Beleaguered Coinbase Crypto Exchange Warns Users That ‘Black Swan’ Bankruptcy Could Wipe Out Their Accounts

The nation’s largest cryptocurrency exchange said retail customers could find themselves at the back of a line of unsecured creditors in the event of a bankruptcy.

The mobile phone icon for the Coinbase app. AP/Richard Drew, file

Some of the 90 million people who use the largest cryptocurrency exchange in America, Coinbase, to trade and store their digital assets found an alarming easter egg buried in the company’s latest earnings report. 

Deep into the disappointing report — which caused Coinbase’s stock to plummet by as much as 30 percent Wednesday — was word that if the company were to go bankrupt, account holders could find themselves locked out of their accounts and the crypto stored in them lumped in with the rest of the company’s assets.

Retail account holders, according to the disclosure, could become “general unsecured creditors” in the event of a bankruptcy, and then find themselves at the back of the line of creditors seeking to recover their money.   

The disclosure is a reminder to crypto enthusiasts that they are trading in an asset that offers few of the legal and regulatory guardrails that cover assets at other institutions.

Bank accounts holding up to $250,000 U.S. dollars, for example, are protected by the Federal Deposit Insurance Corporation. Similarly, the Securities Investor Protection Corporation protects up to $500,000 worth of stock and bonds held at most major brokerage firms.

Multiple branches of the federal government are currently exploring more wide-ranging regulations for the relatively unchecked world of cryptocurrencies and have said they hope to have something finalized by the end of the year.

Coinbase’s CEO, Brian Armstrong, addressed what he described as “noise” about the new disclosure on Twitter late Tuesday.

Mr. Armstrong said that there is no risk of the company declaring bankruptcy, calling such a prospect a “black swan event,” and that the notice was included in the earnings report because of a new disclosure rule from the U.S. Securities and Exchange Commission for public companies that hold cryptocurrencies on behalf of customers.

Mr. Armstrong conceded, however, that because courts and regulators have yet to clarify many of the rules surrounding cryptocurrencies, “it is possible, however unlikely, that a court would decide to consider customer assets as part of the company in bankruptcy proceedings even if it harmed consumers.”

“We should have updated our retail terms sooner, and we didn’t communicate proactively when this risk disclosure was added,” Mr. Armstrong said. “Your funds are safe at Coinbase, just as they’ve always been.”

Users who open a crypto account at Coinbase are, unless they opt for a self-custodial wallet, storing their assets in a wallet owned and controlled by Coinbase, which explains how those assets could be viewed as belonging to the company from a legal perspective in the event of a bankruptcy.

Along with the rest of the cryptocurrency markets, Coinbase has seen rough sailing in recent days.

In its earnings report released after the market closed Tuesday, the company said it saw a decline in the number of customers and a net loss of $430 million in the first quarter of 2022. It also said trading volume dipped to $309 billion from $547 billion during the quarter, and warned it was still declining in the second quarter.

Coinbase’s stock, which made its debut in April 2021 at $381 a share, dropped as low as $50 a share on Wednesday, a decline of 85 percent. Bitcoin, the main cryptocurrency, has also declined precipitously in recent days, trading at less than $30,000 on Wednesday, a decline of more than 50 percent from its all-time highs in November last year.

The New York Sun

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