Identifying, Tracking, and Valuing Cryptocurrency for Litigation Matters

The meteoric rise and bankruptcy of cryptocurrency derivative exchange FTX focused global attention on the risks of investing in unsecured, decentralized digital currency, as well as on its potential for largescale financial fraud. U.S. investors, including high-profile celebrities who had touted the promise of this brave new digital economy, lost approximately $400M seemingly overnight.

FTX CEO Sam Bankman-Fried was arrested on eight counts of wire fraud, money laundering, violations of securities laws and other financial crimes. An estimated $7B was lost in the collapse, and it will take years to untangle and litigate the scheme—and to perhaps recoup some fraction of the invested millions.

Definition and Value

Bankman-Fried was not the first to divert customers’ funds in a financial sleight-of-hand, but the nature of cryptocurrency may have led him to believe it would be easier to conceal his fraud. Cryptocurrencies—like Bitcoin, Etherium, and Dogecoin—are digital assets based on a network distributed across many computers, which allows them to exist outside the control of governments and banks.

Proponents hail crypto as the democratization of currency and an opportunity for bold investors to score big gains; detractors fault its price volatility, high energy consumption for mining activities, and ease of use for scammers.

Unlike stocks and bonds, real estate, commodities, and traditional currencies, crypto has no intrinsic value. Yet it has value in the financial markets based on supply and demand. As is the case with traditional assets, the price of crypto is determined by daily market trading. Online sites like allow you to track daily pricing and trade volume.

Over the past decade (2013-2022), the performance of Bitcoin, perhaps the most widely known and well-established cryptocurrency, has demonstrated the price volatility of crypto. On Nov. 19, 2013, Bitcoin’s price reached $755, only to decline to $378 the same day. By Nov. 30, 2013, it had reached $1,163, falling to $152 by January 2015. At its highest, Bitcoin’s value exceeded $65,000 (February 2022); today it is valued at approximately $17,000.

Acquisition and Storage

To acquire crypto, you open an account—on an exchange like Coinbase, an online brokerage like Robinhood, or peer-to-peer payment platform like Venmo or Apply Pay—and transfer funds from your bank or brokerage account to cover your desired purchases.

You can hold your digital coins in your online brokerage or peer-to-peer platform; in a digital wallet like Coinbase Wallet or Kraken on your computer or smartphone; or in a hard wallet—a physical storage device like Ledger Nano or BitBox.

Digital wallets like Coinbase Wallet and Kraken are custodial, but there are also non-custodial wallets where you have a private key and are responsible for the security of your crypto. In addition, crypto ATMs provide a less obvious path for purchasing digital coins. There are over 38,000 crypto ATMs in 80 countries, 86.8% of which are in the U.S. You need a digital wallet to store such purchases.

Discovery and Tracing

As with traditional funds, cryptocurrency can be traced among parties’ accounts through bank statements, tax returns, disclosure on credit applications, statements of net worth, and disclosures on bankruptcy filings.

Start by obtaining and analyzing all monthly bank and brokerage account statements for the period in question, looking for transfers to and from bank and brokerage accounts and cryptocurrency exchanges; cryptocurrency brokers; and peer-to-peer platforms / mobile payment apps.

Once you have identified purchases, transfers, and/or withdrawals on bank and brokerage statements, request the public key so that you can trace activity within the crypto account using a blockchain explorer.

Like transactions of any other property, crypto transactions are taxable by law: IRS Notice 2014-21 describes how existing tax principles apply to transactions using virtual currency. Capital gains and losses are reported on IRS Form 8949 Sales and Other Dispositions of Capital Assets. When a taxpayer receives new cryptocurrency units from a “hard fork” (a divergence in the blockchain), that is considered an accession to wealth and recognized as ordinary income (Rev. Rul. 2019-24).

Cryptocurrency is an asset that may be used to pay creditors in bankruptcy cases. It is possible to find and access the debtor’s cryptocurrency, depending on its type, and the debtor should cooperate with the bankruptcy trustee in assessing the value of digital assets. Coinbase, a reputable crypto exchange, will assist trustees with locating crypto assets of specific debtors (Bankruptcy trustee guide | Coinbase Help); provide trustees with digital wallets to transfer and hold cryptocurrency; and can assist in freezing accounts.

Although a crypto asset may have little value at the time of a Chapter 7 bankruptcy filing, the asset can increase in value by the time the meeting of the creditors occurs, at which point it can be liquidated. In a Chapter 13 bankruptcy, the debtor pays off all or some of their debt through a payment plan over several years. Under a Chapter 13 plan, the repayment amounts are based on the value of an individual’s non-exempt assets. Cryptocurrency is generally considered a non-exempt asset, but it is critical to check your state’s law since individual states may have “wildcard” exemptions.

Just as with any other asset, transferring cryptocurrency within two years of a bankruptcy filing could be considered fraudulent. Courts look for the “badges of fraud” (which vary by state) to see if the debtor voluntarily or involuntarily made such a transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was indebted.

Generally, the courts will look to whether the transfer was made to an insider (i.e., a family member or other related party); whether the debtor became insolvent after the transfer; and whether the debtor received less than a reasonably equivalent value in exchange for the transfer. A debtor who engages in a fraudulent transfer that involves cryptocurrency and/or fails to disclose such assets could be subject to penalties and/or criminal charges.

Cryptocurrency Scams

The opacity of online transactions and the perception that online trails are more easily concealed have attracted fraudsters to crypto. The Federal Trade Commission reports that over 46,000 people have lost more than $1B in crypto since January 2021. Crypto scams range from investment, phishing, and romance scams to Ponzi schemes to fraudulent employment offers. “Rug pull” scammers hype a new project with a narrow window of opportunity to get in low and realize big profits fast.

Once they get your money, they disappear with it. Red flags to watch out for include promises to double your investment (or even give you free money); limiting payment to cryptocurrency alone; extortion via ransomware; minimal details about your investment and money movement; celebrity endorsements; and multiple transactions occurring in a single day.

Organized crime has been quick to recognize crypto’s advantages, laundering money by moving illicit funds through hundreds of digital wallets before depositing the funds and cashing them out at a crypto exchange. Unlike bank accounts, thousands of wallets can be opened without proof of identity within seconds.

Criminals launder money by moving it into the cryptocurrency system, using “mixers” or “tumblers” that take in funds from multiple customers, mix those funds together, and then output the mixed funds across (less-regulated) digital currency exchanges. Tools like tumblers hide the origin and receipt of cryptocurrencies, which can make it harder to trace funds.

Fortune Favors the Prepared

FTX was a house of cards, but cryptocurrencies are real digital assets. Crypto has value in the financial market and can be identified, traced, and valued by skilled forensic accountants with experience in financial litigation matters. Specialists in this field can identify, collect, and analyze online data across multiple platforms in an evolving financial landscape to assist plaintiffs, defendants, and government agencies in litigation matters related to money laundering, divorce, tax evasion, fraud, embezzlement, misrepresentation, and other financial crimes.

Sareena Sawhney is a director of the Valuation, Forensic Accounting and Litigation Support team of BST & Co. with 25 years of experience in the fraud, forensic accounting, and litigation support fields.


As published in the New York Law Journal on July 13, 2023 at 10:00 AM. Click here to read the original article.