In the extremely volatile world of cryptos, companies turning worthless within days and investors losing their money overnight have become the norm. But what is more worrying is that investors are left with no redressal mechanism if the exchanges, where they park their funds, go bankrupt. In such an event, the value of all their crypto assets will literally become zero.
While no formal declaration in this regard has been made by Indian crypto exchanges, Coinbase, one of the largest international exchanges, recently gave a scare by declaring that investors’ cryptocurrency assets may not be their own in the event of bankruptcy.
“Since 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 declared in a US Securities and Exchange Commission filing recently. That statement indicates the difference between storing funds in banks and blockchain-based crypto exchanges.
Investors at the mercy of CEX
Investors generally keep their funds in custodial wallets provided by various centralised crypto exchanges (CEX). They do this for quick access to their funds for trading and to avoid paying various associated fees for transferring money from bank accounts to these exchange wallets. However, unlike bank deposits that come with some guarantee, these exchanges are not legally bound to return investors’ assets.
Notwithstanding the tall claims made by these exchanges with regard to safety of assets parked in their wallets, time and again it has been proven that investors are at the mercy of these CEXs. The most recent example of this is delisting of Terra (LUNA) by many exchanges.
“Centralised Crypto Exchanges (CEX) are like a company only. Their business model gives ease of trading by holding consumers’ money in their systems. CEX works like a bank account or as a custodian where a customer needs to trust and rely on them that their money is safe. But it is not controlled by a centralised bank such as RBI, which protects the bank’s deposits for its customers,” says Dileep Seinberg, founder and CEO of MuffinPay, a crypto fintech company.
Technically, a CEX has control over investors’ funds and crypto assets. Like any other company, if it files for bankruptcy, all the help and holdings are lost.
“Crypto investors who choose to avail crypto-custody provided by exchanges are at risk of losing their crypto assets if the exchanges file for bankruptcy,” says Sharat Chandra, VP, Research and Strategy at blockchain-based identity management platform EarthID.
Currently, there is no regulation in India to protect customers’ money from crypto exchanges owned by private entities.
What should customers do
Citing a common refrain in the crypto-community “Not your keys, not your coins”, Chandra suggests it is better to hold crypto assets in self-hosted or non-custodial offline wallets. “Access to private keys of digital assets is a crucial aspect here. Investors who hold their assets in self-hosted or non-custodial wallets shouldn’t be wary of exchanges going bust because the custody of their assets rests with them,” he says.
Seinberg says it is always safe to hold crypto in your wallets like hardware or in decentralised exchanges, which are independent of the central authorities. “For example, if you could have held LUNA in your wallet, it does not get delisted; it simply shows the value as zero. But it never disappears. If it gets back to its system, you will be able to swap Luna or access it without anyone’s approval,” he says.
Points to Remember
* Hold your crypto in non-custodial, hardware wallets
* Always remember— not your keys, not your coins
* No rules to protect customers from private exchanges
* Investors can lose crypto parked with exchanges in case of bankruptcy
* Exchanges have control over investors’ funds and crypto assets
(Cryptos and other virtual digital assets are unregulated in India. They are considered extremely risky for investment. Please consult your financial advisor before making any investment decision)