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Should Coinbase Users Be Worried About Losing Crypto in a Bankruptcy?

Coinbase has worried its users. Having released a Q1 earnings report that showed flagging earnings, the US-based crypto-exchange also included a disclosure in said report which suggested that it could treat its customers as “general unsecured creditors” in the event of bankruptcy. In other words, the exchange admitted that it might potentially use its customers’ crypto in order to pay off higher priority creditors (such as the entities which have bought nearly $3 billion in Coinbase’s corporate bonds), should it suffer some kind of financial collapse.

Given just how volatile the cryptocurrency market is, it isn’t entirely out of the question that Coinbase might one day go bankrupt, even if it’s in a secure financial position right now. As such, users who don’t trade often should consider moving their cryptocurrency to their own self-custody wallets, a rule of thumb that applies to every user of every crypto-exchange in the sector.

What happens to your crypto if an exchange goes bankrupt?

Coinbase Admits Users Will Be Last In Line for Compensation in Event of Bankruptcy

What Coinbase’s declaration means is that, in the event of bankruptcy, its users will get their funds back only after the exchange has paid off its more important creditors first, as well as the lawyers and bankers handling its bankruptcy proceedings. Put differently, there might not be much crypto left for users once everyone else has been compensated.

So in a worst-case scenario, users may find that they lose all of their money. And in a best-case scenario, they’ll still need to fill out paperwork outlining what they’re owed and potentially wait months (or longer) for compensation. And needless to say, they may receive only a fraction of what they had actually held on Coinbase at the time of its hypothetical bankruptcy.

It’s likely that the users of other crypto-exchanges would find themselves in a similar situation if their respective trading platforms went bust. However, Coinbase is the only major exchange that’s also publicly listed, meaning it’s the only one legally obliged to disclose just how it would operate in the event of a bankruptcy.

As such, we can only speculate what Binance, Kraken, FTX and others might do if they collapsed, although Binance and Kraken, for instance, do appear to be planning their own IPOs. So it may be only a matter of time before they admit that they’d do something similar to what Coinbase would do.

However, despite the current lack of transparency, users of these and any other crypto-exchange should assume that they’d risk losing all of their crypto if their exchange went bankrupt. Because of this, it’s always best that investors keep in mind the timeless adage, ‘not your keys, not your crypto,” which was repeated numerous times following Coinbase’s revelation.

Source: Twitter

In practical terms, this means that users are strongly advised to buy their own hardware wallets, to which they should transfer their crypto as soon as possible. Companies such as Ledger and Trezor now provide highly secure wallets that enable users to hold and move their crypto themselves. They can also consider online software wallets, if they don’t fancy having to keep their own hardware wallets stored somewhere safe.

Whether users go for a hardware wallet or a software-based alternative, such solutions provide users with self-custody over their own crypto. This means that only they have access to the private keys that enable cryptocurrency transfers, so no exchange could ever use their crypto to pay off creditors in the event of bankruptcy.

How Likely Is It that Coinbase Goes Bankrupt?

Assuming that, for whatever bizarre reason, you can’t use your own wallet and have to keep your cryptocurrency on Coinbase, what are the chances that the American exchange goes bankrupt in the not-too future?

The short answer is that there’s very little immediate risk of this happening. However, Coinbase hasn’t been performing as well as it might have hoped in the past few months, as indicated by its latest financial statement.

Indeed, it posted a loss of $430 million in the first three months of 2022. Its $1.17 billion revenue for this quarter represented a 53% drop compared to the previous quarter, as well as 22% drop compared to analysts’ expectations of what it would actually do in Q1 2022. Its monthly transacting users also dropped from 11.4 million in Q4 2021 to 9.2 million in the first three months of the year.

Source: Coinbase

One bad quarter isn’t enough to ring alarm bells, but if Coinbase continues down this path for the rest of the year, the situation could begin looking a little more precarious.

Making things look worse is also the fact that Coinbase’s stock price has fallen by 80% since it first listed in April 2021. On top of this, the value of Coinbase’s bonds — which it’s using to raise debt funding — have also sunk, with its 10-year bonds carrying a yield of 9.9%, which is basically the same as 10-year bonds issued by the Russian government. These bonds are currently rated as ‘junk,’ implying that they’re risky.

While Coinbase is easily one of the biggest and most successful exchanges in the world, the decline in its financial fortunes indicates that users shouldn’t be complacent. Of course, CEO Brian Armstrong has taken to Twitter to underscore the point that it’s currently nowhere near bankruptcy, while its Q1 financial report indicates that it’s sitting on total assets worth around $20.9 billion, as against liabilities worth $14.4 billion.

Source: Twitter

Regardless of the risk of bankruptcy, users shouldn’t keep their cryptocurrency on exchanges anyway, unless they’re about to trade it. Given how many exchange hacks the market has experienced over the past few years, keeping your crypto on an exchange has always been a big risk, irrespective of how well your trading platform is doing financially.

As such, the smart investor should absolutely acquire their own wallet and move their cryptocurrency to it as soon as they can. That way, if an exchange is ever hacked or goes bankrupt, they’ll still have exactly the same amount of funds as before.

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CryptoVantage Author Simon Chandler

About the Author

Simon Chandler

Simon Chandler is a journalist based in London. He writes about technology, markets and politics, and has bylines for Forbes, Digital Trends, CCN, Wired, TechCrunch, the Verge, the Sun, the New Internationalist, and TruthOut, among many others. His Twitter handle is @_simonchandler_

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