Tokenization: the Next Logical Step in Bankruptcy Claims Trading

Tokenization is one of the most revolutionary applications of blockchain technology. It's the idea of turning real-world assets (RWAs) into digital representations that can live on blockchains, opening a whole world of possibilities on how people interact and derive value from those RWAs.

The bankruptcy claims market is, perhaps, the one space that needs this the most. An estimated 20 million users are holding on to claims worth $20 billion following the recent wake of bankruptcies in the crypto space. And for a lot of them, tokenization of claims may just be the respite they’ve been waiting for.

The messy business of bankruptcy claims

When a company files for Chapter 11 bankruptcy, creditors can assert their right to payment by filing a Proof of Claim with the bankruptcy court. The claim specifies the amount owed and is usually the creditor’s only hope of getting their money back.

But, having a bankruptcy claim doesn’t guarantee payment. This is because bankruptcy proceedings and restructuring financial affairs are often messy procedures. Proceedings may take years to conclude due to administrative obstacles, legal problems, and complex financial issues. And at the end of it all, not all claims are treated equally.

Bankruptcy claims are assigned different priority levels. There are high-priority claims, which must be repaid in full. Holders of other claims have to wait until these claims are sorted out. This means lower-priority claims often don’t get paid in full or even end up totally unpaid.

Thus, many creditors have grown weary of the bankruptcy process. This has led to the development of an OTC aftermarket for bankruptcy claims.

Here, creditors sell their bankruptcy claims to investors for cash, usually at a lower price than the value of the claim. The investor hopes to make a profit down the road when the bankruptcy proceedings conclude.

Bankruptcy claims trading typically takes place with the help of bankruptcy lawyers or agency brokers. And while it has certainly helped creditors derive some value from their claims, it has its own share of problems.

Problem with traditional claims trading

Today, people who want to buy or sell bankruptcy claims can only do it via bankruptcy lawyers or brokers. However, both options can be expensive – lawyers demand high legal fees while agency brokers charge a significant portion of the transaction cost as commission. Therefore, they’re typically only accessible to larger claim holders.

The market also suffers from an overall lack of transparency and information asymmetry. Buyers don’t have convenient access to the relevant information about claims. This leaves them vulnerable to vulture pricing. Both buyers and sellers are also often victims of payment fraud and impersonation scams.

Thus, they often have to engage the services of financial advisors or bankruptcy attorneys to help assess the risks and opportunities of assets, which further increases the costs of claims trading.

Traditionally, the solution to all these problems was to have a whole lot of money. But this is not something all claim holders and potential investors have. This makes it difficult for investors to buy or sell claims, leading to another huge problem – lack of liquidity in the bankruptcy claims market.

Fortunately, blockchain technology has a better solution – tokenization.

How tokenization changes things

When RWAs are tokenized, they have the same financial value as the underlying assets, with the added feature of being as tradeable as cryptocurrencies. And this is what will revolutionize bankruptcy claims trading.

Take fungibility for instance. Fungibility is the ability to exchange one asset with another of the same type without affecting its value. With tokenization, a bankruptcy claim can be converted into many digital tokens, each representing a fraction of the claim’s value. These tokens can then be freely traded on a crypto exchange with other tokens or even fiat currency.

Do that for multiple bankruptcy claims and you end up with a massive pool of fungible tokens. These can be easily traded without needing lawyers, investment advisors, or agency brokers. This leads to a greatly reduced cost of investment.

Tokenization also greatly increases the level of transparency. When claims are pooled and made tradeable on an exchange, there will be more price transparency, leading to better pricing.

All these features make bankruptcy trading a more attractive and accessible option. It opens up the market to both small and large claim traders. And, with more investors comes more liquidity, which, in turn, makes trades cheaper and more accessible.

Is tokenizing bankruptcy claims the future?

With billions of dollars locked up in bankruptcy claims and no relief in sight, tokenization may just be what the crypto market needs. Fortunately, this concept isn’t just theoretical speculation.

There’s a crypto company looking to tokenize claims trading. Called Open Exchange (OPNX), the company has built an order book exchange that lets people buy and sell tokenized claims (as well as crypto), starting with Celsius and soon, FTX. The company has

standardized claims into tokens that can then be freely traded or used as collateral to trade crypto futures.

More similar solutions will likely emerge to tokenize RWAs, like claims. This means that the next couple of years will be an interesting time in the bankruptcy claims market as tokenization opens new avenues for trading for more people than ever before.