How Does a Crypto Company Bankruptcy Affect Investors?

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The major downside to cryptocurrency is the risk of loss, which is even more difficult to manage when a crypto company is holding your coins. In July 2022, Voyager and Celsius, the two major crypto trading platforms declared bankruptcy. But what does that mean for investors?

Key Takeaways

  • Cryptocurrency users have limited recourse if the cryptocurrency company they use goes bankrupt.
  • After the bankruptcies of crypto firms Celsius and Voyager, investors have a reason for concern.
  • Cryptocurrency holdings are not protected by government-backed insurance.

Bankruptcies Leave Crypto Investors Unable to Withdraw

The bankruptcy of Voyager and Celsius highlights the unique risks cryptocurrency holders and investors face when trusting crypto firms with their funds. These two incidents alone could lead to well over $1 billion in investor losses.

Voyager filed for Chapter 11 bankruptcy protection on July 1, 2022. The company said customers should get all United States dollar deposits returned but can’t say what portion of their crypto holdings will be returned to customers. It claimed it held $1.3 billion in customer crypto assets on its platform as of the bankruptcy filing.

Celsius Network, a large cryptocurrency lending platform, filed for bankruptcy protection on July 13, about a month after pausing all withdrawals, swaps, and transfers between customer accounts. In a filing with the United States Bankruptcy Court in New York, Celsius shared that it owes roughly $1.2 billion more than it has on hand.

With Voyager and Celsius customers unable to withdraw their cryptocurrency assets, it’s important for cryptocurrency users everywhere to consider any risks of the exchange or lending platform they’re using, if applicable.

Cryptocurrency is Not FDIC Insured

While confusing marketing messages have led investors to believe otherwise, cryptocurrency holdings are never FDIC (Federal Deposit Insurance Corporation) insured. If a bank fails, this agency insures deposits.

Investors should know that if the crypto exchange goes out of business, no government agency will make them whole. That’s different from a bank, where the government insures funds up to account and institution limits.

The FDIC has gone so far as to require any member banks and financial institutions that engage in any activities related to cryptocurrencies to disclose that activity to the FDIC for supervisory feedback.

Stablecoins, a category of cryptocurrency always pegged to a national, government-backed fiat currency, also fall outside FDIC insurance coverage. As holders of the TerraUSD stablecoin experienced, those currency pegs are not always viable.

Who Gets Priority During a Bankruptcy?

During Chapter 11 bankruptcy proceedings, there’s a clear chain of who gets paid for the remaining assets. Even if a company owes $1 billion more than it has in assets, investors may not be left empty-handed.

Under Chapter 11, the bankrupt company must produce a detailed schedule of assets and liabilities, among other financial statements and reports. During the bankruptcy process, the company, lawyers, and a bankruptcy judge work to figure out who gets what.

The legal code states that, in general, the first payments are made to secured creditors. Once those obligations are met, funds go to repay debts to unsecured creditors. Investors are nearly last in line when it comes to recovering their assets.

When the pool of assets to be returned to individual investors is calculated, everyone is notified of the pro-rata share they will receive. If the company owes $100 million to customers and has $90 million left after paying off debt, customers would get approximately 90% of their deposits returned.

How to Recover Funds from a Bankrupt Cryptocurrency Company

If you followed know your customer (KYC) requirements and created your account with legitimate information, the crypto company should have your contact information and an accounting of what you’re owed on file. If the company goes bankrupt, you should ideally hear from them right away with information on recovering funds.

Most companies will employ their own process to distribute funds to customers. That may require you to follow up by completing forms, confirming your address or payment information, and keeping up with any other necessary paperwork to get your crypto or cash returned.

While there’s a risk cryptocurrency investors could get no money or crypto back after bankruptcy, there’s also a chance they will get something back, even if it’s just a portion of their original investment returned.

Are Cryptocurrencies Backed by Other Assets?

How Do Stablecoins Work?

Stablecoins are a cryptocurrency asset class designed always to be worth the same amount relative to an underlying asset, like the United States dollar, euro, or physical gold. Asset-backed stablecoins, such as USD Coin and Gemini dollar, issue new currency only when new dollar-backed assets are deposited to the backing account. Algorithmic stablecoins use other methods to maintain the pegged value and don’t rely on underlying assets for value.

Are Cryptocurrencies a Good Investment?

Cryptocurrencies are a relatively new asset with an unproven track record. While it’s possible values could go up significantly in the future, they could also fall to zero. It’s up to each investor to decide if cryptocurrencies make sense for their financial goals and investment strategy.

The Bottom Line

A bankruptcy at any financial institution you work with can be stressful, confusing, and costly. In the cryptocurrency industry, customer confusion and losses and be even worse. But rather than panic, it’s best to let the bankruptcy process pan out to find exactly what you’ll get back.

If you find yourself involved with a bankrupt crypto company, keep close tabs on your inbox and mailbox for information on how you can file a claim and get as much of your money back as possible.