A Securities and 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 were ever to file for bankruptcy. In an SEC Form 10-Q filed in May, Coinbase disclosed that, in bankruptcy proceedings, more than $250 billion in custodial fiat and cryptocurrencies it holds on behalf of its customers could potentially be included in the equity of bankruptcy, and your clients could be dealt with. as general unsecured creditors. The disclosure further states that some of Coinbase’s customer contracts do not limit its liability with respect to security breaches, and that insurance is limited and may not cover the extent of losses or the nature of certain losses, which could result in Coinbase facing liability for losses that exceed its assets. If this were to happen, Coinbase customers using Coinbase custody services could be left without some or all of their cryptocurrency investments in the event of bankruptcy.
The disclosure is likely to be alarming to many Coinbase customers, especially at a time when the company’s financial results are in decline due to what the SEC filing described as “softer market conditions” and Coinbase’s commitment to invest a lot 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 is not at risk of bankruptcy and that the disclosures were in response to a new SEC Staff Accounting Bulletin, SAB 121. The bulletin advises crypto asset holders to provide a disclosure describing the “legal ownership of cryptography”. -Assets held for users of the platform, including whether they would be available to satisfy general creditor claims in the event of bankruptcy. . . .”
Regardless, both the SEC staff bulletin and the 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 exceptions that exist for other financial markets, and federal regulation is lacking. Specifically, the question of whether customer coins are held in custody by a cryptocurrency exchange has yet to be addressed by any bankruptcy court. With the monumental rise of cryptocurrencies and cryptocurrency services in recent years, the possibility of a cryptocurrency exchange going bankrupt in the near future does not seem impossible, even if cryptocurrencies themselves are here to stay.
- SEC Form 10-Q Filing: https://www.sec.gov/Archives/edgar/data/0001679788/000167978822000048/coin-20220331.htm
- SEC Bulletin: https://www.sec.gov/oca/staff-accounting-bulletin-121
- CEO Brian Armstrong’s tweet: https://twitter.com/brian_armstrong/status/1524233480040710144?cxt=HHwWgICsyceRlacqAAAA