Two crypto law experts, Wassielawyer and Adam Levitin, analyze the bankruptcies of 3AC, Celsius, and Voyager.

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Hi, all. Just a quick note before we begin. This episode is an interview with a bankruptcy expert Adam Levitin and an insolvency expert Wassielawyer. It’s an incredible conversation on how the bankruptcies of Three Arrows Capital, Celsius and Voyager will go down. I just wanted to note that we recorded before Friday afternoon, which is when FTX offered to allow Voyager customers who opt into the program access to some of their funds early as long as they create FTX accounts.

So, in case you’re wondering why we don’t discuss this proposal that’s why. However, in discussing it post show, Wassielawyer said it was an incredibly shrewd move and believes that it’s a signal that Sam Bankman-Fried thinks the crypto markets have bottomed. Otherwise, enjoy this incredibly illuminating discussion of how the 3AC, Celsius and Voyager bankruptcies will go down.

Hi, everyone. Welcome to Unchained your no-hype resource for all things crypto. I’m your host Laura Shin author of the Cryptopians. I started covering crypto seven years ago and as a senior editor at Forbes was the first mainstream media reporter to cover crypto currency full time. This is the July 26, 2022 episode of Unchained.

Every other week Unchained hosts The Chopping Block where crypto insiders Haseeb Qureshi, Tom Schmidt, Robert Leshner and Tarun Chitra chop it up about the latest news in the digital asset industry. The next episode is for you night owls streaming Wednesday July 27 at 9:30 pm Eastern time on YouTube.com/c/unchained podcast. Be sure to tune in then.

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Today’s topic is the bankruptcies of Celsius, Voyager and Three Arrows Capital. Here to discuss our Wassielawyer, anti anime penguin in a suit, I mean a lawyer specializing in restructuring and insolvency and Adam Levitin, Georgetown law professor and principal at Gordian Crypto Advisors. Welcome Wassielawyer and Adam.

Hello. It’s good to be here today.

Hi everyone. It’s good to be here today as not Darth Vader.

We’re just going to dive right into what appears to be the meatiest issue and that is something called custodial funds. Why don’t you just define what that is for the listeners and why this is such a big issue I think particularly in Celsius and the Voyager cases?

Yeah. Sure. I think the point about custody funds has been thrown around a lot recently because when you deposit assets into a company or bank that’s failed, what you want is you want a custody relationship because when something is in custody, the title to that asset doesn’t actually pass over to the company you’ve deposited it with. So, what that means is that when the company goes into insolvency, those assets are segregated, and it doesn’t go into a general pool to pay back all of their unsecure creditors. So, those that have assets in custody would be able to get those assets back.

So, I think the starting point here is the question of what is the stuff. So, you have customers who placed funds with say Celsius or Voyager and the question is who’s property are those funds. Do they remain property of the customer or are they property of Celsius or Voyager, and if they are property of Celsius or Voyager, then the customer has a claim in the bankruptcy? The customer is just a creditor and is going to get treated differently in the bankruptcy than if it’s the customer’s property because if it was actually the customer’s property, it will actually ultimately get returned to the customer.

How fast, there maybe a little bit of a delay but the customer will get the property back if it’s the customer’s property, and this is going to be one of the big questions in both Celsius and Voyager’s bankruptcy and it may be different answers in each bankruptcy and there may be different answers for different groups or types of relationships. So, for Celsius for example, it has the earned product and the answer there may be different than with Celsius’s custody wallet.

So, just to be clear, the earned product is like an interest earning product.

Exactly. And with earn, Celsius’s terms and conditions is quite clear that if you’re using earn, you’re making a loan to Celsius. For earn, I don’t think there’s a lot of ambiguity that its not customer property. For the custody wallet, that’s where I think it’s much trickier.

So, the custody wallet is essentially like Celsius just storing your assets, and then it gets pulled, and then it’s harder to make a claim that you have specific funds in there?

Laura, I think the equivalent is depositing assets into a safety deposit box and depositing it into a bank. I think that’s probably a good parallel.

Adam Levitin: I think that’s right. When you think of a safe deposit box, that’s what we call a bailment. It’s like when you check your coat with a coat check valet, or you give your car to the parking valet. It’s not the parking valet’s car. It’s still your car. The parking valet is supposed to park it and do nothing else with it. Not take it for a joy ride.

The problem is if the parking valet has taken it for a joy ride and the car gets totaled, at that point, you’re a creditor of the parking valet and there may be a bit of an element of that going on in Celsius because Celsius seems to have comingled the custody funds with other funds and there’s a billion and a half hole or so in Celsius’s balance sheet.

Wow. So, their terms were saying that the customer would have this custodial relationship if they use that earned product but on the back end.

No. I don’t think that’s exactly right, Laura. I think they were quite explicit with the earned product that it would look a lot more like a loan. The issue is with the custody product. That is where all the questions are coming at right now because I think it recently came out in one of these articles what was actually being said in the bankruptcy court and it was very clear that with the earned products, the products that are generating a yield on it, you’re sort of…the term of use was actually right giving up legal rights to it but you’re giving it up proprietary rights to it. You no longer own it. You lent it to Celsius.

Laura Shin: Oh. Oh. So, those are the funds that are comingled.

But I think all of them are comingled is the problem. So, we have two categories of funds.

Laura Shin: Was it supposed to be when you loaned it that those would be marked as yours or they would be pulled together and then you kind of lose that claim of saying these are definitely mine?

Well, there’s two different groups or two different products. We have earn and custody. With earn by itself, pretty clear that it is a loan being made to Celsius. With the custody, the terms and condition are a little less clear but it’s a decent case that it’s supposed to remain customer property.

I just need you to finish out that thought. When you do make a loan to Celsius, does that mean then that you lose that custody relationship?

Adam Levitin: Yes. Then you’re just a creditor.

You’re taking counterparty risks on Celsius when it happens. When its custody, you’re not meant to take counterparty risks. The equivalent is if you went to a bank and you put a million dollars in the bank and then you put a million dollars into the bank’s safety deposit box. If the bank goes under, you’re an unsecured creditor for the amount of the million dollars you deposited into the account, whereas you can claim back what’s in the safety deposit box, i.e. the four million dollars because that property was always yours.

The problem is that Celsius seems to have comingled the funds that were deposited in the earn capacity with the funds that were deposited in the custody capacity and it’s as if the stuff that’s in the safety deposit box got mixed together with the regular bank deposits.

Okay. So, essentially they weren’t following what the terms of their agreements were. Is that right?

I’m not sure they’re actually violating the terms of their agreements. I believe that Celsius did indicate that funds might be comingled. The problem is comingling itself wouldn’t be an issue if you don’t have a shortfall of funds. It’s when there isn’t enough to pay everyone back, how do you allocate the losses? Do you allocate them on maybe a prorated basis among the custody and the earn customers or do you allocate them all to earn and say look, the custody stuff we never actually touched?

So, what’s your theory, both of you, about how they’ll handle this?

I think the practical implication here is if you look at Celsius sort of assets and liabilities that they put up on Alex Mashinsky’s chapter eleven declaration, they allocated 180 million in custody assets, 180 million in custody liabilities.

So, if it turns out and that’s why they asked the judge this question, if it turns out that those custody assets and liabilities are meant to be segregated, anyone who put their crypto, their money, whatever assets into custody will be very happy about it because you’ll be able to get everything back. You’d get one for one. If it is not treated as a custody relationship and the guys who put assets into custody product turn out to be unsecured creditors, then it will share in a pool with all of the other general unsecured creditors. So, that’s how it’ll work practically.

Yeah. It wasn’t real clear to me from the Mashinsky declaration how strong of a position Celsius was actually taking on this issue. Certainly, the way the kind of high level balance sheet breakdown that was presented in the declaration lines up with the way that Wassielawyer characterizes it but I’m not sure if that was really a very deliberate thing or not. Celsius’s bankruptcy filing does not seem like it was put together super carefully. It seemed like it was a thing that Kirkland and Ellis had to do in a bit of rush, and I’d be careful about reading too much into any particular words that get used.

