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What to do when crypto exchanges go bankrupt

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What to do when crypto exchanges go bankrupt

What to do when crypto exchanges go bankrupt

Wed Jan 25 2023 09:00:00 GMT+0000 (Coordinated Universal Time)

'Bankruptcy' is plaguing the crypto sphere today. One after another, crypto exchanges going bankrupt are seen all over the news. First, there was FTX, one of the biggest exchanges in the industry per market capitalisation, and then came platforms like Voyager Digital and Celcius filing for bankruptcy. Fear is settling into the minds of crypto investors, and now they're looking for answers on how they can secure their assets amidst crypto going bankrupt. 


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How can people profit from crypto when the very platforms that should be helping them are filing for Chapter 11? Crypto investors are now growing uneasy, not knowing what the future holds for crypto anymore. Many are now asking what to do if the worst-case scenario becomes a reality when bankrupt crypto companies become the norm. 

The fact is, your crypto is not protected when bankruptcy comes calling, but there are ways to keep your crypto safe. Learn more about bankrupt crypto exchange and what you can do when this happens here at Bitcasino. 

Crypto exchange collapse: Why it happens

On the news, you'll hear about crypto exchanges out of business like FTX and BlockFi. These bankrupt crypto exchanges have rocked the crypto world because there seems to be a risk for the assets investors store within the platform

So why do bankrupt crypto exchanges keep surfacing today? It can be because of careless investment ventures and even the dip in prices of top crypto coins today like Bitcoin and Ethereum

Moreover, there's also the case of regulationCryptocurrency exchange platforms are not yet strictly regulated by government bodies like the Securities Exchange Commission (SEC). The absence of regulations led crypto exchanges to operate on risky models that led to liquidity problems, thus resulting in coin bankruptcy. Contrary to this, new crypto regulations, especially in the United States, cause exchanges to be suspended since they were deemed not following government regulations of their jurisdiction. 

What's more concerning is that users' assets on the platform are not insured by the Federal Deposit Insurance Corp (FDIC). When banks go bankrupt, the FDIC insures the deposits of users. The same cannot be said for crypto investors with their investments. 

What happens when crypto exchanges go bankrupt?

Cryptocurrencies aren't federally protected and insured, unlike deposits you make in your bank. Even though crypto is decentralised, exchanges are still intermediaries controlled by a central authority. However, no regulations exist, so the government can't ensure that your assets are protected. 

That's why in bankrupt crypto events like in FTX, there's no way to assure that your funds will be returned to you. The government cannot step in to help you recoup your investments in a cryptocurrency exchange since there is no regulatory framework. 

Suppose a crypto exchange files for bankruptcy, the return of your funds is ultimately up to the discretion of the individual platform, especially if it's centralised. They hold custody of your wallet, and when the crypto exchange goes bankrupt, your assets are frozen even though you have a contract with the platform upon signing up. This means you won't be able to withdraw the funds from your custodial wallet. 

Luckily, this won't be a problem for non-custodial wallets since you have sole ownership of your private keys. The main investors affected by this are those who opted for custodial wallets of the exchanges. 


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Crypto exchange bankruptcies: Can you get paid back your investments?

crypto exchange that went bankrupt will likely face Chapter 11 debtors' rules on debtor-creditor recovery. There will be a clear chain of who gets paid with the assets that a cryptocurrency exchange bankrupt company has left. 

Under chapter 11, the insolvent crypto exchange must produce a detailed schedule of assets and liabilities along with other financial statements and reports. While the process is ongoing, the company, lawyers and bankruptcy judge will decide who gets what. 

In the legal code, the payments will be made to secured creditors first. When those obligations are met, unsecured creditors are paid their debts next with what's left of the assets. In general, investors are the last in line to get paid back their funds.

When the pool of assets is calculated, everyone will be notified of the pro rata share they receive. This means there will be a proportionate allocation of the assets based on the stakeholders' priority. 

