Clifford Chance

Earlier this year (2019) the Court of Florence, Bankruptcy Division, declared the bankruptcy of a cryptocurrency exchange, BitGrail. It was an interesting decision as it addressed the issue of whether or not a cryptocurrency was property under Italian law.

Background: The theft of Nano coins

The BitGrail case, which was reported widely in the press in 2018 following a theft of more than 11m Nano XRB coins from the Bitgrail cryptocurrency exchange. Due to the failure if the exchange to return the stolen coins, a BitGrail user later filed for the BitGrail's bankruptcy in an Italian Bankruptcy Court.

The Court report on which the 2019 decision relies concluded that it was BitGrail which (following a single request from a user) sent the Nano node multiple requests for withdrawals; and because the communication mechanism was not characterised by idempotence (i.e. the property of executing a command only once), the Nano nodes could not perceive that the requests resulted in a "double withdrawal."

A cryptocurrency is both "property … over which rights can be claimed" and a "means of payment"

The Court of Florence's landmark decision takes a stand in the debate regarding the legal nature of cryptocurrencies, to find that cryptocurrencies are legal properties (and not mere data).

The Court concluded that the cryptocurrencies stored on the exchange were "property" based on the definition used in the Italian anti money-laundering legislation, pursuant to which a virtual currency is "a digital representation of value which is neither issued by a central bank or a public authority, nor necessarily attached to a legal tender, and which is used as a means of payment and can be transferred, stored or traded electronically" and an exchange is "any natural person providing to third parties, on a professional basis, services aimed at facilitating the use, exchange, storage of virtual currency and their conversion from or into legally established currencies."

The Nano XRB coins also qualify as "fungible assets," because all coins are of the same type, have the same qualities and are subject to the same protocol.

The exchange administrator acquires ownership in the cryptocurrencies and must return an equal number of those assets to the users

According to the Italian Court, the service agreement between BitGrail and its users qualifies as a specific "deposit arrangement" (so-called deposito irregolare), pursuant to which the administrator/custodian becomes the owner of the cryptocurrencies and must therefore return an equal number of those assets to the users. The Court rejected the contrary argument presented by BitGrail, according to which the administrator was not free to use the users' cryptocurrencies.

The Court valued the fact that the assets were managed through a single centralised account, in that the users' assets were not stored in their private wallets but were moved to a centralised BitGrail address (the "BitGrail Wallet") on a daily basis though a dedicated script. This meant that (i) only the administrator held the private key to the BitGrail Wallet and (ii) the users could withdraw or transfer assets only through the platform functions.

For the purposes of Italian bankruptcy law, the cryptocurrencies in the exchange are its assets, and the cryptocurrencies the exchange is unable to return to the users are its liabilities. The quantification of those assets and liabilities can be linked to the cryptocurrency's market value

For an Italian company to be declared bankrupt, certain requirements must be met, namely:

• The debtor's (i) assets exceed EUR 300k and (ii) liabilities exceed EUR 500k. The Court considered that, "while bearing in mind possible fluctuations in [the cryptocurrencies'] values," these requirements were satisfied, based on the market value of, respectively, (i) the assets held by the exchange subsequently to the theft (i.e. more than 2.3k Bitcoin and 10bn Nano XRB coins, the market value of which exceeded EUR 16m and 20m respectively) and (ii) the countervalue of the Nano XRB coins BitGrail failed to return (i.e. more than EUR 9.7m); and
• The debtor is insolvent, in that it is unable to meet its payment obligations. BitGrail was deemed to be insolvent, because it could not return an equal number of coins of the same kind of the hacked Nano XRB coins.

Wallets can be subject to (crypto)seizure

The decision also provides guidance on the urgent measures a holder of cryptoassets may seek: Before filing a petition for the declaration of bankruptcy of BitGrail, the petitioner (a user of BitGrail) had obtained an ex parte order against BitGrail, whereby the Civil Court of Florence ordered the blocking of the platform and take down the website. All the assets stored on BitGrail were seized and the Court appointed a special administrator of the platform and a receiver of BitGrail's assets.