Yeah. Absolutely, one for later, but absolutely there’s a clear difference between how Celsius finally looks and what the Voyager finally looks.

There’s a really interesting divide also under the surface between the custody and the earn customers. The custody customers are all domestic American accounts. So, if you are in the UK or Australia or Finland and you wanted to deal with Celsius, you were dealing with Celsius only as an earned customer. I don’t think that’s something that’s likely to shape the legal treatment, but it’s a factor that’s lurking in the background where maybe there’s a temptation to treat domestic customers better. I don’t think that’s going to play out but there’s at least a possibility there.

Well, I mean, it sounds like the custody customers already generally, based on the definition, come in with a stronger position. Right.

Absolutely. It’s not that they necessarily win but they have a decent argument whereas the earned customers, I don’t see any way that they’re going to end up being anything any other than just general unsecured creditors.

So, how does this all apply to Voyager because we’ve only really been talking about it in relation to Celsius, but I imagine Voyager has a kind of similar situation.

Yeah. With Voyager, I think it’s going to apply in a similar way. I mean, Voyager, all their crypto earnings were comingled. Voyager was less clear in its terms of use though than Celsius. So, if you were depositing funds with Voyager, they didn’t have kind of two separate products. Instead, Voyager uses language that kind of indicates well, it’s still your crypto except the facts are that they get to use it pretty much like Celsius and that’s the trickier situation.

Instead of having two clear categories, Voyager is sort of sitting in the middle. I suspect the treatment in Voyager is going to be that it gets treated as if its property of Voyager and that’s the position that Voyager has been taking is that this is their property, not customer property. But even if it ends up being treated as customer property, and this is a really key point, it’s only customer property to the extent that Voyager has the assets. To the extend there’s a shortfall, those customers are unsecured creditors for the shortfall.

Wassielawyer: Yeah. I absolutely agree.

Yeah. Can we just discuss why it is that retail customers are lower in the pecking order than institutional investors?

No. They’re actually not. It all depends on the terms of the arrangement and to the extent that anyone else lent unsecured to…it’s digital investor like unsecured through Celsius or Voyager or 3AC for the matter, they’ll be in exactly the same boat as the retail investors. If they had security that they would have security of collateral, then they would have recourse in the security of the collateral.

So, all unsecured creditors have the same priority. They all stand alike. I don’t think there is any secured…it’s not clear that there is any secured credit. Voyager doesn’t seem to indicate any secured credit and Celsius, I think by the time they had filed, they had paid off all the DeFi loans that may or may not actually be secured.

Yes. They paid off all their DeFi loans prior to the filing because the DeFi loans were all the collateral. So, it made sense for them to have more assets on the company’s balance sheet than you know not have it. But your question about insolvency priority, unsecured creditors tend to be dead last. In fact, they are dead last and the way you get priority over that is their preferential credit is created by statute. I’m not sure what it is in the U.S. but normally it’s taxes, you know, taxes owed, employees.

You’re forgetting the most important one. You got to pay the grave diggers. It’s the administrative cost of the bankruptcy.

Of course. Because the bankruptcy lawyers Kirkland and Ellis get paid first.

Laura Shin: They already made three million.

Oh. That’s just scratching the surface. I mean, the administrative costs of bankruptcy can get…

It will be high. It will actually be incredibly very high.

I mean like in the short amount of time this has been going they already made three million. I saw an article.

I would expect the total fees here for professionals to be over 100 million.

Laura, that’s why I’ve been in the room with discussions like before people file for chapter 11 and normally credit aside and the debtors to the extent it’s possible for them they would just track in the chapter 11 because once you track in chapter 11 all the creditors go okay, shit. All right. Fine. Let’s not do that please. That’s terrible because there’s going to be so much value leakage to professional fees ahead of me and I don’t get to do anything for months.

Okay. Yeah. Yeah. I mean, you know, just seeing that bill that Kirkland and Ellis sent in for three million, and then, thinking about the various customers who they have like 100 thousand in there or 70 thousand or whatever and it was just like oh, this is obviously not good for them. But anyway, when I tweeted about questions people had for you, someone who is a Celsius customer asked how did it work if your bitcoin loan was liquidated while the company was frozen and it was not possible to send in funds to protect it or close it off. Can that be reversed and funds retrieved during the bankruptcy process?

Let’s see if I have the scenario right in my head here. So, prior to bankruptcy, someone had borrowed money from Celsius, right?

Laura Shin: No. It sounds like they were lending.

They wanted to pay it off. So, it sounds like it was a borrower. Celsius has a third group of folks who borrowed money from Celsius and posted collateral for their loans and the collateral they posted I think may have also been comingled with all the other crypto holdings. So, it sounds like they couldn’t pay it off. Sounds like this is somebody who wanted to make a payment and Celsius wouldn’t accept the payment.

Yeah. Because it was frozen.

Yeah. I think that they probably just have an unsecured claim against Celsius for breach of contract.

I don’t think they’ll get their crypto back. I think they have a dollar claim and how much that will get paid is anyone’s guess. So, think of if you have a claim and it’s allowed that’s like having an entry ticket. It doesn’t mean that you necessarily see any value. It just makes you eligible for a distribution in the bankruptcy. Laura, maybe it would help if we just did a minute of kind of an overview of chapter 11, of the process. So, I’m going to try and do this in like one minute and not talk too long.

Here’s kind of the very nutshell overview of the U.S. bankruptcy process. When a debtor files for bankruptcy, first thing that happens is something called the automatic stay. This is basically like an injunction against any attempt to collect from the debtor outside of the bankruptcy process. At the same time, there is a new legal entity that’s created. It’s called the bankruptcy estate. The bankruptcy estate has title to all of the debtors’ assets no matter where they’re located.

So, what we’re doing is we’re bringing all the assets and all the claims against those assets together into single form and hopefully having a more orderly process. The bankruptcy estate in chapter 11 is managed by an entity called the debtor in possession or DIP. It’s not a pejorative. And that just means it’s the prebankruptcy management running the show but they’re wearing a different hat. The hat that they’re wearing now makes them fiduciaries for creditors and shareholders.

So, creditors will file claims with a claim’s agent for the court. Stretto is the claims agent for Voyager and Celsius and if you don’t file a claim, Celsius or Voyager are probably going to schedule it according to their books and records, and claims are deemed approved unless someone objects but Celsius and Voyager very well may object to certain claims. They’re going to spend some time looking at all the claims, and if Celsius or Voyager want to do anything outside of the ordinary course of business, they need court approval.

So, if they don’t normally scratch their head, they need to go to the court and make a motion for permission to scratch their head. For the first 120 days, the debtor has exclusive right to propose a plan of reorganization or liquidation. That 120-day period though can be extended to 18 months. So, it often is. So, there’s going to be a window where only the debtor has the choice of how to move going forward, but there’s going to be a very important kind of counter weight to the debtor.

There’s going to be set up in the next couple of weeks a thing called the official committee. Official creditors come in. That’s a body of the representative body of creditors that’s selected by Department of Justice official called the United States Trustee, and the members of the official creditors committee are fiduciaries for the creditors they represent.

They will hire their own attorneys and financial advisors and if you kind of think about how the courtroom is going to be set up, instead of being one table for the prosecutors and one for the defendants, you’ll have one table where there’s going to be the debtors counsel and typically one table where the official committees counsel will sit. That kind of gives you a sense of the relative weight of the parties.

Now here’s the thing that’s often not understood well about bankruptcy. It’s the role of the judge because there’s a bankruptcy judge and the bankruptcy judge is like a referee not a quarterback. The judge decides on matters put before him and that means you need to make a motion for the judge to do something. You’re asking the judge to approve or disapprove of something. The judge is not making the plan. The judge is not deciding generally oh this is what’s fair and what’s not.