This puts investors at risk during a crypto exchange collapse because there's no assurance that they'll get their money back after everything's been said and done. For example, a company owes $100 million to customers and has $20 million left to pay off the debts. Customers will only get 20% of their deposits returned because that's what's left from the assets after Chapter 11 was filed. 

Crypto company bankrupt: What crypto exchanges went bankrupt?

The year 2022 has been rough for the crypto industry. Not only did Bitcoin drop its value down to 65%, but gigantic exchanges like FTX went bankrupt just before the year ended. This is a step back from where crypto was during the pandemic in late 2021, when Bitcoin reached an all-time high of over $65,000 and stayed within the $50k-60k range for three months. 

As of January 2023, here are some of the crypto companies that went bankrupt:

  1. FTX exchange

major crypto platform that went bankrupt in November 2022 is FTX. This happened a week after a possible merger with rival crypto exchange Binance fell through. The collapse took place over a 10-day period which started on November 2. By November 11, the major crypto platform had announced that it had filed for bankruptcy after facing a liquidity crisis. 

A scoop from crypto news site CoinDesk revealed that Alameda Research, an affiliate of FTX, held a position valued at $5 billion in FTT, the native token of FTX. This prompted concern across the industry regarding the platform's undisclosed leverage and solvency. 

In the words of John Ray, the new CEO brought in to oversee the bankruptcy process of FTX, he has never seen such a complete failure of corporate controls.

  1. BlockFi

Two weeks after the collapse of FTX, BlockFi followed suit in filing for Chapter 11. The platform has several ties to FTX and has relied on the $400 million credit facility provided for them to stay afloat amidst the market turbulence of 2022. 

BlockFi previously said that it intends to ask a bankruptcy judge to allow some of the 450,000 users of the platform to withdraw their funds. These users who could withdraw funds should have a non-interest-bearing BlockFi wallet account. 

  1. Three Arrows Capital

Crypto hedge fund Three Arrows Capital (3AC) was the first major crypto firm that announces bankruptcy in 2022. It followed the collapse of the cryptocurrency Luna and stablecoin TerraUSD in May of the same year. 

The Singapore-based crypto company was reported to have $10 billion early in 2022, but it began bankruptcy proceedings in the British Virgin Islands as early as June. Those overseeing the 3AC liquidations said that the founders of the crypto company fled overseas and are uncooperative in efforts to recover creditors' assets. 

  1. Voyager Digital

New Jersey-based crypto lender Voyager Digital filed for bankruptcy in July 2022. This happened after 3AC defaulted on a crypto loan worth more than $650 million. The company hoped the bankruptcy proceedings would move quickly through the US court system, especially after selling its assets for $1.4 billion in crypto to FTX. 

However, the sale fell through following FTX's bankruptcy issue. Voyager had no choice but to file for bankruptcy and reopen discussions with potential buyers, including Binance exchange.

  1. Celsius Network

Celcius Network is another crypto lender brought down by the TerraUSD and Luna collapse. Its US bankruptcy case was much messier than Voyager's because the company was embroiled in countless disputes. This includes fraud investigations, disparate treatment of customer accounts, customer privacy and spending on a new Bitcoin mining facility. 

The bankruptcy judge assigned to Celsius' case appointed an examiner to investigate whether the company operated as a Ponzi scheme. The judge called for a broad review of the company's finances. 

Although Celsius welcomed the independent review of its finances, it still expressed concern over overlapping investigations made by its creditors, state security regulators and the bankruptcy examiner. 


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Crypto exchange goes bankrupt: How can you protect your crypto assets?

For now, it's not entirely clear what happens to your funds when a crypto company goes bankrupt. The security and protection of your assets will be in limbo once the exchange files for Chapter 11. But there are ways you can protect your crypto before such events happen. 

Exchanges allow you to store custodial assets in their built-in wallets, meaning that the specific exchange controls your private key. These are called hot wallets because you can access them anytime by opening your exchange account. However, there are other kinds of wallets you can opt for, especially now that bankruptcies are happening. Knowing the best crypto wallet can make or break the security of your assets. 

