Cryptocurrency and Digital Assets in Bankruptcy: Protection Strategies and Disclosure Requirements

The financial landscape has changed dramatically over the last decade. For many people in Alabama, investments that once seemed like a path to prosperity—Bitcoin, Ethereum, and a host of other digital assets—are now a source of significant financial distress. As the cryptocurrency market experiences waves of volatility, individuals who invested heavily now find themselves facing overwhelming debt from other parts of their lives.

This collision of new technology and established law creates a minefield of uncertainty. If you are considering bankruptcy, you likely have pressing questions. Are my crypto holdings treated like a bank account or a stock portfolio? Must I tell the court about my digital assets? Can I protect my investments from being liquidated? The anxiety is well-founded.

Are Cryptocurrencies Considered Property in a Bankruptcy Case?

Yes. The U.S. Bankruptcy Code has a very broad definition of what constitutes property of the bankruptcy estate. Section 541 of the Code states that the estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case,” regardless of where it is located or who holds it.

This definition is intentionally wide-ranging to encompass every conceivable asset. Federal courts have consistently affirmed that this includes all forms of cryptocurrency and digital assets.

• Cryptocurrencies: This covers well-known assets like Bitcoin (BTC) and Ethereum (ETH) as well as thousands of other altcoins.
• Non-Fungible Tokens (NFTs): The unique digital assets you own on a blockchain are considered property.
• Stablecoins: Digital currencies pegged to a stable asset, like the U.S. dollar, are also property.
• Exchange Account Balances: Any funds or assets held in your name on platforms like Coinbase, Kraken, or Binance are part of your bankruptcy estate.

There is no ambiguity on this point. From the moment you file your petition, your digital assets become part of the bankruptcy estate under the supervision of the court-appointed trustee.

The Importance of Full Disclosure: Why You Must List Your Digital Assets

The entire bankruptcy system is built on a foundation of honesty and complete transparency. When you file, you are legally required to submit a set of documents, known as schedules, that list everything you own, everything you owe, your income, and your expenses. You sign these documents under penalty of perjury.

Intentionally omitting your cryptocurrency holdings from your bankruptcy schedules is a serious mistake. The consequences can be severe and far-reaching:

• Denial of Discharge: The primary goal of filing for bankruptcy is to receive a discharge—the court order that eliminates your personal liability for certain debts. If the court finds you intentionally hid assets, it can deny your discharge entirely, leaving you responsible for all your old debts.
• Dismissal of Your Case: The trustee or a creditor can ask the court to dismiss your case for fraud, leaving you back where you started, but with a damaging mark on your record.
• Criminal Charges: Knowingly and fraudulently hiding assets in a bankruptcy case is a federal crime. It can lead to fines and, in some cases, imprisonment.

Some people may believe that because crypto is decentralized or held in a private wallet, it is untraceable. This is a dangerous misconception. Bankruptcy trustees are becoming increasingly skilled at uncovering hidden assets. They can subpoena exchanges, utilize blockchain forensic analysis firms, and review bank records for evidence of transfers to and from crypto platforms. The risk of getting caught is high, and the penalty is not worth it.

How Are Cryptocurrencies Valued for Bankruptcy Purposes?

One of the defining features of cryptocurrency is its price volatility. A coin’s value can swing dramatically in a single day. This creates a challenge for valuation in a bankruptcy context.

For the purpose of your bankruptcy schedules, all assets must be valued as of the date your case is filed. This means you must determine the fair market value of your cryptocurrency holdings on that specific day. You cannot use the price you paid for it or its all-time high. The value is what it was worth on the day your petition was officially submitted to the court.

To establish this value, you should use the price from a reputable, major cryptocurrency exchange at a specific time on your filing date. It is a good practice to take screenshots of the values on that day to document how you arrived at the figures listed in your schedules.

Can I Protect My Crypto Using Alabama’s Bankruptcy Exemptions?

Bankruptcy does not mean you lose everything you own. The law allows you to protect, or “exempt,” a certain amount of property from liquidation. These exemptions are what allow most people who file for Chapter 7 to keep their home, their car, and their personal belongings.

Alabama has its own set of exemption laws that dictate what property and how much of it you can protect. When it comes to cryptocurrency, the question is which, if any, of these exemptions apply. Because crypto is a new type of asset, there is no specific “cryptocurrency exemption” in Alabama law. Therefore, we must look to the existing categories to see where it might fit.

The most likely option for protecting crypto is the “wildcard” exemption. This allows a debtor to apply a certain dollar amount to any personal property that does not fit into another specific category. The amount of Alabama’s wildcard exemption can be used to protect assets like cash in a bank account, valuable collectibles, or, potentially, cryptocurrency.

The applicability of other exemptions, such as a “personal property” exemption, is less clear and remains a developing area of law. The amount of crypto you can protect will depend entirely on its value on the filing date and the available exemption amounts you have not applied to other assets.

