What happens when Crypto companies go bankrupt?
Cryptocurrency sector has been rapidly grown in the last 5 years. The number of Bitcoin wallets created users have gone past 200M mark. With NFTs, the adoption of crypto by users over the past few years has increased exponentially. However, amid the fanfare of heavy crypto adoption among the masses, we can’t dismiss a glaring fact that since the past two years the cryptocurrency sector has seen various reputed crypto exchanges and lenders going bankrupt.
From the fall of Celsius to the collapse of FTX exchange and the most recent Blockfi collapse, every other company has filed for bankruptcy. However the glaring question amid this chaos is about what happens to the funds deposited by the users in the custody of these entities.
Deep dive into the article to gain insights about what happens to your funds in the event of a crypto exchange crash.
What we are going to learn?
Crypto Company Going Bankrupt: What does it mean?
When a cryptocurrency company goes bankrupt, it means that it is unable to pay its debts and is being forced to shut down its operations. This can have serious consequences for the company’s employees, customers, and investors.
Employees may lose their jobs, customers may lose the money they have invested in the company’s products or services, and investors may lose the money they have invested in the company.
In some cases, a company that is going bankrupt may be able to reorganize its business and continue operating, but this is not always possible.
Why do Crypto Companies go bankrupt?
Cryptocurrency companies, like any other businesses, can go bankrupt for a variety of reasons.
Some common reasons include poor financial management, a lack of a viable business plan, a lack of market demand for the company’s products or services, intense competition, and external factors such as changes in government regulations or economic conditions.
What happens during the bankruptcy of a crypto company?
Whenever a company is unable to pay back its users and is faced with a situation with no funds which can threaten its existence the company files for bankruptcy. The act of filing for bankruptcy initiates various processes which can be termed bankruptcy proceedings. However, during these proceedings, the money of the users is frozen by the company.
Whenever a cryptocurrency company fails, it doesn’t get government security, unlike banks. Although cryptocurrency might advertise itself as a better solution which can substitute banks, investors should keep in mind that cryptocurrency deposits aren’t insured by the government.
If a bank fails and is unable to provide investors with the money, it’s the responsibility of the government to ensure that the money is returned to them. However, the funds of a crypto company aren’t backed by government assurance of support.
Although there are various stablecoins in the ecosystem which peg themselves with a nationalised, government-backed fiat currency, they aren’t a viable option because even they aren’t backed by the government.
Read about: Terra UST Collapse
How do investors get paid back during bankruptcy proceedings?
After the commencement of bankruptcy proceedings, there is a clear chain of hierarchy which spells out the rules in place for repayment purposes. An advantage of bankruptcy proceedings is that even if the bankrupt entity has a ton of debt the court ensures that everyone gets a piece of the cake.
The process begins with the company declaring the total assets owned by the entity. This declaration considers any kind of assets possessed by the entity regardless of their form or nature.
After the list of such assets is compiled the judges and lawyers finalise the process and distribute the assets among various creditors.
The process follows a hierarchy process. Primarily the lending of the secured creditors is paid back followed by the lending of the unsecured creditors. Investors usually end up at the bottom of this hierarchy and are paid in the end.
While calculating the repayments supposed to be paid back to the investors a pro-rata mechanism is applied.
The pro rata mechanism works through a simple process. If a company has $500M in debt and it’s left out with $100M as funds to issue repayments, it will finalise that the investors would be paid a 20% amount of their share.
How to recover funds from a bankrupt crypto company?
Always ensure that you have filled out the KYC details. This ensures that information regarding your funds is accounted for by the organisation in their registers. In the event of bankruptcy, a company informs you right away and has a robust mechanism in place to distribute the remaining funds back to the customers. There’s always a possibility that the entire funds might be lost but there are chances you might retain a major portion of it.
What are examples of cryptocurrency companies going bankrupt and the process followed by them?
Voyager Digital which acted like a bank collapsed in the wake of the collapse of the Three Arrows which was a massive crypto hedge fund. Voyager Digital defaulted on a loan of around $660 Million and filed for bankruptcy. While doing so, it also froze withdrawals on its platform and since then the users are in thach regarding the whereabouts of their money.
If we look at the terms and conditions of Celsius, it has clearly stated that in an event of bankruptcy, the funds deposited with it can’t be recovered and will be considered the property of Celsius.
If we look at past incidences of recovery there are very dismal examples. Mt. Gox which stopped operations in 2014 still hasn’t repaid its investors after filing for bankruptcy.
How to identify Crypto companies that may go bankrupt?
There is no sure way to identify which companies may go bankrupt in the future. However, there are some warning signs that a company may be in financial trouble, such as consistently poor financial performance, a high level of debt, and a lack of a viable business plan.
It is important for investors to thoroughly research any company before investing their money, and to be aware of the potential risks involved. It is also a good idea to diversify one’s investments to spread out the risk.
How to protect your cryptocurrency from bankruptcy?
During bankruptcy, the users who have to bear the brunt of the crash are the ones whose funds are locked into custodial crypto wallets provided by the organisation.
Locking up your crypto in a custodial wallet ensures you are in a helpless situation in the event of bankruptcy. Therefore always store away your crypto in a non-custodial wallet.
We have done a detailed post on the best crypto wallets you can use in 2023.
This ensures that the cryptocurrency is stored by being connected to the internet or stored in a hard drive or USB drive. A non-custodial wallet ensures that you are the sole entity in possession of your crypto.
Cryptocurrency is a volatile asset and it has minimal government regulations.
In the event of bankruptcy, the potential for recovery of funds is very complicated and bleak. Therefore it’s viable to opt for various mechanisms through which the custody of crypto stays with the user itself instead of being passed to a foreign entity.