It’s that there are very specific issues put before the judge and if there isn’t a motion before the judge, the judge isn’t going to act on anything. The judge has hundreds of other cases going on. Large business bankruptcies, lots of consumer bankruptcies, so this is kind of a situation where it’s hey tell me what I need to decide right now and I’ll figure it out and if it’s not an issue that’s immediately before me, well, I’m dealing with other problems.

This is a process that’s going to be slow. It’s going to be expensive because the debtors’ attorneys and financial advisors, their fees come out of the top. The official committees’ attorneys and financial advisors, all of their fees come off the top, and these administrative expenses, paying the gravedigger, that’s going to probably in a case like this usually turn into 100 million maybe two will be my guess in that range and that’s money that’s not available for customers and that’s just kind of the cost of the process.

Wow. Yeah. How long do you expect both the Celsius and Voyager bankruptcies to take?

So, it’s important to know that Celsius has not filed a plan of reorganization yet. Voyager has. So, Voyager has provided a lot more sort of details around what they intend to do. Maybe Adam can talk about how these plans work since he’s done such a good job.

Voyager didn’t exactly file a plan of reorganization. So, they did kind of a funny move. Yeah. When they filed, they included as a filing of the court, this half-baked plan except the actual way the chapter 11 process works is you can’t…what you’re going to have to do is ultimately solicit creditors’ votes on a plan. The creditors are going to have a vote.

You cannot solicit their votes until the court has approved a disclosure statement about the plan and the disclosure statement is going to probably, in a case like this, be a 100, 150-page document that’s going to do everything from laying out the history of how the debtor got here to summarizing what the plan does, how it treats every kind of claim, what the debtors business model is going forward, and it’s supposed to give creditors adequate information to be able to vote on a plan. Do they like it or not? Just filing a plan doesn’t let you do anything. You need to get a disclosure statement approved. Otherwise, the plan is just a piece of paper that sits out there. So, I think what Kirkland and Ellis did, and this is something K and E does quite frequently, they’ll file kind of placeholder plan to give an indication of where they’re thinking of going and to try and frame the conversation. It in no way binds Celsius to that being its ultimate plan. Celsius could change direction on a dime and it doesn’t bind anyone else. It’s just a conversation starter.

Okay. So, when do you think we might get the formal plan?

I think that’s going to be some time, especially for Celsius. Voyager is simpler. Voyager has got the problem of figuring out the status of the customer funds. Once it does that, I think…Voyager’s big issue is its loan book was ridiculously concentrated. Like 58 percent of its loan book was Three Arrows Capital, which is just like…the insanity of that is beyond description.

So, if you were a bank in the United States, you are limited to lending if it’s fully collateralized, 25 percent of your capital and surplus to a single borrower. If you figure a bank’s capital is eight percent, we’re talking therefore about no more than two percent of your assets to any one loan, and people go to jail when banks mess that up. That’s why Paul Manafort is in jail in part because he was defrauding a bank to go beyond the loan limit, and he got 58 percent of their loan book, which is pretty much all their assets going to one borrower and 99 percent are over six counter parties. It’s just nuts.

There’s going to be a big question, is there any model which they can reorganize on and I’m rather skeptical because like this is a business that’s built on customer trust and who on earth would trust a company that did such a bad job with risk management to ever get this right in the future. You know, maybe their tech staff was decent. I don’t really know, but if it was decent, that’s something that someone else can buy and pair it up with better risk management. So, the bottom line, how long is this going to take with any of them? It’s a huge guess. For these kinds of cases, we’re probably looking at something that’s approaching two years and how long it actually takes the final distributions could go on longer.

And when you said that Voyager had a simpler case than Celsius, is it because the fact that it wasn’t the comingling, and it really was just the fact they had this one huge loan that defaulted?

I think so. Celsius has their suggestions that there may have been more funny business going on with Celsius. Voyager just seems to have been incompetent on risk management. Celsius seems to have also had that problem but if you look at the KeyFi lawsuit and some of the letters that are being submitted in the docket, there seems to be a sense of some people that Mashinsky was doing something beyond just being a bad risk manager.

Yeah. I completely agree there. I think it looks like why Voyager had gone over is exactly as Adam said. It’s just like standard this massive, massive loan to Three Arrows Capital and otherwise everything was sort of ticking along apart from the exceedingly crappy risk management and based on the indicative sort of plan, it looks like their plan is just going to move the default risk on 3AC or at least remove all of that onto the account holders instead.

So, the draft plan basically says look, you’re the account holder. We owe you money. We’re going to give you a bit of cash, a little bit of crypto that we have left. We’re going to give you some Voyager tokens and we’re going to give you your share of whatever we manage to recover from Three Arrows Capital. So, when we recover anything from Three Arrows Capital, it doesn’t come into this little reorganized company. It goes to third party, and it distributes it to…the company distributes it to you.

Obviously, that’s being incredibly optimistic about what you can actually recover from Three Arrows Capital. In Chapter 11 plan for Voyager is going to be very closely linked to how the Three Arrows liquidation plays out. What Adam has said on Celsius is exactly it. There’s a lot more sort of funny business going on. When I read the filing, they kind of went oh, we only lost about 50 million dollars of Luna. We didn’t get destroyed that badly. They lost about 40 million on the 3AC loan, which is a large amount but small compared to what Voyager has done, but then you start looking at all the strange things they’ve been doing. They lost 35k ETH. Just lost it because someone they gave it to misplaced the keys. You’ve got a private lending platform unnamed. We don’t know who this is that defaulted and there is now a loss of like something about over 400 million, which they are slowly trying to get recoveries on, and one of my favorite calls in the whole thing is there were certain asset deployment positions that were made that in hindsight proved problematic. So, very vague about that, and yeah, we don’t really know what tipped them over. It just looks like a series of incredibly bad decisions.

Yeah. Yeah. Definitely with the Celsius one, even when I was just writing questions for the show I had so many more questions because there were so many more kind of red flags or question marks there but with the Voyager it seemed a little bit more straightforward, which is not to say that they didn’t mess up hugely. But I actually want to circle back to that question of how much people will be able to get or rather Voyager will be able to get from 3AC, but first a quick word from the sponsors who make this show possible.

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Back to my conversation with Wassielawyer and Adam. So, Wassielawyer, earlier when you were saying that a big part of what’s going to determine how much Voyager customers get is what they can claw back from through AC. What is your sense there of how that’s looking for people because we got a little bit of a taste, you know, a week ago on…it’ll be a week by the time this comes out, on kind of what assets 3AC has?

It’s going to be quite difficult to answer that question exactly. What we do know is that from the documents that have sort of come out that there is at least 2.8 billion dollars of claims against Three Arrows Capital right now. We do know that apparently it came out in some sources that they liquidated and secured 40 million dollars of funds. 40 million dollars and 2.8 billion dollars is a pretty massive gap.

On top of that, it does look like Three Arrows Capital doesn’t really have…it may be the case that they don’t have that many liquid assets. I think we covered this briefly on the last show Laura. What sort of assets would they have? They would have equity warrants, token warrants, tokens, tokens that are going to be vested. I mean, they probably hold a crap ton of Luna too.

The yacht. Don’t forget the yacht.

50 million dollar yacht. Yeah. I don’t think it’s been delivered yet.

Adam Levitin: A half-built yacht. Yeah.

So, with a ton of NFTs, you’ve got…and one thing that’s going to be quite interesting is how these…so, when I read the recognition filing in Singapore, and I’m thinking maybe this is for the Three Arrows bid later on or separately is the question of what happens to Defiance funds and what happens to the Starry Nights funds and what happens to this fund called Wobbler. So, what happens is essentially it looks like 3AC have comingled all of their funds under one single entity and it looks like Defiance, and Starry Night, and Wobber were actually managed by persons other than 3AC. So, it’ll be interesting to see how the liquidators walk up to these guys and say hand over everything. Your funds have been liquidated because you’re part of a structure that has been so horribly mismanaged. I feel quite bad for those guys actually.

