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Cryptocurrency is known for being a risky investment, and your assets aren’t insured the way they are with a bank or brokerage firm.
Truth be told, you’re never immune to losses with a risk-on asset. Just speak to all the cryptocurrency users who learned the hard way this year after several high-profile crypto bankruptcies.
Investors were reminded that while their 401(k) plans or individual retirement accounts (IRAs) are guaranteed certain levels of protection. For the most part, these protections don’t extend to crypto accounts.
What Kind of Protection Is There for Crypto Accounts?
If your crypto assets are held by a crypto firm that files for bankruptcy, you could be out of luck. Crypto investors with accounts on Coinbase were told exactly that in May when the crypto exchange began to experience a liquidity crisis.
“Legal protections have not been tested in court for crypto assets specifically, and it is possible, however unlikely, that a court would decide to consider customer assets as part of the company in bankruptcy proceedings,” Coinbase CEO Brian Armstrong said in a May 10 tweet.
A statement like this implies that crypto customers may be treated as unsecured creditors by a bankruptcy court and be on the hook for losing their assets.
Users of underwater crypto firms are now rudely awakened to the fact that they do not hold legal titles to the digital assets in their crypto accounts amid the various crypto scandals from BlockFi’s bankruptcy to FTX’s November implosion.
In most instances, such as with the crypto firm Celsius’s bankruptcy in June, users only have a contract right to be paid back plus a return, says Manny Grillo, a partner at Allen & Overy’s restructuring practice who represents troubled companies.
“In the Celsius case, the bankruptcy court just held that even those accounts that were believed to be custodial accounts, in which investors retained title to their assets, had only been converted from ‘earn’ accounts to ‘custodial’ accounts and so, holders of such custodial accounts cannot pull 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 users are opting to migrate their assets from crypto exchanges to non-custodial wallets to protect their holdings as they realize certain protections don’t 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 that users thought they had and what they have. Some crypto investors thought their crypto accounts would work similarly to a traditional bank account, with Federal Deposit Insurance Corp. (FDIC) insurance and protections, but this isn’t the case.
Due to a lack of regulatory oversight, crypto accounts, for the most part, fall outside the protective purview of the federal government. Moreover, the regulatory framework for legal definitions surrounding cryptocurrencies is still being worked out.
Securities Investor Protection Corp. (SIPC)
SIPC protects consumers from brokerage firm failures. Some big names among brokerage firms include Ameritrade, Fidelity, and E-Trade, among others.
If a SIPC member firm fails, its customers can file a claim with the SIPC to be reimbursed for up to $500,000, including up to $250,000 of cash in your account. You can view a list of SIPC member firms on the organization’s website, but you won’t find most cryptocurrency exchanges on that list.
Although you might notice that eToro and Robinhood are listed as SIPC members because of their brokerage products.
Robinhood even has this disclaimer on its website, “Cryptocurrency investments through Robinhood Crypto are not protected by SIPC and that Robinhood Crypto is not a member of FINRA or SIPC.”
The company has made it clear that protection for its brokerage arm is separate from Robinhood Crypto.
Blake Harris, founding principal at Blake Harris Law, where he assists clients worldwide with asset protection, says, “It only seems to be consistent that the government would not facilitate the cryptocurrency industry by allowing cryptocurrencies to be covered by SIPC.”
Federal Deposit Insurance Corp. (FDIC)
The FDIC is like the SIPC for banks and savings institutions. It insures deposits and ensures institutions are sound with adequate consumer protections.
Like with the SIPC, if your FDIC-insured institution fails, you’re covered for up to at least $250,000 per depositor at each FDIC-insured bank. You don’t need to do anything to get this protection, and in the unlikely event of a bank failure, you can generally expect repayment from the FDIC within a few days.
You can use the FDIC’s BankFind tool to determine if your bank is FDIC-insured but you’ll be hard-pressed to find names like Binance or Kraken listed here.
That’s because the FDIC does not insure crypto exchanges or cover cryptocurrency. The FDIC has even issued letters to crypto sites instructing them to take down misleading statements that allude to FDIC protection.
Other Insurance Protections
Without federal protections, the only protections crypto users have are the ones they put on themselves, Michael Giusti, InsuranceQuotes.com analyst.
“One of the protections people can get includes private insurance policies on the coins. But unless those policies were already in place before the bankruptcy, coin holders would be out of luck.”
He says these policies usually cover theft, loss of access, business risk and decentralized finance (DeFi) coverage.
Theft means if an unauthorized party steals your coins. Loss of access coverage would protect you if you lose your keys, wallet or ability to access your coins.
“Business risk policies are similar to any other business’ risks policies—such as errors and omissions coverage for cryptocurrency company officers,” Giusti says. “And decentralized finance or DeFi coverage protects the underlying technology—typically the blockchain—if it were to fail to perform in the ways it is expected.”
But it would be best if you always read all the print—fine and otherwise—before purchasing a policy. Some insurance is there to help protect the customers, while other insurance may be a marketing gimmick to give you the illusion of safety.
Prospective buyers should ensure they know the amount of coverage, exclusions and stability of the company writing the policy.
Most experts agree that the best insurance is just 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 files for bankruptcy, there’s not much you can do beyond getting in line for repayments if and when they come—and “when” is often measured in years, not days or weeks.
“Bankruptcy cases like these typically have two acts,” Grillo says. Act one is “the collection and valuation of assets from all of the various sources and historic transactions from which they may be recoverable. And second (is) the liquidation or fixing of the claims against those assets followed by distributions.”
In complex cases like those facing crypto exchanges, he says these two acts could take years, pointing out that historic investment vehicle cases like the Madoff cases resulted in significant distributions to investors but took 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 efforts are underway to provide greater regulation that could foster stronger protections for investors.
A few of the legislative proposals include:
- The Digital Commodities Consumer Protection Act. The legislation would give the Commodity Futures Trading Commission (CFTC) jurisdiction over such digital assets.
- The Responsible Financial Innovation Act. The act aims to provide a regulatory framework for the digital asset market and provide “appropriate jurisdictional boundaries” to protect consumers.
There is some overlap between these two bills. Still, experts say that when the new Congress starts next year, there will be more progress toward a legislative and regulatory solution to increase protections for crypto investors.