Ask CryptoVantage: What Happens if My Crypto Exchange Shuts Down?

The Whys and Hows of Exchange Shutdowns

Dozens of cryptocurrency exchanges have shut down since the industry’s inception in 2009. It’s hard to pinpoint how many, but the site Cryptowisser, which keeps tabs on this sort of thing, documented at least 75 exchange closures in 2020 alone. Coinjournal reported 23 exchange failures in 2018, with a staggering 252% increase in closures the following year.

These numbers illustrate the dynamic nature of the crypto landscape, where the fate of exchanges can change fast. Trading platforms can fail due to a variety of reasons, such as:

• Bankruptcy: A common cause of exchanges failing, bankruptcies are triggered by mismanagement, contagion effect, or security breaches. For example, FTX, previously a leading exchange, collapsed in 2022 due to mismanagement involving the diversion of customer funds to a sister company. Mt. Gox, once the largest Bitcoin marketplace, shuttered after losing 850,000 bitcoins due to security incidents. Additionally, Cryptopia, a New Zealand-based exchange, succumbed to a $16 million theft spree.
• Unforeseen events: Although rare, it’s not unheard of. An infamous example is Canadian exchange QuadrigaCX, whose unraveling began with the untimely passing of its CEO, who had sole control over the exchange’s private keys.
• Voluntary closure: Some exchanges may choose to wind things down due to reasons such as unfavorable market conditions, such as the Bitcoin-only exchange Localbitcoins, which didn’t recover from 2022’s bruising crypto winter.

What To Expect if Your Exchange Shutters

If you have money in a bank, you can take comfort in knowing there’s a safety net in case the bank folds. Many countries have deposit insurance schemes to cushion bank customers in these situations.

For instance, the US Federal Deposit Insurance Corporation (FDIC) provides insurance for bank deposits of up to $250,000 per depositor. Similarly, the Canada Deposit Insurance Corporation (CDIC) covers individual deposits for up to $100,000.

But in the case of crypto, you can easily lose your money if your exchange collapses, especially in bankruptcy. This is the reality for thousands of investors who have lost money after their exchange went down and are yet to recoup it. And yet, that you could lose money in such an event isn’t an obvious fact.

Coinbase

Take, for example, Coinbase’s statement in its first quarter earnings report. The company said crypto assets in an exchange could be deemed as “the property of a bankruptcy estate” and hence “subject to bankruptcy proceedings,” with the exchange’s customers likely to be treated as “general unsecured creditors.”

Many in the community were taken aback by this revelation, which suggested that customers, in the event of a bankruptcy, may have to wait forever to receive a portion of the remaining assets after the proceedings are concluded.

Worse, that portion would likely be a fraction or “pennies on the dollar,” of their original holdings, according to an expert in the field, Dustin Palmer, who CNBC interviewed for a feature on the subject.

Lawyer Robert Saval, also quoted for the story, said this would be because customer money would be “diluted by other unsecured creditors such as vendors, lessors, and litigation claimants.” On top of that, the exchange has to cover legal fees for the liquidation process.

Of course that does not mean that Coinbase is a bad exchange. In fact Coinbase is one of the most highly regarded exchanges in history and is often listed as one of the safest crypto exchanges. But it is worth noting that even the best crypto exchanges could be problematic in the event of a bankruptcy.

Managing Expectations

In addition, Palmer noted that the process takes years, like in the case of Mt. Gox, whose customers are yet to see their money nearly a decade after the firm filed for bankruptcy. Another illustration is Cryptopia, for which, four years on, there still isn’t a solid clue of when customers can expect to reclaim their funds.

This reality is one FTX customers had to confront following the collapse of the exchange. The Guardian interviewed some of those customers after the company’s collapse, with some lamenting, “I fully expect to lose it all”, “that’s gone,” or “I know that this money is gone.”