Adam Levitin: But Wassielawyer, you’ve been following 3AC more closely than I have. When the liquidators say they’ve recovered 40 million, that means that that’s either cash that they have control of or they have the private keys for the digital assets?

Not 100 percent sure of that one, but that’s what’s come out of reports that they’ve recovered quote unquote 40 million of assets.

So, I take it then that for all the other assets, no one knows at this point, or at least the liquidators don’t know who has the private keys.

We have to read between the lines here, right, because this is all from what the liquidators have told the courts in U.S. and Singapore when they are applying for recognition. So, what we do know is that it seems that Su and Kyle have not been very cooperative and presumably these are the guys who are holding a shit ton of those keys. At some point, you expect them to play ball, but it does look like as of the date when the liquidators applied to the Singapore court and they weren’t very cooperative.

No one knows exactly where they are.

Apparently, they’re going to Dubai.

This is like where all the people who are fleeing something in crypto end up.

Maybe they just paid off the yacht and they’re just sailing the seven seas now.

The yacht is still yet to be delivered and in Europe.

Maybe that’s exactly where they’re going because if you read these filings, they squirrelled 30 million dollars away to Tai Ping Shan, an entity they’re related to, 10 million dollars to an unrecovered wallet, and the cost of the yacht is 50 million. Maybe the down payment was 20 percent.

Hopefully at some point we will find out more on their whereabouts or if they end up in Dubai, we’ll just hear about it. So, I did want to also then circle back to this other question related to the one that the customer with the bitcoin loan at Celsius had. So, as you guys mentioned, in that case likely that customer will get dollars back and what’s your sense of how likely it is that a lot of the crypto assets in any of these firms will be turned into dollars and what’s your sense of whether or not the customers would prefer to have crypto assets versus dollars?

Okay. I think just to jump in here first. I think there’s a different process…this is a question that’s very relevant to all three, Celsius, Voyager, 3AC, but again to draw a distinction, 3AC is in liquidation. So, it’s going to be liquidated. It’s not going to exist as a company after the process is done whereas, Celsius and Voyager filed for chapter 11 and what they want to do ideally is to continue as a business afterwards.

So, it may be the case that in the plan of reorganization eventually goes through that you get a mixture of crypto, you get distributions in kind using crypto or you get it in cash, whatever the plan turns out to be. This becomes a much bigger question for Three Arrows Capital because if I’ve lent bitcoin into Three Arrows Capital, maybe I want bitcoin back.

Maybe I don’t want a U.S. dollar amount, and it’s a question of when I convert the bitcoin to U.S. dollars if the liquidators do choose to do so. So, I’m looking at this as a fact that, I know what Adam is going to say about it, so I’m just going to throw the mic over to him about how all this works, at least in the U.S.

Okay. So, in the U.S., there are kind of two pieces we have to look at. First is what is your claim and second how can that claim get paid. Regarding what your claim is, it doesn’t’ matter what form you extended value to the debtor, it gets dollarized as of the date of the bankruptcy filing. So, for Celsius, you’re looking at the value of the crypto that you are owed on July 13 and presumably we can get it down to the minute of the bankruptcy petition but if it’s bitcoin, it’s around in the 20 thousand range.

Voyager on July fifth actually turns out to be right around in the same range. So, if you had one bitcoin parked with Celsius, you have a claim for roughly 20 thousand dollars, and it doesn’t matter that bitcoin today might be at 23 thousand. Your claim is for 20 thousand. So, you don’t get any of the market rise. On the other hand, the market falls, your claim is still locked in at 20. The problem is if the market falls, they just don’t have the assets to pay you that 20.

So, either way you get kind of rope a doped here. Either way, it works badly for you. Now that’s the bad news on the what is your claim side. The better news for you is on how your claim can be treated. A chapter 11 plan can be a plan of reorganization or a plan of liquidation. Usually, chapter 11 is thought of as being reorganization but businesses at any size that want to liquidate will use chapter 11 because its more flexible than chapter seven. Management stays in place in chapter 11 and in chapter seven, it gets moved out.

A chapter 11 plan can pay you in any form it wants. It has to give you value that is at least as much as you would get in a hypothetical chapter seven liquidation, but that value is as of the effective date of the plan, so you just have to see what the market value is. They could pay you in bitcoin. They could pay you in shit coin. The only question is do they have the votes for confirming the plan. This is a majoritarian rule exercise.

So, it doesn’t matter if you vote against the plan, if they get the requisite votes and a plan is approved, it binds all creditors regardless of what they want and to the extent you’re not paid under a plan, there’s no one you can try and collect from it afterwards. The debt gets discharged unless there’s like a third party that you say is liable and is a guarantor and hasn’t gotten a release.

Curiously, there are some interesting releases in the Voyager plan. Alameda is at least proposed to get a release. So, if there’s some kind of litigation claim against Alameda that would be gone and creditors wouldn’t be able to try and collect from SBF.

Oh. Wow. I guess that’s maybe because I think they were an investor in Voyager. So, is that just something they negotiate?

I assume that this was…they’re kind of wearing all the hats. They have the single largest equity investor but it’s like a nine and a half percent position. They are the second largest loan counterparty and then they also extended credit back the other way with 75 million, which under the Voyager plan seems to be classified separately and basically just cancelled out.

Okay. Yeah. Because I thought there was something about the way that it was structured where it was meant to prioritize the customers but then they didn’t implement it or something like that.

Yeah. I don’t know what the loan agreement looks like. That’s certainly consistent with how the Voyager placeholder plan treats it, putting in a separate class than customers and then saying that it gets paid nothing would be consistent with that kind of treatment, but I don’t know if there was some contractual agreement before the bankruptcy about that.

Laura Shin: So, I believe there are customers writing in saying that they would prefer that their crypto assets not be dollarized. Do you think that any of the bankruptcy judges or anyone really involved in the bankruptcies will have a sympathetic ear to that or do you feel that they’ll just follow what the law says?

Adam Levitin: It’s not the judges call on this. The judge doesn’t decide what the contents of the plan are. The judge just says yay or nay about whether the plan is confirmable. So, ultimately there’s going to have to be a plan confirmation hearing. It’s like a little mini-trial and the judge is going to have to decide whether the plan meets a whole list of criteria and if it does then the judge doesn’t have any discretion about confirming the plan. Even if the judge thinks the plan is a bad idea, if it’s…

You think they’ll be sympathetic?

The decision is made by just simply voting against the plan. The account holders, the unsecured creditors can simply say this plan doesn’t work. We want a different plan. But as long as the debtor has plan exclusivity, it’s the debtors call what’s in the plan. So, the debtor right now is determining what’s on the menu, but you can decide whether you want to order or not what’s on the menu but as a collective decision. You’re bound by the collective. Once plan exclusivity lapses, then you know, any creditor that wants can come in and propose a plan.

And how long is that period?

Up to 18 months. It’s extendable up to 18 months. Yeah.

So, how likely is it that you think Celsius or Voyager will be sympathetic to that desire and make that part of their plan?

So, Laura, I think it’s incredibly difficult for anyone administrating a bankrupt estate to start dealing in all these different currencies. So, I think it’ll be quite difficult for them to figure out this whole returning bitcoin, returning ETH, returning all of these various shit coins along with U.S. dollars. So, it’ll be difficult. I’m not sure how…I’m sure it’ll be quite different because in the Three Arrows case, it has to be dollarized at some point. With the chapter 11s, I think it’d just be administratively difficult dealing with so many different crypto assets.

