Uncharted Waters: Bankrupt Crypto Exchange Assets | Nelson Mullins Riley & Scarborough LLP

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A Securities Exchange Commission disclosure filed by popular cryptocurrency exchange Coinbase has shed light on the question of what would happen if Coinbase or a similar cryptocurrency exchange files for bankruptcy protection. In an SEC 10-Q form filed in May, Coinbase disclosed that, under bankruptcy proceedings, more than $250 billion in fiat and cryptocurrencies held on behalf of its customers could potentially be included in the bankruptcy estate, and its customers could be dealt with. as general unsecured creditors. The disclosure further provides that some of Coinbase’s customer contracts do not limit its liability for security breaches, and that insurance is limited and may not cover the extent of losses or the nature of certain losses. which could expose Coinbase to liability for losses that exceed its assets. If this were to happen, Coinbase customers who use Coinbase’s custodial services could lose some or all of their cryptocurrency investments in the event of bankruptcy.

The disclosure is likely alarming to many Coinbase customers, especially at a time when the company’s financial results are down due to what the SEC filing describes as “softer market conditions” and the Coinbase’s commitment to invest heavily this year. In the same report, Coinbase announced a net loss of nearly $430 million for the quarter. Coinbase CEO Brian Armstrong said in a tweet that Coinbase has no risk of bankruptcy and the disclosures were in response to a new SEC staff accounting bulletin, SAB 121. The bulletin advises holders of crypto assets to provide a disclosure describing “legal ownership of crypto.” -assets held for platform users, including whether they would be available to satisfy general creditor claims in the event of bankruptcy. . . .”

Either way, the SEC staff bulletin and Coinbase disclosure draw attention to the uncertain legal landscape surrounding cryptocurrency exchanges and how their assets would be treated in bankruptcy proceedings. Due to the newness of the cryptocurrency market, bankruptcy priority laws do not contain certain exclusions that exist for other financial markets, and federal regulation is lacking. Specifically, the issue of whether customer currencies held on deposit by a cryptocurrency exchange has yet to be addressed by a bankruptcy court. With the monumental rise of cryptocurrencies and cryptocurrency services over the past few years, the possibility of a cryptocurrency exchange going bankrupt in the near future does not seem impossible, even if the crypto itself is here to stay.

Sources:

  1. Filing of SEC 10-Q form: https://www.sec.gov/Archives/edgar/data/0001679788/000167978822000048/coin-20220331.htm
  2. SEC Bulletin: https://www.sec.gov/oca/staff-accounting-bulletin-121
  3. Tweet from CEO Brian Armstrong: https://twitter.com/brian_armstrong/status/1524233480040710144?cxt=HHwWgICsyceRlacqAAAA

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