What happens to my funds if a cryptocurrency exchange goes bankrupt?

What happens to my funds if a cryptocurrency exchange goes bankrupt?
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Bankruptcy filings from Celsius and Voyager have raised questions about what happens to investors with crypto when a platform fails.

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Traders hoping to get their funds back from failed cryptocurrency exchanges soon are likely to be disappointed, legal experts told CNBC.

Celsius and Voyager Digital crypto trading and lending firms filed for bankruptcy this month has left users’ assets locked up on their platforms. Both firms froze customer accounts which led to liquidity problems after the outflow of withdrawals.

Celsi operated as a bank, taking deposits from customers and lending them out, or taking risky gambles with decentralized financial products for high returns.

Voyager had a similar model. The company was hit by the bankruptcy of Three Arrows Capital, a high-profile cryptocurrency fund that defaulted on a $660 million loan from Voyager.

This kind of interaction has left the cryptocurrency market susceptible to infectionwith major firms falling like dominoes, the drop in token prices removed excessive leverage in the system.

Is my crypto safe?

Cryptocurrencies are unregulated, meaning they don’t offer people the same protections they get with money held in a bank or stock in a brokerage firm.

For example, the US Securities Investor Protection Corporation insures up to $500,000 in cash and securities to traders if a member broker experiences financial distress.

The Federal Deposit Insurance Corporation offers bank depositors up to $250,000 in protection if an insured lender fails.

Similar schemes exist in the UK and the European Union.

Since there are no laws governing cryptoassets, there is no guarantee that investors will be able to get their funds back if an exchange freezes someone’s account, or worse, collapses entirely.

“There is currently no such scheme,” said Loeb & Loeb partner Daniel Besikoff for crypto.

“It wouldn’t surprise me if that happens,” he said. “This will increase calls for improved regulation.”

What if the exchange fails?

For now, it’s still not entirely clear. While there are examples of crypto firms filing for bankruptcy overseas – Mt. For example, Gox in Japan – such an event is unprecedented in the United States

Creditors of Mt. Gox, which went offline in 2014, is still awaiting the return of billions of dollars worth of cryptocurrency.

According to Daniel Saval, a lawyer at Kobre & Kim, the problem with centralized cryptocurrencies is that funds from different clients can be mixed to make risky bets. Such mixing can result in judgments that the assets are owned by the exchange rather than the users.

“Users may be surprised to learn that crypto and cash held in their accounts may not be considered their property in a bankruptcy scenario,” Saval says.

“Exchanges will often combine cryptocurrency and funds from different customers in the same storage wallet or account.”

Read more about technology and cryptocurrency from CNBC Pro

What happens to customers’ funds in the event of bankruptcy will depend heavily on the company’s user agreement and how they use their assets, Besikof said.

Celsius’ rules of use state that any funds invested in the firm are “irrecoverable” in bankruptcy. The firm filed for Chapter 11 protection last week, revealing a $1.2 billion hole in its balance sheet and about $4.7 billion owed to users.

Celsius claims to have $167 million in cash on hand. However, it still does not allow customers to withdraw their funds and is unclear when withdrawals will reopen.

Voyager says its customers’ dollars are held in an FDIC-insured account at Metropolitan Commercial Bank in New York, but, this claim was contested by legal experts and the bank itself. The FDIC only offers protection of funds in the event of a bank failure, not cryptocurrency exchanges.

For its part, Voyager says it is working with its banking partner on a “reconciliation and fraud prevention process” before users can regain access to their cash.

Voyager also announced a plan to repay users with cryptocurrency in their accounts, Voyager shares and the company’s own token, as well as any debt received from Three Arrows Capital.

Both Celsius and Voyager hired the prestigious law firm Kirkland & Ellis to represent them in court.

“Investors holding crypto assets through Voyager Digital and now Celsius are in dire straits, with accounts frozen, claims suspended, and the cost and timing of any recovery unknown,” Besikof said.

“Until these issues are resolved, they have a lot of work to do in bankruptcy court.”

Celsius and Voyager filed for what’s known as Chapter 11, a form of bankruptcy protection that allows firms to restructure their debt. The goal is to ensure that there is still a viable business by the end of the process.

Users of Celsius and Voyager are likely to be treated as “unsecured creditors,” a classification that legal experts say puts them in the same bucket as a business’s suppliers and contractors.

That means they will probably be there the back of the long tail behind creditors – banks, employees and tax authorities – who are queuing up for payment from the court process.

in May regulatory filingCoinbase said its users would be treated as “general unsecured creditors” in the event of bankruptcy.

“In general, the majority of customers in cryptocurrency exchanges are unsecured creditors, so when an exchange fails, secured creditors are paid back first, along with legal fees,” said Dustin Palmer, managing director of consulting firm Berkeley Research Group. “Customers will be paid last on a pro rata basis. In a typical bankruptcy, it’s pennies on the dollar.”

“Clients will likely have to wait until the full bankruptcy process is completed before receiving a reward, and bankruptcy typically takes years,” Palmer added. “Lehman took years. For example, some Mt. Gox customers still haven’t received any rewards.”

Saval added that recovery for customers in bankruptcy proceedings “may be further reduced by other unsecured creditors such as vendors, lessors and claimants.”

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