In the wake of Terra/Luna’s collapse in May 2022, followed by FTX’s spectacular demise a few months later, the crypto industry has become a heavy user of Chapter 11 bankruptcy. BlockFi, Celsius, Core Scientific, FTX/Alameda, Genesis Global, Prime Trust, Three Arrows Capital, Voyager — former linchpins of the crypto ecosystem — have all ended up filing. There have been bruising court battles. The legal costs have been staggering. Millions of customers have suffered enormous economic damage, hardship, and disillusionment.

Yesha Yadav is the Milton R. Underwood Chair, Associate Dean, and Professor of Law at Vanderbilt Law School. Robert Stark is Chair of the Bankruptcy and Restructuring Practice Group at Brown Rudnick LLP. This op-ed, part of CoinDesk’s “State of Crypto Week” is based on the longer article, “The Bankruptcy Court as Crypto Market Regulator,” here.

With bankruptcy courts taking control of some of crypto’s biggest firms and examining the market’s workings, it is worth asking whether this substitute regulatory regime is working, or whether its intervention is adding to the uncertainty facing the market.

First, a little context. Most financial firms are, outside of bankruptcy, supervised by government regulators, like the Securities and Exchange Commission, Commodity Futures Trading Commission or the Federal Reserve. Bankruptcy works in tandem with the regulators, with bankruptcy focusing primarily on reworking the balance sheet and regulators continuing to monitor the company’s business practices. If all goes well, the company leaves bankruptcy in a sound financial position and without any objections voiced by regulatory supervisors.

This has not been the experience for crypto insolvencies. The digital asset industry has been allowed to mature without a dedicated regulatory framework, resulting in runaway risk-taking, opaque business practices, and suspect governance. More to the point, bankruptcy courts have found themselves largely on their own, sifting through the wreckage of 2022’s crypto winter without any regulatory support.

Courts have been forced to rely on the Bankruptcy Code to decide difficult legal questions that, traditionally, would have been addressed by regulators. And, they have been asked to take on this task in a tumultuous industry environment, where distressed and unpredictable conditions have made bankruptcy financing practically impossible to obtain. Even as bankruptcy courts have tried their best, their efforts at bringing order to crypto-markets have largely failed.

Still, bankruptcy’s intervention has generated important benefits for the industry. Bankruptcy’s objectives are often aligned with those of traditional regulation. Take disclosure. Bankruptcy courts are demanding when it comes to making companies reveal information about themselves, their business, what went wrong, and why. If circumstances point to serious wrongdoing (or management seems untrustworthy), bankruptcy courts can compel the appointment of an “examiner” to investigate facts and deliver a public report.

In the Celsius bankruptcy, the court-appointed examiner delivered a 689-page report detailing the firm’s lapses in internal controls, failures in risk management, and possible fraud. Seven months after the report’s publication, Alex Mashinsky – Celsius ex-CEO – was led off in handcuffs.

Read more: Where Is Crypto Policy Heading in a Post-FTX World?

Bankruptcy courts have also delivered powerful teaching moments to crypto enthusiasts and to regulatory authorities. In Celsius, the bankruptcy court was required to decide whether deposits in interest-bearing “Earn” accounts belonged to customers or to the bankruptcy estate. Celsius’ customers came to learn that, once they entrusted their digital assets with Celsius, the company was free to use them as it pleased. This rendered customers merely unsecured creditors of the bankrupt firm, left to fend for themselves near the bottom of the repayment ladder, with the crypto belonging legally to Celsius’ estate. The ruling was unsparing. But it directed regulatory authorities to a point of acute public vulnerability.

Bankruptcy also gives regulators a forum to push policies without having to develop rule-making or legal actions of their own. When Voyager asked the bankruptcy court to approve its sale to Binance.US, the SEC intervened in opposition to the transaction. It argued that the sale came with serious regulatory problems, though it was unable to back up its contentions with evidence acceptable to the judge. The court brushed aside the SEC’s objections. But this highly visible attack — exposing profound regulatory risks hanging over the deal — caused it to fall through. Voyager proceeded to a liquidation.

Despite the regulatory overlap, bankruptcy courts are a very poor substitute for thoughtful administrative regulation. Crypto’s major insolvencies show that bankruptcy courts are simply not equipped for the job. Traditional oversight comes with a slate of public policy aims: reducing systemic risk; protecting customers; and creating usable knowledge for the consuming public. Bankruptcy law may have some similar intentions, but it cannot fully deliver on any of these goals.

Importantly, bankruptcy’s mission focuses on the particular debtor, its creditors, and stakeholders. It has only limited concern for the marketplace. This has serious consequences. Take disclosure — a foundational regulatory tool. Bankruptcy courts ensure that information is disseminated only to help the debtor’s stakeholders make an informed choice about the company’s fate in Chapter 11. Unlike standardized and vetted disclosures mandated by the SEC, bankruptcy delivers information incrementally, idiosyncratically, and in non-standard ways. Examiners are not appointed all that often. There isn’t one in FTX/Alameda, for example.

Bankruptcy courts also cannot help the crypto industry avoid insolvency-contagion and other forms of “systemic” risk. Traditional regulation includes tools that aid financial firms, such as providing deposit insurance or emergency federal financing. Such tools are not available to bankruptcy courts. Even here, bankruptcy has a short-sighted lens. It focuses just on the debtor and its stakeholders, and no more. If one bankruptcy filing causes a dozen more, that makes for a busy judicial caseload. Stopping further contagion is the work of traditional regulators.

Finally, bankruptcy courts apply the law as dictated by the Bankruptcy Code. Sometimes this results in outcomes that seem unfair to large numbers of innocent people. Harming any number of vulnerable stakeholders is the cost the Bankruptcy Code often accepts for saving a failing business.

The harm visited on Celsius’ customers is case in point. The court applied the law, regardless of the impact on the industry or customers. Even if this logic applies as a matter of bankruptcy law, it can feel deeply wrong as a matter of basic public policy. In traditional securities markets, customer assets generally never enter bankruptcy in the first place.

Ultimately, these crypto bankruptcies are providing a clear lesson: there is no substitute for comprehensive regulation of the industry. Bankruptcy can be helpful, but it is certainly not an effective regulator. A robust regulatory framework is urgently needed if the marketplace and its customers are to avoid another crypto winter even colder and deeper than this one.