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Cryptocurrencies are known to be risky investments and assets are not guaranteed like banks and brokerage firms.
To be honest, no risk-on asset is loss-proof. Talk to all the cryptocurrency users who learned how they’ve struggled this year after several high-profile cryptocurrency bankruptcies.
Investors were reminded that a 401(k) plan or individual retirement account (IRA) is guaranteed a certain level of protection. In most cases, these protections do not apply to cryptocurrency accounts.
What protections do cryptocurrency accounts have?
If your crypto assets are held by a crypto company filing for bankruptcy, you may be out of luck. That’s exactly what I was told in May.
Coinbase CEO Brian Armstrong said on May 10, “The legal protections for crypto assets have not been specifically examined by the court, and it is unlikely that the court will be able to protect customers’ assets. is considered part of the company and may proceed with bankruptcy proceedings.” tweet.
Such statements mean that cryptocurrency customers may be treated as unsecured creditors by bankruptcy courts and lose their assets.
Amidst various crypto scandals, from BlockFi bankruptcy to FTX’s November implosion, users of underwater crypto firms disrespect the fact that they do not retain legal ownership of the digital assets in their crypto accounts. I am waking up to
In most cases, users only have the right to repay and return contracts, like the crypto firm Celsius, which went bankrupt in June, said a partner in the restructuring practice at Allen & Overy, which represents troubled companies. says Manny Grillo.
“In the case of Celsius, the bankruptcy court found that even accounts believed to be custody accounts where investors retained ownership of assets were only changed from ‘earning’ accounts to ‘custody’ accounts. , so owners cannot withdraw assets out of such custody accounts today,” he says.
A custodial account in the crypto world means an exchange account or wallet that holds a user’s cryptocurrency private key. A non-custodial wallet gives you complete control over your private keys.
In light of all the recent cryptocurrency bankruptcies, more and more users are realizing that no specific protection exists for these “hot” accounts, and they are opting out of non-custodial options from cryptocurrency exchanges to protect their holdings. Experts say they are choosing to migrate their assets to wallets.
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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 the rights they have. Some crypto investors thought that with Federal Deposit Insurance Corporation (FDIC) insurance and protection, crypto accounts would function like traditional bank accounts, but that was not the case.
Due to the lack of regulatory oversight, cryptocurrency accounts are mostly outside federal protection. Additionally, the legally defined regulatory framework surrounding cryptocurrencies has yet to be resolved.
Securities Investor Protection Council (SIPC)
SIPC protects consumers from failure of brokerage firms. Among the brokerage firms are well-known companies such as Ameritrade, Fidelity and E-Trade.
If a SIPC member company goes bankrupt, its customers can file a claim with SIPC and receive a refund of up to $500,000, including up to $250,000 of cash in their account. You can view a list of SIPC member companies on the organization’s website, but most cryptocurrency exchanges are not on that list.
As you may have noticed, eToro and Robinhood are listed as SIPC members due to their intermediary products.
Robinhood’s website even has a disclaimer stating that “cryptocurrency investments by Robinhood Crypto are not protected by SIPC and Robinhood Crypto is not a member of FINRA or SIPC.”
The company has revealed that its brokerage division protection is separate from Robinhood Crypto.
Blake Harris, founder of Blake Harris Law, which helps protect the assets of clients around the world, said, “Governments are not trying to promote the cryptocurrency industry by allowing cryptocurrencies to be covered by SIPC. It seems consistent,” he said.
Federal Deposit Insurance Corporation (FDIC)
The FDIC is like the SIPC for banks and thrift institutions. It guarantees deposits and ensures that institutions are sound with adequate consumer protection.
Similar to SIPC, each FDIC-insured bank will be insured up to a minimum of $250,000 per depositor in the event of the failure of an FDIC-insured financial institution. You don’t have to do anything to get this protection. In the unlikely event that the bank fails, he can usually get his money back from the FDIC within days.
You can use the FDIC’s BankFind tool to determine if a bank has FDIC insurance, but you’d be hard-pressed to find names like Binance and Kraken listed here.
This is because the FDIC does not endorse crypto exchanges or cover cryptocurrencies. The FDIC even issued a letter directing cryptocurrency sites to remove misleading statements implying FDIC protection.
Other insurance protection
Without federal protections, the only protections cryptocurrency users have are the ones they impose on themselves.Michael Giusti, InsuranceQuotes.com analyst.
“One of the protections people can get includes private insurance for their coins. But unless these policies are already in place before bankruptcy, coin holders are out of luck.”
According to him, these policies typically cover theft, loss of access, business risk, and decentralized finance (DeFi) coverage.
Theft means when coins are stolen by an unauthorized third party. Loss of access coverage protects you if you lose the ability to access your keys, wallet, or coins.
“Business risk policies are similar to other business risk policies, such as malpractice and omission coverage for executives of cryptocurrency companies,” Giusti said. “And the scope of decentralized finance or DeFi protects the underlying technology (usually blockchain) if it fails to perform in the manner expected.”
However, it is always best to read all printed material before purchasing a policy. Some insurance is meant to protect customers, while others are marketing gimmicks to give the illusion of safety.
Prospective purchasers should make sure they are aware of the coverage, exclusions, and stability of the company writing the policy.
Most experts agree that the best insurance is to keep your cryptocurrencies away from your online accounts.
What happens if a cryptocurrency exchange goes bankrupt?
If a cryptocurrency exchange files for bankruptcy, there is little you can do other than find out when the repayments will be made. Also, “when” is often measured in years rather than days or weeks.
“There are usually two acts in a bankruptcy case like this,” says Grillo. The first step is to “gather and evaluate the assets from various sources and all of the past transactions from which it may be possible to recover the assets. Correction and then distribution.”
In complex cases like the one facing cryptocurrency exchanges, these two acts could take years, he said, while historical investment vehicle cases like Madoff’s It brought in a hefty distribution to investors, but notes that it took years.
For users whose exchange has already filed for bankruptcy, the light at the end of the tunnel is bleak at best.
For other cryptocurrency users, however, it may take some comfort to know that efforts are underway to provide stronger regulation to better protect investors.
Some of the legislative proposals are:
- Digital Goods Consumer Protection Act. This law gives the Commodity Futures Trading Commission (CFTC) jurisdiction over such digital assets.
- Responsible Finance Innovation Act. The law aims to provide a regulatory framework for digital asset markets and provide “appropriate jurisdictional boundaries” to protect consumers.
These two bills have some overlap. Still, experts say there will be more strides towards legislative and regulatory solutions to better protect cryptocurrency investors when the new parliament begins next year.