That’s a really important point. The administrative difficulties but also if you’re holding all these crypto assets, you’re holding assets that are quite volatile and yes they might go back to the moon or they might fall and if you think that you’re putting the hat on as fiduciary for creditors and shareholders, that probably pushes for dollarizing and just selling off all the crypto.

Do a slow sell off, so you don’t crash the market and push down your own prices, but do a slow sell off, turn it all into dollars and pay out the dollars. That’s certainly the easiest way to do it. You can imagine there will be some unhappy customers with it but if you’ve dollarized it before you propose a plan, then there’s not much the customers can do to complain. There is no crypto left.

Right. I mean, I just think what you said about being a fiduciary, that’s like seeing it from a non-crypto person’s perspective because the reason that these people want to keep the crypto assets is because they don’t care about the dollar value. They care about the crypto. So, it’s like one ETH is one ETH and that’s more valuable than any amount of dollars, so for them it’ll be like I don’t care what the dollar value is because I just want the ETH. But anyway, I mean, I understand what you’re saying.

Adam Levitin: I would say for a typical hold on for dear life person, I think that’s true except that’s not the…if you’re putting your money in Celsius or Voyager, it’s because you’re looking to get a dollar return. Maybe you’re willing to take the payment in kind, a Celsius token, but ultimately you’re looking to get a dollar return. So, this is a different kind of investor than someone who is just buying bitcoin and hoping that the market is going to go up. This is actually a type of investor that’s a little more risk averse because they want the fixed dollar return rather than just watching the commodity price go up and down.

This is a much bigger issue with Three Arrows Capital actually because of the investor profile there and how this thing is going to play out, so I’ve thought about this a fair bit and sort of shout out to gonebegood because he’s been discussing this with me and has come on some pretty amazing ideas and thoughts about how this would play out because what you have is you’ve got investors that a lot of them from all these sources it shows them extending BTC denominated loans.

These are large, large amounts of bitcoin and when Three Arrows went to liquidation, bitcoin was trading at what between the 80 and 20k range. Closer to 18 probably, and since then bitcoin has rebounded a bit and over the next two years plus however long this liquidation takes, bitcoin price could very well recover. This is based on a very brief read. I am not a BDI lawyer but based on the very brief read of how BDI insolvency works, if you’ve got loans in other currencies, you have to change it to U.S. dollars when you file the proof of claim.

So, you have to dollarize it, and this is something that people will sort of be thinking about going I don’t really want to have my bitcoin and other loans essentially liquidated at 80k and then two years later bitcoin is like 100k and maybe Su is right and the super cycle is a real thing. So, that’s an issue and sort of shoutout again to gonebegood, he sort of went well if he looked at bitcoin or his crypto assets as a commodity, then what you’re suing for you could be suing for non-delivery of a commodity and that is a contractual claim.

It’s not a liquidated claim, so there isn’t a number to it at the moment but then it still opens the door possibly to you getting maybe possibly bits of the upside if bitcoin recovers, but at some point, this unliquidated claim still has to be dollarized. There has to be a number ascribed to it and it’s a question mark as to when that point of time is if you ask me. Probably requires a lot more thinking around contract law and individual circumstances etcetera.

Listeners might be wondering why if this is the British Virgin Islands you would dollarize to U.S. dollars and it’s because the British Virgin Islands have used the U.S. dollar as their official currency since the 1950s. It’s a weird situation but I think it’s about geographic proximity.

Based on my reading, it doesn’t look like bitcoin is defined as a currency or as money under the BDI legislation. So, the sort of commodities-based interpretation could hold some weight here.

Oh. Interesting. Well, so we’ll have to see how that plays out. One other topic that I wanted to be sure that we talk about is there might also be a possibility of claw backs, of pre bankruptcy transfers. So, yeah, what kinds of transfers would be classified that way and then how would we determine whether any of those should be clawed back?

There are two categories or actually three categories that are worth talking about. Probably the most important from a customer perspective are what are called voidable preferences, and the idea is that certain transfers made to creditors in the 90 days before bankruptcy can be unwound and if you’re an unsecured creditor, the transfer is unwindable.

There are some defenses, and the most important ones are there’s a diminimus amount that’s just not worth litigating over and then there is an ordinary course of business defense. So, if the transfer was in the ordinary course of business of both the debtor, so if you withdrew money from Celsius let’s say, that’s a payment to a creditor because Celsius owed you money, you withdrew your funds in the 90 days before bankruptcy, that might be in the ordinary course of Celsius’s business to pay withdrawals.

That happens all the time presumably with Celsius, but it also has to be in the ordinary course of the customer’s business, and that’s where I think there’s an interesting question. It’s not weird to think that a customer might withdraw funds at some point but if the customer had been holding funds, holding funds, holding funds and never withdrew until this one moment, I think it’s kind of hard to say that withdrawing funds is actually in the ordinary course of the customer’s business.

So, I think that’s an issue the court will have to figure out if Celsius or Voyager pursue these avoidable preference actions and I think they’re likely to do so because there’s a substantial pool of money that could be clawed back that way. Once that money is clawed back, if it is, then the folks whose money got clawed back, they have unsecured claims in the bankruptcy. So, you thought you got out before the bankruptcy and if you didn’t get out before 91 days before the bankruptcy or more, you might get dragged back into the bankruptcy. That’s the most important group.

There are two other things that can be clawed back. Another thing are what are called fraudulent transfers. It doesn’t have to be actual fraud. This is just transfers made to hinder, delay, or defraud creditors. I don’t think that really exists with Voyager but maybe with Celsius, especially with transactions with insiders. Maybe there’s something there. And then, the other really, really interesting thing in the background for Celsius is going to be the treatment of the redemptions and the DeFi loan collateral.

So, DeFi loans are characterized as being collateralized, and we think collateral, oh, it’s a secured loan. Well, it’s certainly functionally secured but bankruptcy loan doesn’t care about functional security. It cares about whether a loan, whether there’s something like a security interest hasn’t been perfected and that’s a term of art meaning that you’ve taken certain legal steps that lock in the priority of a security interest. If a security interest has not been perfected, it can be avoided. It’s gone. It just becomes unsecured.

These DeFi loans seem to have been secured through just basically a smart contract protocol. That’s not going to cut it with bankruptcy. That means that they can be treated as unsecured loans and therefore because they were unsecured loans, you can treat the redemptions as preferences, and you can claw back the redemption payment. The problem is these DeFi protocols who are you clawing it back from, right? It’s going to be a freaking mess. Yeah. You try and there’s going to be a huge mess figuring out how if at all it’s possible to claw funds back from a DeFi protocol. I don’t know what the answer is but there is potentially a lot of money at stake and if this were 10 million dollars, they might be this isn’t worth figuring out but when you’re talking about hundreds of millions, then there’s a lot of pressure to figure out a way to claw back money from everyone who uses a DeFi protocol.

I mean, like just from the perspective of the smart contract itself my answer like that’s not possible. Do you know what I’m saying?

Well, especially with ether, it’s quite easy to track balances. You see where money, everyone who put money into a pool, you see they get the money out of the pool. I think you can trace that. Now can you actually figure out who owned those wallets, right, that’s another mess.

Yeah. That’s incredibly illuminating. To be honest, I’ve never really thought about the DeFi loans in that way. I kind of went oh, wow, I guess good for them. They over collateralize, they manage to get out but the way you sort of framed it, I think you’re absolutely right that they would be subject to some sort of claw back claim there and how you do a claw back against DeFi protocols and DAOs, Laura, I think we’re going to need about three hours. I’m going to need three hours and a couple days of research and I’ll let you know what could work.

The unincorporated DAOs might be treated as general partnerships where everyone involved is jointly and separately liable or maybe they’re not. I mean.

Yeah. Adam be careful saying that about everyone in a DAO being totally self-reliable because maybe you’re giving the U.S. Terra holders an idea about suing every single Luna holder in the world.

