Bankruptcy: a legal procedure in which people or business declare that they will not be able to pay their debts.
Chapter 11: a provision of the USA Bankruptcy Code that allows companies and businesses to restructure their debts and carry on with their activities.
Cryptocurrency: a digital or virtual money that runs without a central bank and employs cryptography for security.
Federal Deposit Insurance Corp. (FDIC): a department of the US government that protects bank and thrift institution deposits.
Know Your Customer (KYC): a method used by companies to confirm the identification of their customers in order to stop fraud and money laundering.
Pro rata share: the equitable division of a responsibility or asset among various parties.
Stablecoins: a kind of cryptocurrency that links its value to a reserve of assets, like fiat money or commodities, in order to maintain a constant value.
Unsecured creditors: In the case of bankruptcy, creditors without collateral to support their claims against a debtor.
Major cryptocurrency exchanges and mining businesses declaring bankruptcy bring to light the unique risks that crypto investors face.
The Federal Deposit Insurance Corporation (FDIC) does not provide insurance for cryptocurrency holdings, leaving investors without a safety net in the event that a crypto exchange goes out of business.
Despite their name, stablecoins are not risk-free and their value might fluctuate.
There is a chance that investors won't get their money back in bankruptcy proceedings because they are almost always last in line for reimbursement.
When dealing with cryptocurrencies, investors in cryptocurrencies should be aware of the limitations of decentralization and should take into account the risks related to the exchange or loan platform they are utilizing.
Introduction: Bankrupt Exchanges
Cryptocurrency markets have experienced their fair share of ups and downs. Investors must question the security and viability of their assets through the lenses of decentralisation in light of the recent bankruptcy of large centralised cryptocurrency exchanges (CEX) and mining firms in 2021 and 2022.
In this article, we'll look at the ripple effects of these unique bankruptcies, investors' risk management policies and, the difficulties of earning money and crypto assets in a distributed environment which claims to be decentralized but which, in reality, is rather centralized.
FTX, Voyager, Celsius, and other bankruptcies
A slew of bankruptcies in the cryptocurrency business in 2022 shocked the market and the world. Two significant cryptocurrency trading platforms, Voyager and Celsius, as well as the Nasdaq-listed mining company Core Scientific, filed for Chapter 11 bankruptcy (USA only). These incidents underscore the dangers that crypto investors who trust cryptocurrency platforms and third parties with their money, face (Do you own research people! DYOR). Investor losses from these bankruptcies could total more than $1 billion.
Not your keys, not your cheese
Contrary to common belief, the Federal Deposit Insurance Corp. (FDIC) does not provide insurance for cryptocurrency holdings. This implies that no government organization will compensate investors if a cryptocurrency exchange shuts down. Cryptocurrency investments do not have the same safety net as bank deposits, which are protected by the government up to specified limitations (but recent bail ins prove that things could change). Even member banks and financial institutions engaging in cryptocurrency-related operations/investments are required by the FDIC to disclose those activities for supervisory consideration.
Stablecoins: a systemic risk
Although some cryptocurrencies, such as stablecoins, are backed by real world assets and commodities, their stability cannot be ensured as a rule of thumb. For instance, the value of TerraUSD stablecoins decreased when the currency's peg to the US dollar broke down. This shows that stablecoins too face hazards and are not protected by FDIC insurance. And the very nature of these currencies means that as soon as they drop (De-peg) investors panic.
The Hierarchy of Re
payment in nasty bankruptcies
There is a clearly established hierarchy of who receives payment from the residual assets when a firm files for Chapter 11 bankruptcy. First, secured creditors, then unsecured creditors. Investors, unfortunately, are paid almost last in line.
Investors may receive some of their money back, but the total depends on what proportion of the remaining assets they receive and the time frame can take months.
To redistribute residual assets, a bankruptcy judge, attorneys, and the company must work together during the bankruptcy procedure. This is the risk incurred by investors in an ecosystem which lacks regulations.
Recovering Funds from a Bankrupt Crypto Company is difficult but not impossible
The insolvent crypto organization must get in touch with investors that have followed Know Your Customer (KYC) regulations and provided accurate information about their status. The insolvent company should also advice on how to get their money back.
In order to collect a percentage of the initial investment, the procedure can involve filling out paperwork, verifying personal information, and staying on top of required documentation. However, there is always a chance that investors won't get their money back.
The Limits of Decentralisation
Because of the decentralised, often peer-to-peer nature of cryptocurrencies, investors in the fiat world must rely on exchanges (CEX) in order to trade, earn money and generate their profits. Investors are exposed to the dangers associated with centralised institutions and must risk manage their assets responsibly.
In conclusion, it is critical for investors to comprehend the risks connected with centralised institutions such as Centralised Crypto Exchanges (CEX) and the boundaries of decentralisation as the crypto ecosystem changes and evolves. Investors may more easily navigate the unregulated world of cryptocurrencies and make more educated decisions by studying and implementing risk management policies for themselves and their clients.