumes the cryptocurrency has not already been fraudulently transferred or liquidated.

The fluid market also means that ill-gotten cryptocurrencies can be easily transferred through several layers of persons and to anonymous beneficiaries, making tracing all the harder. Insolvency practitioners will likely have to take out what is known as a Norwich Pharmacal order in various jurisdictions against custodians to obtain information necessary for the tracing exercise, which can be time-consuming and costly. Even if the cryptocurrencies are recovered, the liquidators will need to determine the timing of when these assets should be realised for the general body of creditors.

Q: How could the Hong Kong insolvency regime be adapted to better accommodate the unique characteristics of cryptocurrencies as property?

A: While cryptocurrency presently functions like money or fiat currency, it does not appear to be capable of being a debt for the purpose of issuing a statutory demand in Hong Kong. Assuming cryptocurrency is treated as money, users will be entitled to issue statutory demands against the cryptocurrency exchange as a precursor to any winding-up for the debt owed. This may fast-track the process for the recovery of assets by having the liquidators step in earlier, rather than go through extensive litigation against the exchange before winding-up.

There also needs to be a cross-border insolvency co-operation agreement with other jurisdictions that will allow for the enhancement or expansion of liquidator powers to quickly locate and recover cryptocurrency on behalf of the company.

Tang Chong Jun is an executive director at Helmsman and a managing partner at Tang & Co in Hong Kong

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