It may not make sense to sue everyone, right. You only sue the deep pockets. It’s also going to depend upon how DAO is set up. Some DAOs actually have incorporated entities and some don’t. The general partner argument is only for the ones where there’s nothing incorporated.

I have to say even for the beginning part of your claw back description, it sounds like that would just require human individuals to send back these crypto assets, which you can’t…you know, famous instances of people being arrested and then they won’t reveal the private key. Like, I mean, that even just sounds super messy.

Well, yeah. It’s messy but courts do have the power to hold people who do not comply with court orders in contempt and that means among other things, you can put them in jail.

Right. I’m just saying that like plenty of police have arrested people who still refuse to give up their private keys.

Yeah. I think practically it would be very, very difficult but theoretically you could get a court order and say pay this amount back, and you know, if you don’t, you’re in contempt of court. Potentially you could go to jail for it until you reveal your private keys, pay out monies, potentially.

Yeah. I’m just saying it doesn’t sound easy to do. The smart contract to me sounds like nearly impossible but people are difficult in their own way, different from smart contracts, but you know, even a two-year-old can be really difficult to manage. But anyway, one other thing that I was so curious about with Celsius was as everybody has noted, on this balance sheet they said they valued their CEL tokens or CEL tokens at 600 million dollars.

That was insane. That was insane. Absolutely insane. Yeah. So, I’ve tweeted about this. I think the whole was actually 1.8 billion. It’s now 1.2 billion. You can’t just create your own coin and describe it as 600 million when the market cap is nowhere near that.

Yeah. The market cap is about 215 million.

Yeah. Something like that. Yeah.

Laura Shin: Yeah. Or at least when I wrote this script, 215. So, I was just wondering like first of all, would the bankruptcy judge or whoever is kind of looking at this, would they just consider that like blatantly lying or is there some way to explain how this number could be justified or like what’s your take on what they did there?

Where it stands right now it doesn’t really matter those numbers in Mashinsky declaration. If and when Celsius ever proposes a plan that’s going to need a disclosure statement and it’s going to need some discussion about what its assets are and its going to have to explain itself if it’s putting any value on the Celsius tokens.

Laura Shin: Okay. So, at the moment, this is why it sort of seems pulled out of thin air and not even related to the market cap at all.

Adam Levitin: Yeah. As Mashinsky said, he puts in a little graphic in the declaration of unaudited high-level financials.

Laura Shin: Okay. Yeah. So, then the other thing I wanted to ask about this plan was Celsius’s intention to basically save itself by mining a lot of bitcoin, but they need the court to approve them finishing building out the mining center. First of all, what’s your sense of how likely it is that that will be approved, how feasible do you think this plan is at helping Celsius recoup its costs, and like I don’t know, a part of me when I was reading all this, I was a little bit like I feel like a lot of this is so similar to how they ran their business, you know what I’m saying, in terms of like the pie in the sky. Yeah. I was curious to hear your thoughts.

Laura, sort of reading the whole thing, it does look like what Celsius has done is they just want to build a mining business and have taken a ton of funds from depositors and basically just channel all of it into the mining business and hoping this mining business is going to take off. I think they were considering an IPO and then that would all magically play out and they would pay back all depositor’s loans.

I think they think that this is how they’ll recoup their losses, or at least that’s what they’re claiming.

An initial reading, it almost seems like if you’re a depositor to Celsius, you were investing in their mining business to be honest, just on initial reading.

Oh. I think more than that. So, usually you look at the financials of mining companies and usually they have a good deal of debt that is just to fund the acquisition of their mining rigs. Celsius doesn’t have that debt. Usually, it’s done as basically a lease of the rigs is the way it’s structured. The reason they don’t have that debt is they financed their rigs with customer funds.

In some ways, the good news for Celsius is a mining business. The rigs don’t seem to be collateral for anyone. What’s not clear to me is how high bitcoin prices have to be for the mining business to be profitable. If bitcoin is at 20 thousand, the cost of production might exceed the value of any bitcoins they can get. So, profitability of the mining business is hugely dependent on the price of bitcoin, and then, this is a prominent problem that all miners have is that it’s an arms race.

So, there was just an announcement this week that one of the rig manufacturers have been able to come up with the next generation, even more energy efficient processor, and I don’t know how big the energy savings are there but one possible implication is everyone who’s just invested hundreds of millions in mining rigs bought outdated technology that won’t be able to compete and they’re going to have to put in more money to buy the next generation of rigs.

It’s an iffy business and one of the challenges any crypto company is going to have in a bankruptcy is that a bankruptcy plan cannot be confirmed by a court unless the court finds that the plan is feasible. This doesn’t mean that the plan is a sure fire thing that’s going to necessarily work but it basically has to mean that it’s more likely than not that the plan is going to work and that the company isn’t going to need to be back in bankruptcy needing further financial restructuring, and if you have an industry where the viability of a business is so heavily dependent on swings and asset prices, that gets trickier.

It’s not unprecedented. We have that with like oil and gas for example, but here, the mining, it presents a real challenge. Oil and gas, it’s not unrealistic. The volatility of oil and gas prices is small compared with bitcoin let’s say.

Another thing I wanted to ask about was this KeyFi lawsuit. We briefly mentioned it earlier. For listeners who don’t know, it was filed by Jason Stone who’s a former money manager for Celsius and he did not have a formal contract between them, but he was handling lots of money, hundreds of millions of dollars.

Don’t you find that funny itself? Right. Here’s the money manager who’s going to manage enormous sums and yet can’t be bothered to have a formal contract.

I was having Crypto Capital déjà vu. Do you know what I’m talking about with the Tether case? Tether ended up having to loan hundreds of millions of dollars to the parent company because they had entered into some business agreement with Crypto Capital, which was like sort of shady business in Europe and Crypto Capital had hundreds of millions of dollars of theirs and for whatever reason got tied up in some kind of I forget regulatory governmental something or other.

And so, Tether ended up giving this massive loan to iFinex is the name of the company and that New York AG called them out being like you’re saying you’re fully backed but you just lent all this money out duh, duh, duh, duh, duh. And so, in the end, they just I think had agreed to like give transparency reports after that, but I think they might have had a small fine. Anyway, the point is there was no contract between iFinex and Crypto Capital.

So, it just reminded me so much of this, but essentially, Jason Stone who also by the way was like anon, it was like 0xonebt or something. He was like a popular Twitter account, but he alleged that Celsius manipulated markets and didn’t institute basic accounting controls. He also accused the lender of being a ponzi scheme. He cited certain instances where for instance, he knew that they had taken a loan from Tether paying like X amount in interest but then were promising customers that they could earn even more in interest which like literally makes zero business sense. But anyway, he is now suing for damages for an amount to be determined at trial and I was just wondering how likely is it do you think that Stone sees any money and how would his claims be prioritized against that of customers.

So, this is all just to point out this is probably one of those asset deployment positions which in hindsight prove problematic. Obviously absolutely ridiculous that they are managing this ludicrously large wad of money without a formal contract. So, that bit is probably true because if it weren’t Celsius would have caught it all garbage. The rest of it, Adam can expand on it, but if what is being alleged is true it’s obviously these things of terrible, terrible mismanagement, but then again, this is a one-sided statement at this point. So, we have to see how this one plays out.

Yeah. Unfortunately for Stone, even if everything he says is true, all he is is a general unsecured creditor and he stands at the back of the line with all of the customers. The fact that he filed a lawsuit doesn’t get him anything special.

Laura Shin: Okay. So, we’re going to try to do the last key questions sort of in a rapid style. I was wondering for the state regulators that are now investigating Celsius, if there’s any enforcement action or anything. I’m just wondering how will that affect the bankruptcy or I don’t now if they’re just kind of unrelated or what you see there.

