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Cryptocurrency is known to be a risky investment, and your assets are not insured like they are with a bank or brokerage firm.
Truth be told, you are never safe from loss with a risky asset. Just talk to everyone cryptocurrency users who learned the hard way this year after several high-profile crypto bankruptcies.
Investors were reminded that even if their 401(k) plans or Individual Retirement Accounts (IRA) are guaranteed certain levels of protection. For the most part, these protections do not extend to crypto accounts.
What kind of protection is there for crypto accounts?
If your crypto assets are held by a crypto firm that is filing for bankruptcy, you might be out of luck. Crypto investors with accounts on Coinbase were made aware of exactly that in May, when the crypto exchange began experiencing a liquidity crunch.
“Legal protections have not been tested in court for crypto assets specifically, and it is possible, though unlikely, that a court could decide to deem customer assets part of the business in a bankruptcy proceedings,” Coinbase CEO Brian Armstrong said in a May 10 statement. Tweeter.
A statement like this implies that crypto customers may be treated as unsecured creditors by a bankruptcy court and liable for the loss of their assets.
Underwater crypto business users are now brutally aware that they do not hold legal title to the digital assets in their crypto accounts amid the various crypto scandals of The bankruptcy of BlockFi to FTX’s November implosion.
In most cases, like with crypto firm Celsius’s bankruptcy in June, users only have a contractual right to a refund plus a return, says Manny Grillo, a partner at Allen & Overy’s restructuring firm that represents distressed companies.
“In the Celsius case, the bankruptcy court has just ruled that even accounts believed to be custodial accounts, in which investors retained ownership of their assets, had only been converted from “earning” accounts. “in ‘custody’ accounts and therefore, holders of those custodial accounts cannot withdraw their assets today,” he says.
A custodial account in the crypto world means an exchange account or wallet that holds the private keys to a user’s crypto. Non-custodial wallets allow you to have full control over your private keys.
In light of all the recent crypto bankruptcies, more and more users are choosing to migrate their assets from crypto exchanges to non-custodial wallets to protect their holdings as they realize that certain protections do not exist for these “hot” accounts, experts say.
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FDIC and SIPC do not cover crypto exchange accounts
There is a fundamental disconnect between the rights users thought they had and what they have. Some crypto investors thought their crypto accounts would work the same as a traditional bank account, with insurance and protections from the Federal Deposit Insurance Corp. (FDIC), but it is not.
Due to a lack of regulatory oversight, crypto accounts, for the most part, escape federal government protection. Additionally, the regulatory framework of legal definitions surrounding cryptocurrencies is still being developed.
Securities Investor Protection Corp. (SIPC)
SIPC protects consumers against failures of brokerage firms. Some of the big names in brokerage firms include Ameritrade, Fidelity, and E-Trade, among others.
If a SIPC member business goes bankrupt, its customers can file a claim with SIPC for reimbursement of up to $500,000, including up to $250,000 in cash in your account. You can view a list of SIPC member companies on the organization’s website, but you won’t find most cryptocurrency exchanges on this list.
Although you may notice that eToro and Robinhood are listed as SIPC members due to their brokerage products.
Robinhood even has this disclaimer on its website: “Investments in cryptocurrency through Robinhood Crypto are not protected by SIPC and Robinhood Crypto is not a member of FINRA or SIPC”.
The company has made it clear that protecting its broker arm is separate from Robinhood Crypto.
Blake Harris, Founding Director of Blake Harris Law, where he assists clients around the world with asset protection, said: “It seems logical that the government is not making the cryptocurrency industry easier by allowing cryptocurrency currencies to be covered by SIPC.”
Federal Deposit Insurance Corporation (FDIC)
The FDIC is like the SIPC for banks and thrifts. It insures deposits and ensures that institutions are sound with adequate protections for consumers.
As with SIPC, if your FDIC-insured institution fails, you are covered for up to at least $250,000 per depositor at each FDIC-insured bank. You don’t have to do anything to get this protection, and in the unlikely event of a bank failure, you can usually expect a refund from the FDIC within days.
You can use the FDIC’s BankFind tool to determine if your bank is FDIC insured, but you’ll have a hard time finding names like Binance or Kraken listed here.
This is because the FDIC does not insure crypto exchanges or cover cryptocurrency. The FDIC has even sent letters to crypto sites asking them to remove misleading statements alluding to FDIC protection.
Other insurance coverage
Without federal protections, the only protections crypto users have are the ones they put on themselves, says InsuranceQuotes.com analyst Michael Giusti.
“One of the protections people can get is private parts insurance policies. But unless these policies were already in place before bankruptcy, coin holders would be out of luck.
He says these policies typically cover theft, loss of access, business risk, and decentralized finance (Challenge) blanket.
Theft means if an unauthorized party steals your coins. Loss of access coverage would protect you if you lose your keys, wallet, or the ability to access your coins.
“Enterprise risk policies are similar to all other enterprise risk policies, such as errors and omissions coverage for executives of cryptocurrency companies,” says Giusti. “And decentralized finance or DeFi hedging protects the underlying technology – usually blockchain – if it didn’t work as expected.”
But it would be best if you always read all the printouts, good or bad, before buying a font. Some insurance is there to help protect customers, while others can be a marketing gimmick to give you the illusion of security.
Potential buyers should make sure they know the amount of coverage, exclusions, and the stability of the company writing the policy.
Most experts agree that the best insurance is simply to keep your crypto in cold storage away from an online account.
What happens if your crypto exchange files for bankruptcy?
If your crypto exchange declares bankruptcy, there’s not much you can do except queue for repayments if and when they come – and “when” is often measured in years, not days or weeks.
“Bankruptcy cases like these typically involve two acts,” says Grillo. The first act is “the collection and evaluation of assets from all the various historical sources and transactions from which they can be recovered. And second (is) the liquidation or fixation of claims on those assets followed by distributions.
In complex cases like those faced by crypto exchanges, he says both of these acts could take years, pointing out that historic investment vehicle cases like the Madoff cases have resulted in large distributions to investors but have taken years.
For users whose exchanges have already filed for bankruptcy, the light at the end of the tunnel is murky at best.
But for other crypto users, there may be some consolation in knowing that efforts are underway to provide stricter regulation that could foster stronger protections for investors.
Here are some of the legislative proposals:
- The law on the protection of consumers of digital products. The legislation would give the Commodity Futures Trading Commission (CFTC) jurisdiction over these digital assets.
- The law on responsible financial innovation. The law aims to provide a regulatory framework for the digital asset market and to provide “appropriate jurisdictional limits” to protect consumers.
There is some overlap between these two bills. Still, experts say that when the new Congress begins next year, there will be more progress toward a legislative and regulatory solution to increase protections for crypto investors.