The “Clawback” Provision: Can the Trustee Recover Past Crypto Transactions?

The bankruptcy trustee has the power to look back at your financial transactions in the period leading up to your filing. The goal is to identify and reverse certain transfers to ensure all creditors are treated fairly. This is often called the trustee’s “clawback” power. Two types of transfers are of particular concern:

• Preferential Transfers: These are payments made to certain creditors shortly before filing bankruptcy. For example, if you owed a family member $5,000 and you transferred them Bitcoin to pay off the debt a month before filing, the trustee could see this as “preferring” that family member over your other creditors. The trustee may be able to sue the family member to recover the value of that Bitcoin for the benefit of all creditors. The look-back period is typically 90 days for general creditors and one year for “insiders” like family members or business partners.
• Fraudulent Transfers: This involves transferring assets to hide them from the bankruptcy court or selling them for less than their fair market value. For instance, if you “sell” 1 BTC to your friend for $100 a week before filing bankruptcy, this is a clear attempt to defraud your creditors. The trustee can undo this transaction and recover the Bitcoin. The look-back period for fraudulent transfers can be two years or even longer under Alabama law.

Any transaction involving cryptocurrency is recorded permanently on the blockchain. Transferring digital assets before filing is not an effective way to protect them and will almost certainly create significant legal problems in your case.

What Happens to Crypto Held in Different Types of Wallets?

Not all crypto storage is the same, and the way you hold your assets can have legal implications.

• Hot Wallets (Custodial Wallets): These are accounts on centralized exchanges like Coinbase or Kraken. When you hold crypto here, you do not technically control the private keys. The exchange holds the assets for you. This is similar to money in a bank account. It is clearly your property, must be disclosed, and is subject to the trustee’s control.
• Cold Wallets (Non-Custodial Wallets): These are hardware devices (like a Ledger or Trezor) or software wallets where you, and only you, control the private keys. While this gives you direct control, it does not change the ownership status in bankruptcy. The assets in a cold wallet are still property of the bankruptcy estate. You are legally required to disclose them and may be compelled by the court to turn over the assets or keys to the trustee if they are not exempt.

Recent high-profile bankruptcies of crypto exchanges like FTX and Celsius have raised complex legal questions about who truly owns the assets held on a platform. In some of those cases, courts ruled that the crypto held in certain user accounts belonged to the company’s estate, not the individual users. This highlights the importance of getting clear legal advice based on how and where your specific assets are held.

How Chapter 7 vs. Chapter 13 Treats Digital Assets

The way your cryptocurrency is handled depends heavily on which type of bankruptcy you file.

• Chapter 7 Bankruptcy: In a Chapter 7 case, the trustee’s job is to liquidate (sell) your non-exempt assets to pay your creditors. If you own cryptocurrency that exceeds the value you can protect with your available exemptions, the trustee will require you to turn it over. It will be sold, and the proceeds will be distributed to your creditors. If all your crypto is covered by an exemption, you get to keep it.
• Chapter 13 Bankruptcy: In a Chapter 13 case, you do not liquidate assets. Instead, you propose a three- to five-year repayment plan. You get to keep all your property, including your non-exempt cryptocurrency. However, the value of that non-exempt crypto will affect your plan payments. The law requires that your repayment plan pay your unsecured creditors at least as much as they would have received in a Chapter 7 liquidation. Therefore, you must pay the value of your non-exempt digital assets into your plan over its term.

Practical Steps for Preparing to File Bankruptcy with Crypto Assets

If you own digital assets and are considering bankruptcy, preparation is key. Taking these steps before you file can make the process smoother and help avoid complications.

• Compile a Complete Inventory: Create a detailed list of every type of cryptocurrency or digital asset you own. Note where each asset is held (which exchange or wallet).
• Download All Transaction Records: Go into every exchange account you have ever used and download your complete transaction history. This includes buys, sells, trades, and transfers.
• Do Not Make Any Last-Minute Transfers: Resist the temptation to sell assets, pay off friends, or move crypto into a new wallet. Any transaction made shortly before filing will be scrutinized by the trustee.
• Organize Your Records: Keep your inventory and transaction histories in a safe place and be ready to provide them to your attorney. Transparency from the very beginning is the best policy.

The Right Guidance in an Evolving Legal World

Navigating cryptocurrency in bankruptcy is challenging and ever-evolving. Missteps can jeopardize a financial fresh start. If you are struggling with debt and have questions about how your cryptocurrency holdings would be treated in bankruptcy, do not leave your future to chance. The dedicated bankruptcy team at Padgett & Robertson is here to provide the clarity and direction you need. We can evaluate your specific situation, explain how Alabama bankruptcy law applies to your digital assets, and guide you through every step.

Contact us at (800) 303-1416 for a confidential consultation to explore your options and protect your financial well-being.