Adam Levitin: It depends what they’re seeking. Bankruptcy stops any attempt to collect money from the debtor but if the state regulators are seeking let’s say a cease and desist order or some sort of prohibition on Mashinsky engaging in business in the future, that’s not stayed by the bankruptcy. They would be able to proceed just in parallel with the bankruptcy then.

Laura Shin: Okay. Something I was just curious about was a lot of people are taking issue with having both Celsius and Voyager did marketing. It’s been called out for instance that Alex Mashinsky the CEO of Celsius often wore a t-shirt saying banks are not your friends when, you know, clearly Celsius is like a type of bank, or the day before they paused withdrawals, he tweeted at someone who had been saying like hey, I’m hearing people aren’t able to withdraw from your platform, and he tweeted back do you even know one person who has a problem withdrawing from Celsius?

Why spread fud, fear, uncertainty and doubt, and misinformation? So, things like that versus like Voyager and talking about like your funds are, your USD is FDIC insured, which now the FDIC is actually investigating this. So, you know, do you see kind of issues with marketing playing any role?

I was going to say I see a huge slew of potential misrepresentation claims across the board because of the way all these companies operate, right, and I’m not saying just Voyager and Celsius but also Three Arrows Capital and even Terra, it’s basically entirely based on customer trust and confidence and when you’re running out of liquidity to stop paying off people, what you see all of these guys do with Celsius and Voyager and you go back further with 3AC, what, from the filings I see, sort of Su and Kyle and their employees telling their counterparties, I think you go back further to Do Kwon sort of tweeting, right.

What you want to do is try to maintain confidence and make sure that people don’t all start leaving because when they all start leaving you have a real problem because then you have a bank run, but then, there’s this little question of how accurate the information that you put out stemmed the bank run and I think this is a question that will take a while to be decided.

There’s certainly the possibility of misrepresentation claims. Some of them might be against Celsius and some might be against Mashinsky himself. To the extent that it’s a claim against Celsius, I don’t think that changes anything because if Celsius already owed you 100 thousand dollars, how are you harmed by the misrepresentation? You didn’t yank the money the day before the bankruptcy when it would have probably been clawed back anyhow, I don’t think it changes what your claim is in the bankruptcy.

It’s sort of like two breaches of contract don’t get you anything more than one breach of contract. Where it may be different though is if there are misrepresentation claims against Mashinsky himself where he is personally liable. Those would not normally be covered by the bankruptcy. That’s not a claim against Celsius. It’s a claim against Mashinsky.

Presumably, any Celsius bankruptcy plan will have third party releases in it, which will deem Celsius’s customers to have released various third parties including Mashinsky but that’s going to be a hard-fought issue and lurking in the background is U.S. law on the availability of third party releases may well change before this bankruptcy is finished and this is a really hotly contested issue in Purdue Pharma’s bankruptcy with the Sackler family. There’s an appeal pending with that right now and we could see a change in the law that would limit Mashinsky’s ability to get a release in the Celsius bankruptcy.

Laura Shin: Okay. And I did have people tweeting asking things like whether any of the cofounders or CEOs of these companies, so Mashinsky or Stephen Ehrlich of Voyager or Kyle and Su, what are the odds that any of these people does any jail time?

I knew that question was going to come up and right before this I went and gave myself a 10-minute primer on what Singapore’s laws look like when it comes to criminal liability for all this. I’m not that sure about the U.S. but based on what has actually come out, there’s a few ways this plays out. First of all, the Monetary Authority of Singapore has issued a reprimand to the Three Arrows founders.

Wait. Just one quick question. So, I believe Su and Kyle are American but you’re saying it’s just because Three Arrows was based in Singapore?

They were in Singapore at the time they were doing these things, so presumably Singapore criminal law would apply because they were operating Three Arrows Capital out of Singapore. MAS, Monetary Authority of Singapore issued a reprimand to I think it was to Su and Kyle, maybe just Three Arrows saying that they breached the securities and futures act I believe. The provision referred to potentially carries a jail term of up to two years if convicted, that’s the main point, under the general criminal law.

I think the UK, you have, they call it fraud but I think in Singapore, it just comes as a general category called cheating and I’m just going to read it out because I have it in front of me. By deceiving any person whether or not such deception was the sole or main inducement fraudulently or dishonestly induces the person deceived to deliver or cost of delivery of any property to any person or to consent that any person shall retain any property or intentionally induces the person deceived to do or admit to do anything which you would not do or omit to do if you had not so deceived and which act or omission causes or is likely to cause damage or harm to any person in body, mind, reputation, or property is to cheat.

So, that is a complete mouthful and sorry for inflicting that on everyone but essentially there is a question of whether some of the behavior which you see in the correspondents in the affidavit that came out from the 3AC liquidators that Su and Kyle may have sort of misled the investors as to the state of the company, as to the state of the finances of Three Arrows Capital and therefore induced these customers to keep their funds within Three Arrows Capital when they otherwise would have pulled it out, and this sort of comes back to the sort of article we were discussing earlier before this call, right, where Su and Kyle said that the lenders were comfortable for financial position but the fact is based on everything we’ve seen from all the WhatsApp messages and Discord messages and Telegram messages and what not, it looks like they just straight up lied about the exposure to Terra and the financial position.

So, there’s a question there, but the issue with this criminal stuff is who actually brings the claim and I Googled this, and I read through this very briefly, the prosecutor in Singapore has to bring the claim. So, the attorney general’s chambers has to bring the claim and they have a discretion as to whether or not to bring it and this discretion would be based on how likely things are going to succeed, you know, whether its public policy is in best interest of…yeah, public policy, etcetera. So, the gating mechanism of whether or anyone is going to go to jail is whether or not the attorney general’s chambers actually decides to prosecute.

Laura Shin: Okay. Yeah. I think the blockchain letter sort of would be another piece of evidence or at least that’s what they seem to be trying to imply, blockchain.com, in terms of the deception. So, maybe Adam, you can answer for Mashinsky because I believe Stephen Ehrlich probably is Canadian.

Their citizenship is not going to determine what law applies, and there could be criminal violations potentially in more than one jurisdiction also. I think you need to divide this into prebankruptcy behavior and behavior in the bankruptcy. For prebankruptcy behavior, Three Arrows Capital, yeah, there’s some indications that there may have been fraud whether that arises to the level of criminal fraud in Singapore or in the U.S., you know, if you have underlying fraud that can then be a predicate for wire fraud or mail fraud. Those would be federal prosecutions. I have no idea if there’s any interest at this point from the Department of Justice of even touching this stuff.

Celsius also if you look at what’s in the KeyFi lawsuit, there’s some implications of fraud there too. If I were Mashinsky, I would be a little concerned about that, and then, Celsius has some other weird problem and, I think 2018 or 2019, Celsius entered into a consent order with the state of Washington for engaging in unlicensed money transmission among other things, and the consent to order basically Celsius just promised it wouldn’t do that in Washington anymore and Celsius stopped having state of Washington accounts after that. Consent to order doesn’t really spell out what Washington thought constituted the money transmission, but presumably if it was unlicensed money transmission in Washington it would also be that in many other states, and Celsius doesn’t have a money transmitter license. It is a federal felony to operate a money transmission business in the U.S. without a state license.

So, there may be another problem there for Celsius. Again, it would require the Department of Justice to actually think this is worth pursuing and they may just say look, we got plenty of other fish to fry, why get into this whole crypto area, which is politically charged and let the market sort it out in some way. That’s all the prebankruptcy.

They seem to like doing the crypto cases in my opinion, but anyway.

They like doing like the hacker cases or the money laundering cases. This is different. That’s the prebankruptcy stuff. I don’t see anything with Voyager yet that indicates anything other than…Voyager just seems stupid but not criminal. You don’t go to jail for being stupid. Otherwise, this country would look very different. But there’s also the question what happened in the bankruptcy.

