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Is Your Cryptocurrency Safe if Your Crypto Exchange Files for Bankruptcy?

Written by John Stoddard on May 26, 2022 Category: Banking, Business Law & Transactions, Firm News
Cryptocurrency has been around for almost 15 years, and it keeps landing in the headlines—but not always for good reasons. Now, crypto owners are worried about exchange bankruptcies.
Most crypto owners hold their assets in custodial wallets, or on an exchange. This is because the customer doesn’t have to worry about managing and preserving the private key—in essence a long, elaborate password—that unlocks the assets.
If an exchange holds the cryptocurrency, isn’t the customer protected? You know, like how the SIPC protects an investment when a brokerage goes under, or how the FDIC protects up to $250,000 in the event of a bank failure. Unfortunately, no. Not at all.
Coinbase Global, the nation’s largest crypto exchange, recently reported dismal earnings for the first quarter of 2022. It lost $430 million and nearly twenty percent of its monthly users.
Although its CEO tried to reassure its customers and investors that there is no risk of bankruptcy, the earnings report included some disturbing information. Coinbase acknowledged that crypto assets it holds in custody for its customers could be subject to bankruptcy proceedings, where those assets could be considered property of the bankruptcy estate.
The customers, who probably believe they are the “owners” of the assets, would be relegated to general unsecured creditor status. In other words, they would be out of luck, and they would be the last to be paid—if at all.
This is all hypothetical, of course, for now. Cryptocurrency exchanges have collapsed or failed in Japan, New Zealand, and Australia, but not in the United States. And we can’t predict with certainty how a bankruptcy court would interpret a custodial agreement.
However, the Coinbase acknowledgement and a basic understanding of the broad scope of 11 USC § 541, defining property of the bankruptcy estate, is cause for concern.
Upon filing bankruptcy, all legal or equitable interests of the debtor in property are considered property of the estate. So are any transfers avoided and recovered by a bankruptcy trustee, such as preferences and fraudulent transfers.
Call us at Dalton & Tomich if you have any questions surrounding a potential or actual bankruptcy filing that may affect you—whether it’s your crypto exchange or the supplier you just paid.

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