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WazirX, one of India's largest and well-known crypto marketplaces underwent insolvency proceedings in 2024 following a $235 million hack carried out by North Korean hackers. This insolvency proceeding revealed a fundamental gap in India's insolvency framework when dealing with the crypto assets. Even though the crypto assets are now given recognition in the IBC as 'property', the procedure for dealing with those assets is still uncertain. Under the Insolvency and Bankruptcy Code, the crypto asset holders/users are treated as unsecured creditors because of which they face a severe disadvantage when compared to other creditors and even shareholders under the waterfall mechanism. It is necessary and high time for the Parliament to legislate a law with clear legal recognition, procedure and remedy to ensure equal treatment of crypto asset holders. 

Section 3(27) of the Insolvency and Bankruptcy Code defines 'property' inclusively, raising the question as to whether the crypto assets can also be included under the ambit of intangible assets. Indian legal framework in recent years has taken significant steps in recognizing the crypto assets as property. In Internet and Mobile Association of India V. Reserve Bank of India, the Court did not directly address the aspect of 'property' with respect to the digital currencies, but acknowledged the 'real existence and effect' of the Virtual Digital Assets (VDAs). This was a major breakthrough; it gave VDAs the same importance as any other property or currency. The Income Tax Act, 1961 and the Finance Act, 2022, explicitly incorporated virtual currencies, conferring proprietary status. In the case of Rhutikumari V. Zanmai Labs Pvt Ltd , the WazirX case, Justice N. Anand Venkatesh stated that “crypto assets are not a tangible property nor is it a currency. However, it is a property, which is capable of being enjoyed and possessed in a beneficial form. It is capable of being held in trust.” This case acts as a foundational stepping stone for the recognition of crypto assets in the Indian legal system.

The decentralized and anonymous nature of crypto transactions makes it extremely difficult for the authorities to trace ownership across jurisdictions. This is often used as a loophole by the debtors to hide their assets when the Corporate Insolvency Resolution Process (CIRP) happens: In re Schultz, the debtor shielded $30,000 worth of crypto assets to escape liquidation from the creditors. Ownership of crypto assets in the context of insolvency is generally decided by looking into the interplay between three levels:

who has control over the private keys--> legal classification--> contractual relationships

This complexity becomes particularly important when looked through the lens of insolvency under the IBC, where the classification of such 'owners' determines their position in the whole CIRP process. It is significant to decide if they will be treated as creditors, shareholders, or excluded from the process altogether.

Crypto assets are generally owned and controlled through private keys. In the case where the debtor owns the key, the crypto asset becomes a part of the estate like any other movable property and enters the CIRP process. Where a third person (other than the debtor) owns the key, the crypto asset will be excluded from the CIRP entirely. The latter example is also a comparatively straightforward case, where no confusion arises.

Complexity arises when the crypto assets are held and operated through intermediaries called exchanges, where the exchanges control the crypto assets on behalf of the users. Here, the nature of the users' rights primarily depends on the contractual relationship between the users and the exchanges. The legal relationship between the users and the exchanges can be discussed from four possible perspectives- trust, outright title transfer, quasi-bailment and mere contract. Under outright title transfer, the ownership rights are entirely transferred to the intermediaries: here, the users can only have a creditor claim over their assets during the CIRP. Quasi-bailment, a less certain concept, attempts to apply possession-based principles to crypto assets, but its legal status remains unclear. In a pure contractual relationship, the user only has limited protection based on the terms and conditions of their contract.

Trust relationship on the other requires more attention. Here the exchanges act in a fiduciary capacity with users retaining the proprietary rights. If this distinction is clearly established in the terms of their agreement, the users and their crypto assets will be excluded from the CIRP. However, if there is no such clarity, the users cannot technically have any proprietary interests over the assets. In the second case (where there is no clarity) the users and their assets will be included in the CIRP, where they are considered as creditors and not as owners. More specifically they are considered unsecured creditors, as they do not have any security interest over the crypto assets. As unsecured creditors, the crypto asset users will be given the least priority in the overall insolvency resolution process. They cannot be a part of the Committee of Creditors (CoC). The unsecured creditors generally have a very little say over the restructuring of the debtor's assets, which often results in them receiving low recovery rates.

Individuals from diverse backgrounds participate in this market. Among them, some groups are structurally more vulnerable than the others in the market of crypto currency. Retail holders are the most vulnerable. Many lack basic legal knowledge and awareness of the crypto market. They enter into the market with a general assumption that the mere purchasing of crypto assets will automatically grant them the full ownership of those assets. As their relationship with the intermediaries does not resemble a conventional transaction and Section 5(8) of the IBC requires the payment of funds against consideration for the time value of money, the retail crypto asset holders have very little chance of recovery of their assets. This problem gets further more complicated, as the intermediaries tend to mix the users' funds (commonly called 'pool') together with their own funds, blurring the separation between the company's funds and the users' funds. This adds on to the difficulty of tracing the actual owner of the assets.

'Cross-border crypto asset holders' and 'users of cross-border crypto asset intermediaries' face a very distinct danger subject to the jurisdictional risk. In cases where Indian users enter into transactions with intermediaries incorporated abroad, identifying the real owner of the asset becomes difficult. This may push the Indian users/holders to take part in international insolvency proceedings. International proceedings are not only expensive but also highly uncertain and their procedure is very complex.

The issues existing in crypto asset insolvency are not only because of technical/procedural gaps but also go deeper into the inherent structural problems of the crypto assets and the IBC. Even though the crypto assets are considered 'property' in the Indian jurisprudence, the lack of regulatory framework over the ownership and transactions worsens the position of these stakeholders. It is high time to rethink and reform the way the crypto assets and its stakeholders are understood within insolvency law. Granting stronger proprietary protections, regulating the crypto assets and creating a separate category for its stakeholders could bridge the gap between the existing legal framework and the economic realities of the crypto markets. It is important for the Parliament to address the inherent issues of the crypto assets when legislating the law. One concrete example would be to establish the trustee status of the crypto users and their obligations in the IBC. This will solve the issue of forcing the users to be a creditor by default. The Parliament should incorporate a separate classification in the existing IBC, clearly stating the powers of crypto asset holders and the nature of their relationships; or, the Parliament should draft a new law specifically designated for the Virtual Digital Asset holders, thereby removing the existing legal gap.

Author is a fifth-year BA LLB (Hons.) student at Sai University's School of Law, Chennai. Views are personal.

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