It's better to place your digital coins in cold, non-custodial wallets to protect them. With these wallets, you have full control over your private key. This means that in the event of the exchange filing for bankruptcy, you'll still be able to access your crypto because the exchange doesn't have custody of your assets. 

To know more about how you can better protect your assets in case of an exchange filing for bankruptcy, here's a list of the pros and cons of using hot and cold wallets:

Factors

Hot Wallet

Cold Wallet

Custody of private keys

The custody of your crypto assets goes to the exchange. This can be risky when the platform files for bankruptcy since you won't have control over your funds

The wallet is decentralised, and you have 100% control over your crypto through the private keys.

Asset storage

Stores your assets online, which is vulnerable to hacking and data breaches.

Stores your assets offline which lowers the risk of hacking and data breaches. 

Private key loss

There's no major effect when you lose your private keys because it'll be easy to regain access via the platform.

Losing private keys means you'll lose access to your crypto forever. 

Liquidity

You can easily trade crypto in the exchange after depositing.

Trading can be challenging because you have to wait for crypto to be deposited and the transaction to be confirmed. 

Private information

Exchanges will require you to fill up KYC processes and money laundering checks. 

All transactions are kept pseudonymous.

Crypto exchange files for bankruptcy: What do you do?

The question now is, what actions should investors make to safeguard their crypto assets? Even though the exchange isn't facing bankruptcy, every investor now should prepare for the worst to help save their assets. 

With that said, here are some actions you should take to ensure the security of your assets:

  1. Stay calm and act with a cool head

Making decisions while still emotional can lead to mistakes. Before you rush into the market in a panic, reflect on why you're trading with crypto. Ask yourself whether you're trading for long-term or short-term goals. This will guide you in making the right decision. 

  1. Make sure your coins are stored in a non-custodial wallet

Cold storage is a must. Relinquish the rights of the exchange over your assets and private keys, so you're the only one with access to your wallet. 

  1. Assess the situation and act accordingly

Bankruptcies of crypto exchanges are happening. It's the reality that the crypto sphere is facing today. Although not every exchange faces this sad reality, you still need to do things to ensure that your crypto is safe. With the current market trend, it's better to store your crypto in cold storage rather than let it sit on the exchange's built-in hot wallet just in case the worst happens.

  1. Evaluate the future

Analyse first the fundamental situation that could play out for crypto given the current developments. Will there be a widespread call for government regulation? Will these regulations help or hinder the cryptocurrency market? Browse through the news and developments regarding the crypto market and make your decisions from there. 


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The collapse of crypto exchanges: Is this the reality?

With the turmoil of the crypto market today, it's better to be safe than sorry. Although not all crypto exchanges face the threat of bankruptcy, you should safeguard your assets best. The only way for certain to have power over your coins is by moving them to cold storage wallets, wherein it's only you who have access to the private keys. 

FAQs about crypto exchange bankrupt

Can crypto go bankrupt?

The crypto coin itself can't go bankrupt, but its value can drop near zero. Moreover, the company that issued the coin has the possibility of going bankrupt, which can affect the coin's valuation. 

Which crypto exchange is the safest?

With the threat of bankruptcy, even the biggest exchanges can fold. That's why it's better not to place custody of your coins on a built-in exchange wallet. However, some exchanges offer non-custodial wallets where you can keep your private keys. Exchanges like these include Coinbase and Binance. 

Why not keep crypto on an exchange?

Built-in wallets of exchanges are called hot wallets. These are custodial wallets, meaning the exchange has access to your coins. If the exchange fails, your assets can be frozen if stored on the platform to prevent liquidity. 

Do you lose Bitcoins if an exchange goes bankrupt?

You don't lose your Bitcoins per se when an exchange goes bankrupt, but there's a high chance that the deposits you placed wouldn't be recovered. That's because the custody of your coins is with the exchange, and they are part of the company's assets. 

Words by: Sunday Carreon


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What to do when crypto exchanges go bankrupt