If you knowingly and fraudulently conceal assets or books and records related to assets from any basically custodian or officer of the court, that is a bankruptcy crime in the U.S. and that may be a problem with Three Arrows, right. If they don’t turn over the private keys, arguably that’s knowingly and fraudulently withholding from custodian or other officer of the court any recorded information related to the property or financial affairs of the debtor. You can be looking at up to five years of jail time for that.

The hook for U.S. law there is that there’s this Title 15 case that got filed in the southern district of New York and Title 15 cases are really meant to just kind of be a mechanism for coordinating bankruptcies that are primarily outside of the U.S. The main show is not New York but to the extent there are assets in New York, it creates a coordination mechanism but that’s enough to trigger U.S. bankruptcy crime statutes. Given that the main show is outside the U.S., I don’t know if anyone…

Wassielawyer: I’m happy to sort of jump in here because I’m just scrolling through this, and yes, there is criminal offense for dishonest and fraudulent removal and concealment of property to prevent distribution to creditors. So, there absolutely is the equivalent in Singapore as I expect most of the rest of world. So, if they start being incredibly noncooperative, it may seem that they may have to run off to Dubai or somewhere else just to stay out of jail, although there is a question of whether there is a Dubai…

I don’t think Dubai has an extradition treaty with the United States.

No. It doesn’t. I’ve looked into this one and it doesn’t have an extradition treaty.

I mean, I don’t know if you saw it in the Bloomberg article, they are in the process of moving to Dubai. So, what does that say to you?

They want to get away from Singapore. They want to get away from the MAS. They definitely don’t want to be in the U.S. I mean, Dubai is like the place where you go to if…it’s got a pretty dodgy reputation, right.

Nothing that can’t be cured by sponsoring some soccer teams.

Laura Shin: Okay. Then how long do you expect each of these bankruptcies to play out?

Two to three years I think.

Yeah. Two to three years is probably right.

These are not going to be fast. I mean, it’s hard to give a real accurate guess at this point, but two to three years, I think, before we see a plan confirmed. How long it takes for all the assets to be fully ministered, that could take much longer.

I think these sort of precedent you may have for this, I mean, just look at Mt. Gox stuff, right. It’s taken absolutely years to play out. Was it 2014 something? Like way before they even did anything crypto related or knew what crypto was was when it all happened. Well, and the Mt. Gox thing, there’s a fairly interesting point here given the length of time it took because I believe the bitcoin was sitting in Mt. Gox. This goes back to the question we were discussing probably closer to our area. The bitcoin then appreciated massively in value in the last eight years or so and it looks like it actually come to a fair distribution where there has been some sort of civil rehabilitation proceeding such that the creditors seem to be able to enjoy the upside rather than the companies magically becoming solvent maybe just by bitcoin price appreciation. So, this may be good news for the 3AC creditors. Maybe there is a solution somewhere where you don’t get liquidated at 18K when bitcoin goes to 200K or whatever it is while holding.

Do you think it’s likely that Celsius and Voyager or either one of them will eventually be up and running again as a business?

And Wassielawyer, do you have an opinion?

I don’t know. It depends. They clearly want to. They clearly want to because of chapter 11, but I think Adam’s comment is coming from the fact that yeah, gaining confidence.

The filing of 11, yes, they may want to but even if Kirkland and Ellis looked and said you have no chance of reorganizing, they would still file them for 11, not for seven.

Laura Shin: Oh. I see. Okay. Last question, now truly as you all know, cofounder Su Zhu of Three Arrows Capital said that he was a creditor of Three Arrows for five million dollars and cofounder Kyle Davies wife Kelli Chen said she was owed 65.7 million. What’s the likelihood that Su and then also Kyle’s wife receive anything as creditors?

To be honest, it depends on the nature of the loan agreement, of this arrangement. It could not be a legitimate loan. It could be just them claiming they are owed monies because the evidence we’ve seen that’s put out is you know a very short document that 3AC okay we confirmed that we owe you this amount of money. Can a shareholder legitimately be a creditor of the company? Yes. Is this the case? We don’t know. Is it likely they’re going to be net up out of all this, I really doubt it because we can go into this more detail but Adam with all of the potential clawbacks against Kyle and Su, I could go on all day about it? You know, potentially fraudulent trading, unfair preferences, which operates in a very similar way to what Adam described earlier on, breach of the rights of duties. There’s a whole list and there’s the personal claims that are going to be showing up against them as well. So, yeah, I think we probably need more information there, but could it be legitimate? Yes. But is it really? We don’t know.

I don’t know enough about British Virgin Island liquidation proceedings to know how they would be treated. I can say that in U.S. bankruptcy case, there’s first the question is do you actually characterize the relationship as a loan as Wassielawyer would say or do you say well it’s actually more like an equity contribution or maybe it’s just bullshit and there is nothing there but even if you say it’s a loan, in a chapter 11 case you would expect to see insider positions classified separately from other creditor claims and probably subordinated, which means in this case, you know, it would be getting nothing. So, I would expect for Celsius for example that Celsius insiders are going to be put in a different class and would get no recovery. I can’t imagine Mashinsky walking away with a penny from Celsius.

Adam, can I ask you one question please? I’m sorry I’ve been dying to ask you this question. On the Voyager sort of draft, the way it’s sort of set up, the creditor process, is there segregated account holders from unsecured creditors, is there a world where because of you guys having a cross-class cram down is there a world where account holders say this is a terrible deal and the secured creditors in the right majority and they get cram down of the plan? Is there a world where that happens?

Adam Levitin: Yes. You only need one…so, bankruptcy, there are two ways you can confirm a bankruptcy plan. You can confirm it consensually or with what’s called cram down and that’s where the plan being crammed down the throats of the non-consenting creditors. We also have a technique called the cram up and you can imagine what that might be. With a consensual plan, it’s a little bit of a misnomer. It doesn’t mean that everyone agrees to it.

It means that every class that is impaired has voted for the plan by a requisite majority. A cram down plan in contrast means only a single class voting for the plan and that single class could even be a class that has one creditor in it, right. There are rules on how you can classify creditors. There’s some restrictions but you could have a class maybe it’s vendors or maybe it’s a class just of small claims that votes for the plan and they force it down on everyone else. That’s entirely possible.

All right. Well, we will have to see how it all plays out. So, you guys, this has been an amazing conversation. I so appreciate that you shared your knowledge. Where can people learn more about each of you and your work?

Yes. I’m an anti anime penguin in a suit and you can follow me on Twitter, wassielawyer. Sometimes I’m also a lawyer.

Adam Levitin: So, you can follow me on Twitter too at Adam Levitin or I also blog at creditslips.org. and otherwise, you can read my scholarship, you can find it on SSRN. Most relevant for this area is a forthcoming article with the very original title of Not Your Keys, Not Your Coins but it’s a 70 plus pages of detail about how we might characterize custody relationships with cryptocurrency exchanges and brokers and that’s coming out in Volume 101 of the Texas Law Review.

All right. Well, it has been a pleasure having both of you on Unchained.

Awesome. It’s been fun being here Laura. Thank you.

It’s been a pleasure. Thank you very much.

Thanks so much for joining us today. To learn more about Adam and Wassie, check out the show notes for this episode. Want exclusive access to even more Unchained content? Subscribe to my bulletin newsletter for weekly round-ups and interviews you won’t see on the podcast. Visit LauraShin.bulltetin.com. Unchained is produced by me Laura Shin with help from Anthony Yoon, Matt Pilchard, Juan Aranovich, Pam Majumdar, Shashank and CLK Transcription. Thanks for listening.

Posted in: 2022, Shows, Unchained Tagged in: 3AC, Adam Levitin, bankruptcy, celsius, chapter 11, creditors, Crypto Lawyer, custody, earn, Georgetown Law, Gordian Group WassieLawyer, Laura Shin, Unchained Podcast, voyager

Georgetown Law Professor and Principal at Gordian Group

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