Crypto-Bankruptcy Claims: When the Going Gets Tough, the Tough Get Trading
By Divyansh Dev (Borden Ladner Gervais LLP)
The domino-like collapse of crypto-traders is catalyzing the commodification of bankruptcy claims. For example, launched in February 2023, Open Exchange, also known as OPNX, claims to be the first platform that combines trading of bankruptcy claims, with a specific focus on serving claimants who have been harmed by crypto crises. This development brings to life several of the findings outlined in the seminal work "Anti-Bankruptcy" by professors Douglas G. Baird and Robert K. Rasmussen.
Baird and Rasmussen argued that traditional forms of reorganization have become obsolete due to the success of market forces. They observed that reconciling the interests of various stakeholders during business reorganization is becoming more challenging, and this has resulted in financial innovations that slice and dice control rights in a corporate rescue. Baird and Rasmussen identified an interplay between game theory and Coase Theorem, which becomes interesting when applied to the field of crypto-bankruptcies.
In game theory, ‘empty core’ occurs when multiple parties are unable to reach a stable agreement with each other because there is always another coalition that some parties prefer, leading to defection from any unanimous agreement that may be made. In bankruptcy, for a core to be nonempty, the proposed coalition must offer a better deal to a sufficient number of claimants than any other deal that those claimants could get. If there are too many competing deals, there may not be a stable equilibrium for forming a rescue plan, and thereby resulting in an empty core. Distressed crypto-exchanges should be viewed as an alternative or open offer to defect a collective rescue plan, presenting a personalized resolution for individual claimants instead of treating them as a single class. This may be especially enticing in situations where there are no natural leaders among the creditors to perform consensus-building obligations necessary for corporate rescue. Resultantly, if there is a lack of consensus among claimants on the corporate rescue method, individual claimants may choose to trade their claims on the exchange instead.
According to the Coase Theorem, if people have well-defined property rights and low transaction costs associated with that property, they will negotiate fairly to allocate resources, regardless of the original property distribution rules. However, the issue with crypto-assets is that they don't have universally accepted property rights or classification, leading to unfair bargaining power during the bankruptcy process. Nonetheless, the creation of a platform exclusively for trading crypto-claims assumes ownership rights among the same creditor class and lowers transaction costs, increasing the perception of fair bargaining power.
Baird and Rasmussen previously identified several benefits that creditors may avail outside the bankruptcy process, which are now highly relevant in the context of crypto bankruptcies. Firstly, such an exchange offers an easy exit for those claimants who are not equipped to navigate the bankruptcy system or are unfamiliar with its intricacies. Secondly, crypto-claimants, by the very nature of their investments, do not expect to wait for the resolution of the court-led bankruptcy process to receive their claims. Immediate payments may, therefore, make them feel better off than waiting until the end of bankruptcy proceedings. On the buy-side, sophisticated and large-scale purchasers of bankruptcy claims may have a greater appetite and capacity for returns over a longer time horizon.
Time and again bankruptcy protection sought by crypto-traders has become a recurring event, which is unsurprising given the lack of incentives for government or legislators to make the crypto market more robust and less prone to bankruptcy. This is also a reason why private crypto-claim exchanges have mushroomed, offering alternatives outside of bankruptcy and promoting a "radically transparent and accessible financial world." In effect, these exchanges are potentially in a favorable position to fill the void left by government regulators, particularly in terms of promoting transparency and accessibility, while also causing negative public perceptions surrounding traditional bankruptcy procedures when it comes to crypto-traders. This is a cause of concern as private crypto claim-exchanges may prioritize expediting the resolution and satisfying creditor claims, even if it results in a net loss for creditors, making their assurances potentially deceptive. Additionally, by using these alternative platforms, a creditor may have to relinquish other claims and actions, such as avoidance transactions under bankruptcy, which the traditional bankruptcy system offers as a distinct advantage. Any potential evolution of these exchanges into platforms for debt assignment and collection against the crypto-trader rather than solely for the sale of bankruptcy claims must also be addressed before its too late.
In conclusion, the collapse of crypto-traders has opened an avenue for commodification of bankruptcy claims, with private crypto-claim exchanges emerging as alternatives to traditional bankruptcy procedures. However, it is important to strike a balance between accessibility and transparency in the crypto claims market and ensuring adequate creditor protection. Any potential evolution of these exchanges into debt service platforms rather than solely for the sale of bankruptcy claims must be prevented to avoid another season of crypto-winter.