When A Crypto Exchange Becomes Bankrupt – What Truly Happens?
Exchanges play a vital role in the cryptocurrency ecosystem. Interestingly, a lot of people do not know what happens when a cryptocurrency exchange goes bankrupt. Since June, several cryptocurrency exchanges have suspended their trading due to volatile market conditions. Celsius, a crypto-lending firm, stopped users from trading, transferring, and withdrawing in June 2022. Other exchanges like Vauld, CoinLoan, Voyager Digital, and CoinFLEX also did the same.
Over the past months, the crash that began in May has further intensified. It has further led to liquidity inadequacy among cryptocurrency exchanges. This volatility raises a fundamental question that this article seeks to answer.
What Happens When A Cryptocurrency Exchange Goes Bankrupt?
The biggest drawback of cryptocurrency is its inherent risk of loss. This naturally becomes exponentially more challenging to manage when a crypto company holds your coins. For example, the cryptocurrency exchange FTX experienced a severe liquidity crisis in November 2022, leading to a Chapter 11 bankruptcy filing. Two of the most prominent cryptocurrency exchanges, Voyager and Celsius, filed for bankruptcy in July 2022. Nonetheless, what does this imply for traders?
To begin, when a cryptocurrency exchange goes bankrupt, its customers’ funds are frozen. The bankruptcy circumstances of crypto exchanges like Voyager and Celsius’s illustrate the particular dangers that cryptocurrency owners and investors take on when trusting exchanges with their money. Users/investors were unable to access their cryptocurrency holdings on these exchanges. Therefore, users of any cryptocurrency should carefully weigh the benefits and drawbacks of their chosen exchange or lending platform.
In a bankruptcy case, the court gives the final order of who gets paid out of the remaining assets. To achieve this, the bankrupt firm must submit a comprehensive inventory of its assets, liabilities, and other financial statements and reports. This is where the bankruptcy judge, the company, and the lawyers come in to sort out who gets what.
Is My Crypto Safe When A Cryptocurrency Exchange Goes Bankrupt?
In contrast to conventional fiat currency transactions involving an intermediary (such as a bank or other financial institution), cryptocurrency transactions occur directly between the recipient and the sender. So, even if you use a crypto wallet provided by your exchange or an external wallet to store your assets, there is no guarantee that your cryptocurrencies will be safe in the event of a disaster like bankruptcy. The Federal Deposit Insurance Corporation will never insure a cryptocurrency investor’s funds, despite misleading advertising saying otherwise. When a traditional bank goes under, depositors can rest easy knowing the FDIC protects their money. However, this does not apply to crypto.
Users whose crypto assets are stored in a custodial wallet stand the least chance of getting their money back if the cryptocurrency exchange goes bankrupt. Those who keep their digital currencies in non-custodial wallets where they retain control of the private keys will not be impacted.
How Can I Protect My Crypto?
Investors have the option of taking their cryptocurrency holdings off of a trading platform and storing them in private wallets. Here, each user must keep the secret password or private key to their cryptocurrency wallet safe and secure. The truth is that doing so is not without its dangers. A crypto owner’s funds may be permanently lost if they misplace their private key. However, where the cryptocurrency itself has lost its value, you may end up owning nothing.
The key takeaway is that if you use a cryptocurrency exchange, you run the risk of becoming a general unsecured creditor of the exchange if it ever goes bankrupt. Your claim of “ownership” of the currency, as stated in the exchange’s contract with you, is irrelevant. Nevertheless, if you are connected with a bankrupt crypto company, keep a close eye on your email and mail for advice on how to make a claim and recover as much of your money as possible.