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May 26, 2022

Coinbase regulatory filing highlights the risks associated with crypto again

Following the announcement of its first-quarter results, shares in cryptocurrency exchange Coinbase, the largest US cryptocurrency exchange, fell 23 percent. However, attention was quickly shifted to a regulatory filing reported on the same day.

The filing by Coinbase revealed that users may lose access to the cryptocurrencies stored in their accounts if the company was to enter bankruptcy proceedings. Coinbase said that “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.”

Alarm for Coinbase users

Naturally, this caused great alarm for Coinbase users who fear that their funds are not safe. By the end of Q1, Coinbase held $256 billion in cash and cryptocurrencies for its customers. CEO Brian Armstrong assured users on Twitter that Coinbase has no risk of bankruptcy and that the filing is simply a new requirement of the US Securities and Exchange Commission called SAB 121. Public companies must regularly disclose extensive amounts of information related to their business to aid investors in understanding the full risks involved with their investments.

If users are treated as unsecured creditors in the case of an insolvency proceeding, they would be prevented from selling or exchanging their coins due to the automatic stay imposed on creditors. Unsecured creditors are typically the last to recover money and users would need to fill out and file extensive paperwork demanding what they are owed.

Regulating crypto

Regulators have long warned users about the lack of oversight and protection granted by cryptocurrency trading platforms. Unlike securities held for customers by a registered brokerage—which are legally segregated from the assets of the brokerage—crypto assets held on behalf of users by trading platforms may be subject to bankruptcy proceedings. Crypto is not considered a security and so does not carry the coverage built into traditional financial services, which are covered by the Securities Investor Protection Corporation (SIPC).

Armstrong wrote in his series of tweets that “this disclosure makes sense in that these legal protections have not been tested in court for crypto assets specifically.” This highlights how a lack of regulation within decentralized systems coupled with a lack of precedent regarding a cryptocurrency exchange bankruptcy in court will continue to create uncertainty for users.

In the US, the Biden administration has been calling for Congress to include regulations for cryptocurrency exchanges. An Executive Order was released by President Biden back in March of this year that acknowledged the potential of the technology behind crypto and the innovation it offers, as well as the risk that it can pose to consumers, investors, and businesses. Market watchers expect lawmakers to tighten cryptocurrency regulation in the years to come.

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