This week, investors learned a hard lesson when news emerged that one of the largest cryptocurrency exchanges in the United States, Coinbase, had declared in a U.S. Securities and Exchange Commission filing that its users’ crypto assets might one day not be their own in the event of bankruptcy.
“Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings, and such customers could be treated as our general unsecured creditors,” Coinbase said.
The company holds $256 billion in crypto and fiat, according to its SEC report ending in March. However, crypto holdings housed in Coinbase wallets do not come with FDIC insurance, as offered by insured banks when storing cash or securities.
Many traditional brokerages will not allow cash or securities to be claimed during bankruptcy, and Congress ensures that up to half a million of a customer’s cash or securities are protected.
With a potential Coinbase bankruptcy jeopardizing their crypto assets, however, investors’ alarm bells rang loudly this week. However, Coinbase CEO Brian Armstrong allayed the public by declaring there was no risk of the company facing bankruptcy: “Your funds are safe at Coinbase, just as they’ve always been,” Armstrong said. “We have no risk of bankruptcy.”
Travis Bott, CEO of Meta Labs Agency, told TheStreet Crypto that the disclosures helped customers better grasp the difference between insured custodial wallets versus self-custody wallets, which allow customers to preserve control over private keys.
“Customers in all markets should have the opportunity to receive the information regarding products and services they are using so they can make informed and educated decisions based on that information,” Bott said.
Recently, Coinbase disclosed that it had $430 million of losses in the first quarter of the year, along with a 19% drop in monthly users. Over the past week, Coinbase effectively lost half of its value, despite the fact that the company was anticipating an 8 cent per share profit.
Instead, the company’s shares dipped 79% this week, and trading volume also dropped to $309 billion, its lowest point in a year.
“We believe these market conditions are not permanent and we remain focused on the long-term,” Coinbase said. “We approach the opportunities ahead with confidence and steady hands.”
However, government officials are watching cryptocurrency’s dramatic slide this week closely, and warning of impending regulation. Last month, Treasury Secretary Janet Yellen said that the government was concerned about the impending risks: “Our regulatory frameworks should be designed to support responsible innovation while managing risks – especially those that could disrupt the financial system and economy.”
Even before the current crypto crash, officials warned about the perils of a custodial crypto wallet: “When you trade on a crypto exchange — and I’m saying this to the investors who might watch this — you no longer own your crypto asset,” SEC chairman Gary Gensler told The Wall Street Journal last year. “If that exchange gets hacked, if somebody steals the underlying token… You’re just a creditor. And when crypto exchanges fail, you’re just in line in bankruptcy court.”