Beware: The companies that hold your crypto are not insured as the banks are

by Arthur · July 5, 2022

But that risk is by no means limited to price volatility.

Should the company that holds your crypto assets declare bankruptcy or otherwise be unable to meet its financial obligations, you may be unlucky. While your traditional savings and investment accounts can never be 100% safe in case your institution becomes insolvent, your traditional bank and brokerage house as well as your 401 (k) plan offers higher levels of guaranteed protection for your money than a crypto account.

Investors were reminded of that difference when Coinbase, a publicly traded crypto-trading and storage platform, revealed last month that should it ever go bankrupt, customers could be treated as unsecured creditors by a bankruptcy court, meaning they could lose their cryptocurrencies.

“It is possible, no matter how unlikely, that a court will decide to consider client funds as part of the company in bankruptcy proceedings,” said Coinbase CEO Brian Armstrong in a tweet thread in early May.

But managers in the company have indicated that it is not in danger of bankruptcy and the customer’s «funds are safe». The company also noted that it updated its retail user agreement to clarify that customer funds are separate from – and not to be confused with – the company’s assets.

Still, in the event of a bankruptcy, “a judge will follow what the law says, not what you include in the retail user agreement,” said bankruptcy attorney Alan Rosenberg. But, he added, “it is impossible to predict what will happen [because] there is very limited case law. “

This is because the legal, fiscal and regulatory frameworks for digital assets – not to mention the legal definitions of what a specific cryptocurrency is – are still under development. They are not legal tender, and they are not always seen as securities.

This is partly why they do not enjoy the same guarantees as more traditional financial accounts.

So read the legal notice before you buy, sell or store digital assets any company that facilitates crypto trading to see what protection they offer.

Given that Coinbase is listed on the stock exchange and therefore required to be more transparent than privately owned companies, the promises and guarantees will probably be among the best offered for those who want to invest in crypto.

For investments and savings where you want to have a greater sense of security, here are some of the key protections offered by traditional financial accounts.

Bank and credit union accounts

If you have a current or savings account, a money market deposit account or a deposit certificate in a bank or credit union, make sure that the institution has deposit insurance.

Banks are usually insured by the Federal Deposit Insurance Corporation (FDIC). Should your bank fail, that coverage will protect up to $ 250,000 per depositor for each account ownership category with an FDIC-insured bank. There are several types of deposit accounts you can have in one bank (eg personal account, business account, etc.) and each will be covered separately. In addition, if you own a joint account, each owner is covered up to $ 250,000. (Use this FDIC calculator to find out your coverage given the information about your situation.)

And if you have deposits in a self-managed retirement account with a federally insured bank, they will also receive up to $ 250,000 in protection.

Federally insured credit unions offer the same level of coverage through the National Credit Union Administration (NCUA).

Broker accounts

If you have an IRA or a taxable stock and bond account with a registered broker-dealer who is a member of the nonprofit Securities Investor Protection Corporation, you will receive up to $ 500,000 in protection should the brokerage go bankrupt.

Up to half of this amount can be used to protect cash in your account linked to your securities – for example, if you have just sold some shares and transferred the income to your account with the brokerage house.

In addition to SIPC insurance, a brokerage house can provide additional protection to its clients through private insurance companies such as Lloyd’s of London.

In addition comes the Securities and Exchange Commission issued a customer protection rule that requires registered broker-dealers to protect clients’ securities and cash, and prohibits dealers from using customer money to finance the firm’s overhead or activities.

401 (k) s

If your employer goes bankrupt, the money in the 401 (k) cannot legally be treated as the company’s assets by a bankruptcy court.

“[The Employee Retirement Income Security Act] protects 401 (k) assets that have been deposited and are fully earned if the employer goes bankrupt, “said Hattie Greenan, spokeswoman for the Plan Sponsor Council of America.