Initial Coin Offerings and Insolvency Law

In the last few years, an ever-increasing number of platforms are launching ICOs (initial coin offerings). But what happens if an insolvent debtor holds tokens and insolvency proceedings are opened? How can tokens be made available for the debtor’s creditors? How can post-commencement avoidance rules be enforced? And how can fraudulent transaction avoidance rules be enforced?

ICOs are primarily studied from the perspective of securities law. By contrast, my paper ‘Blockchain Securities, Insolvency Law and the Sandbox Approach’ focuses on ICOs from the perspective of insolvency law and aims both at scrutinising some insolvency law aspects of ICOs regardless of the jurisdiction involved and the insolvency proceedings adopted, and at developing a different view of this new phenomenon in order to understand the challenges that it poses in a more holistic way.

One first challenge is how to find out that the assets exist and how to make them available to the general body of creditors when the debtor is non-cooperative. If insolvency proceedings are opened against an insolvent debtor, the appointed insolvency practitioner (IP) must determine the debtor’s assets which are available for creditors in accordance with the general principles of property law and contract law. However, difficulties emerge if the insolvency assets include tokens: firstly, because the debtor who owns these items exercises the related rights through a digital key, which is known only to the debtor; secondly, because the debtor might have bought the tokens by employing a username, which can differ from his/her/its real name and which cannot be easily traced back to it. Hence, if the debtor has decided not to make the tokens available for the creditors, the debtor will probably keep them hidden, and the IP will not even be aware that the insolvency assets include those items. But what if the IP learns that the debtor owns those tokens? How can those tokens be made available for the debtor’s creditors?

A second challenge relates to the risk that the debtor transfers the tokens after the insolvency proceeding. The opening of insolvency proceedings divests the debtor of his/her/its assets – these will be administered by the appointed IP. However, if the debtor nevertheless transfers an asset, most jurisdictions make this transaction void or ineffective with regard to his/her/its creditors by operation of law. This implies that the IP will be entitled to require the transferee to return that asset, or its value, to the insolvency assets. Theoretically, these rules should also apply to cases in which the debtor has transferred assets via blockchain. Again, here the IP might not be aware of these transactions. However, if the IP is aware of them, he or she will certainly encounter some difficulty in enforcing post-commencement avoidance rules because blockchain transactions are technically irreversible. Here, the IP could apply the same rule which is applicable when the transferred items have perished or are no longer present in the transferee’s assets. This means that the IP can only claim against the transferee for a restoration in money. However, if a transaction concerns tokens, this form of restoration could be unsatisfactory. Like a house or a car, these items have a specific value, but, like traditional securities, these confer a bundle of rights including the right to vote and the right to be paid pro quota profits. Moreover, like traditional securities, tokens may appreciate in value.

Finally, almost all jurisdictions lay down a set of rules aiming at reversing the effects of transactions that a debtor has performed within a specific time before the opening of insolvency proceedings, if these payments and transactions result in a diminution in the debtor’s assets. Certainly, this regulation varies from jurisdiction to jurisdiction. Nevertheless, almost all jurisdictions prescribe that, if the legal requirements are met, the relevant transactions are void or ineffective with regard to the debtor’s creditors. As a general rule, these prescriptions are applicable also to transactions performed via blockchain. However, again in this case, the aforementioned problems arise.

Are these issues merely insolvency law issues? How might a policymaker manage them? Would the principle of technology neutrality be involved? Arguably, the situation is much more complicated and in this respect my paper argues that these problems originate from the fact that the issuance of tokens is creating a divide between the world where tokens are issued, offered and sold, and the world where law is enforceable.

Renato Mangano is a Professor of Commercial Law at the University of Palermo (Italy)