Crypto Bankruptcy - What Is It and How Does It Work

The topic of crypto bankruptcy has ceased to be rare. After the loud crashes of major exchanges and projects, it became obvious that even in the world of decentralization, there is a risk of insolvency. But how does bankruptcy work in an industry where assets are distributed across the blockchain and owners are often impossible to identify?
 Legal mechanisms are just beginning to catch up with crypto technologies, and the question of what to do with cryptocurrency in bankruptcy becomes crucial not only for companies but also for private investors.

What Does Bankruptcy in Cryptocurrency Mean

The term crypto bankruptcy combines classic procedures of financial insolvency and features of digital assets.
 While traditional assets can be seized, sold, or used in settlements with creditors, cryptocurrency adds complexities — it is decentralized, has no physical form, and is often stored in wallets accessible only to the owner.

In essence, bankruptcy in crypto is a legal process in which a company or individual is recognized as unable to fulfill obligations to creditors, including assets in cryptocurrency.
 However, there are peculiarities:

• Crypto assets are difficult to evaluate due to volatility;
• Identifying token owners is not always possible;
• Funds may be distributed across different networks and wallets.
  
  

The complexity lies in the fact that crypto in bankruptcy is subject to different rules depending on the country. In some places, it is recognized as property, in others as a financial instrument, and in some jurisdictions simply as digital code.

Seizure of Cryptocurrency in Bankruptcy

When a court decides on bankruptcy, the process of searching for and seizing assets begins. In the case of cryptocurrency, this presents a separate challenge. Seizing cryptocurrency is possible but requires technical and legal tools.

Seizure mechanisms include:

1. Identifying the debtor's wallets. Investigators and blockchain experts analyze transactions using analytical platforms (Chainalysis, TRM Labs, etc.) to trace addresses associated with the company or individual.
2. Requesting data from exchanges. If assets are stored on centralized platforms (Binance, Coinbase, OKX), the court may request their freezing.
3. Blocking fund withdrawals. During the procedure, exchanges restrict any actions with the debtor's cryptocurrency.
4. Transferring assets to the trustee. After confirming ownership rights, the crypto is transferred to a special wallet controlled by the arbitration trustee.
   
   

However, if funds are stored in cold wallets or DeFi platforms, access to them may be completely lost. This is why seizing cryptocurrency in practice often proves impossible if the owner has already moved the assets to private storage.

Interestingly, some courts have begun to view cryptocurrency as a "special type of property," allowing it to be seized similar to bank accounts but with the involvement of technical specialists.

DFA and Their Role in Procedures

It is worth separately considering the role of DFA (digital financial assets) in bankruptcy processes. DFAs in bankruptcy differ from regular cryptocurrencies as they are issued under a license and have legally secured backing — currency, securities, or commodities.

DFAs are regulated by law, meaning they can be officially recognized as a company's or individual's assets. This significantly simplifies their seizure, evaluation, and subsequent realization.

Example: If a company owns digital bonds (DFAs) issued on a licensed platform, these assets can be included in the bankruptcy estate and used for settlements with creditors. Meanwhile, when it comes to classic cryptocurrencies like BTC or ETH, their status depends on whether they are recognized as property in a given jurisdiction.

Thus, DFAs become a tool that reduces legal uncertainty and makes crypto assets more "transparent" to regulators and courts.

Practical Examples

Over the past years, the world has already seen several high-profile cases of crypto bankruptcy that have exposed weaknesses in the industry.

1. FTX (2022). The largest crypto exchange collapsed after a liquidity leak. The company declared bankruptcy in the US, and the process of asset recovery became one of the most extensive in history. It was revealed during the investigation that a significant portion of the crypto had been transferred to DeFi and anonymous wallets.
2. Celsius Network. A platform for lending crypto assets froze client funds and filed for bankruptcy. The trustees managed to recover some assets, but only through cooperation with centralized exchanges.
3. Mt. Gox. The first case of a mass exchange collapse, resulting in the loss of around 850,000 bitcoins. The legal proceedings have been ongoing for almost a decade, and the process of compensating clients is progressing slowly.
4. BlockFi and Voyager. These companies also faced insolvency after market downturns. Legal processes were delayed due to the complexity of accounting for crypto assets.
   
   

These stories show that cryptocurrency in bankruptcy often leads to legal conflicts. Refunding funds is impossible without access to wallets, and even courts are powerless without technological support.

Risks and Asset Protection

The main risk in crypto bankruptcy is the loss of control over funds. Token holders and investors often do not realize that storing crypto on centralized platforms does not give them legal ownership rights.

Main risks:

• Asset freezing. Exchanges may block user wallets during legal proceedings.
• Lack of guarantee of return. Unlike banks, crypto platforms do not participate in deposit insurance systems.
• Loss of access. If a company declares bankruptcy and wallets are controlled only by internal administrators, users cannot recover their funds.
• Opacity of storage structure. Many projects use mixed funds where client funds are combined with corporate funds.

How to protect yourself:

1. Store funds on your own wallets. Cold storage is the best protection against freezes.
2. Study the jurisdiction. Choose platforms registered in countries with clear legal regulations.
3. Monitor transparency. Companies that publish Proof of Reserves are more transparent and reliable.
4. Use DFAs. Regulated digital assets are protected by legislation and can be recognized as property.
5. Diversify risks. Do not hold all assets on one exchange or in one token.
   
   

The world of cryptocurrencies has become part of the real economy, and now its participants have to face the same legal risks as in traditional finance. Crypto bankruptcy is not just a loss of liquidity but a complex process involving the interaction of technology, law, and human factors.

Understanding how cryptocurrency seizure works, the role of DFAs in bankruptcy, and ways to protect investments allows for informed action and minimization of losses.
 In the future, crypto assets will likely obtain full legal status, and bankruptcy procedures will become more transparent and predictable. For now, the main rule remains the same: control the keys — control the assets.