Stablecoin issuer Tether faces scrutiny over $840m loan it scooped from Celsius Network as crypto lender’s bankruptcy tests application of insolvency rules to digital assets.

Celsius filed for bankruptcy protection in the United States this month, becoming the latest victim of the recent crypto price crash and leaving hundreds of thousands of its clients facing losses on their investments.

Tether, whose $66 billion stablecoin known as USDT plays a key role in crypto markets, recouped an $840 million loan to Celsius before bankruptcy by selling bitcoin Celsius pledged as collateral. .

The question now is whether Celsius could recover the value Tether received when the loan was liquidated. The answer would clarify an uncertain area of ​​bankruptcy law and, in the worst case scenario, Tether would hit the reserves that underpin USDT.

“Can Celsius recover. . . loan liquidations completed within 90 days of filing? Law firm Celsius Kirkland & Ellis said during a presentation in New York bankruptcy court last week. The issue was part of the “legal issues essential to the outcome of the case”.

Tether, Celsius and Kirkland did not respond to requests for comment.

Resolving issues around Tether lending and other crypto-secure borrowing will involve complex issues of how secured lending rules apply in the digital asset market. In the case of a secured loan, the borrower pledges assets to the lender as collateral.

“We’re in an area where the law is quite uncertain and quite at odds with general market expectations,” said Brandon Hammer, bankruptcy attorney at Cleary Gottlieb.

Many in the crypto markets have mistakenly assumed that simply taking possession of the crypto pledged as collateral will protect their position as a secured lender under bankruptcy law, Hammer said.

In fact, they could still be forced to return the assets, leaving them with only an unsecured claim equal to the value of the loan.

Tether had an outstanding $840 million USDT stablecoin loan to Celsius in May. He said this month that Celsius had pledged 130% of the bitcoin loan value as collateral.

In May and June, as bitcoin prices fell, Celsius was unable to provide more collateral to maintain the loan in response to a margin call from Tether, Celsius chief executive Alex Mashinsky said. , in a court case.

Tether then sold the bitcoin pledged by Celsius to repay the loan and returned the remaining collateral. The mutually agreed liquidation resulted in losses of $100 million for Celsius, Mashinsky said.

Tether, whose USDT token has recovered to its target price of $1 in recent days after two months of trading at a slight but persistent discount, said this month that it suffered no losses on its loan to Celsius.

The stablecoin issuer added that its “risk culture demonstrates an understanding of both the lending business and takes into account the regulatory landscape in order to achieve and maintain its business objectives.”

The liquidation will likely be reviewed by Celsius and the committee that will be formed as part of the bankruptcy proceedings to represent unsecured creditors, bankruptcy lawyers said.

“One of the things that is going to be looked at is whether or not Tether has been fully secured. Has Tether properly honed its security in its collateral?” said Tad Davidson, co-practice lead of bankruptcy at Hunter Andrews Kurth.

Lenders who have not properly established their claim to particular assets – a process called “honing” – can find themselves relegated to the mass of bankrupt unsecured creditors at the bottom of the pile, potentially suffering huge losses. If there is a dispute as to whether the security has been perfected, a settlement can be agreed or, in the worst case, the debtor can sue the creditor.

“The way you perfect bitcoin security has not been tested in any type of litigation,” said Jonathan Cho, bankruptcy attorney at Allen & Overy.

The uncertainty increased when El Salvador declared bitcoin legal tender last year. The Uniform Commercial Code, rules followed by nearly all U.S. states, characterize foreign government-recognized means of exchange as physical currency whose security can only be perfected through physical possession – a problem for digital currency.

“It’s crazy that the actions of El Salvador dictate the results of US law, but that’s the way it is,” said Adam Levitin, a Georgetown law professor and director of Gordian Crypto Advisors.

The UCC was updated this month to include specific rules on cryptographic security that focus on asset control. But the rules do not yet have the force of law and are not retroactive. Current best practice in crypto markets is to issue public documents known as UCC filings that declare a security interest in intangible assets, or to enforce rules on investment assets that involve a third-party custodian takes control of the asset, attorneys said.

It’s unclear whether Tether has taken either approach. There is no UCC repository for Tether security in New Jersey, where Celsius is based. There may be UCC deposits for Tether interest elsewhere. Tether’s public explanation of the loan liquidation process made no reference to a third-party custodian.

In bankruptcy proceedings, even the smallest errors in the perfection of security can be exploited by aggressive creditors seeking to improve their position. Celsius said it had $5.5 billion in liabilities but only $4.3 billion in assets.

Robert Gayda, partner at Seward & Kissel, said: “If you have someone who is not going to make a full recovery, you are going to have a motivated body of creditors who are going to want to look into this Tether transaction.”

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