What Happens to Your Assets if a Crypto Exchange Goes Bankrupt?

Key Takeaways

• Many exchanges legally claim ownership over user-deposited crypto, making you an unsecured creditor during bankruptcy.
• If user assets are not separated from the company’s, they can be used to pay off creditors—possibly leaving you with nothing.
• The most secure way to protect your cryptocurrency is through self-custody using hardware or cold wallets.
• Recovering funds through bankruptcy proceedings can take years, and outcomes are rarely in favor of retail investors.

The rise of cryptocurrency has reshaped the financial landscape, offering individuals unprecedented control over their digital wealth. Yet, with innovation comes new risks. What happens to your assets in the event that a cryptocurrency exchange goes bankrupt is one of the most critical concerns facing investors.

This article explains the mechanisms of cryptocurrency exchange bankruptcy, its implications for your holdings, and—above all—how to safeguard yourself.

Understanding the Role of a Crypto Exchange

Cryptocurrency exchanges are online platforms that allow users to buy, sell, trade and sometimes store digital assets like Bitcoin, Ether, and other altcoins. Other services like staking, lending, and derivatives trading are also provided by certain exchanges.

Exchanges generally fall into two categories: custodial and non-custodial.

• Custodial exchanges: Custodial exchanges like centralized exchanges are operated by companies that act as intermediaries between buyers and sellers. These exchanges safeguard users’ digital assets and store their private keys. Users have to trust that the exchange will protect and store their money.
• Non-custodial exchanges: Non-custodial exchanges, like decentralized exchanges, operate without a central authority. They allow users to retain control over their private keys and only facilitate the trades. The responsibility of securing funds rests with the user.

While custodial exchanges are often more user-friendly and feature-rich, they come with a significant risk: if the platform fails or is hacked, users could lose access to their funds.

What Is A Bankruptcy?

Bankruptcy is a legal process initiated when a business can no longer meet its financial obligations. In the traditional financial system, bankruptcy can result in a restructuring of the company (Chapter 11 in the U.S.) or a complete liquidation of its assets (Chapter 7).

The same basic rules apply when a cryptocurrency exchange declares bankruptcy. The company must disclose its assets and obligations and decide how to pay off its creditors, including users. However, because crypto is still a relatively new asset class, the legal treatment of these assets is often unclear and inconsistent.

Legal Classification: Are You a Beneficiary or a Creditor?

The way your claim is classified is very important in bankruptcy proceedings. You become an unsecured creditor if the court determines that your assets belong to the exchange. This means you are last in line to be paid after secured creditors and administrative costs.

However, your cryptocurrency may be returned to you if it is legally recognized as being held in trust and excluded from the exchange’s bankruptcy estate. That said, proving this can involve lengthy legal battles and significant delays.

How Exchange’s Bankruptcy Affects Your Crypto Holdings

Whether or not you recover your assets in a crypto exchange bankruptcy depends largely on three factors:

• Asset segregation: If the exchange has maintained user assets and company funds properly separated, your cryptocurrency may be considered “custodial assets” and may be returned to you. Unfortunately, a lot of exchanges combine user assets into one pool, and if those assets are mixed with the company’s, they may be considered part of the bankruptcy estate.
• Terms of service: The terms of the user agreement you agreed to when registering for the platform may be crucial. You can be considered an unsecured creditor if the exchange declares that deposited cryptocurrency becomes its property. As a result, your chances of making a full recovery are significantly reduced.
• Jurisdiction and legal precedents: Laws governing crypto assets differ from country to country. In some jurisdictions, courts have ruled that user assets held in trust must be returned. In others, crypto may be viewed as part of the company’s estate to be liquidated and distributed to creditors.

Real-Life Examples of Crypto Bankruptcies

Below are three notable examples that illustrate what can go wrong and what you can learn.

• Silvergate Capital (2024): Silvergate Capital, a crypto-focused bank, entered bankruptcy in September 2024 after shutting down operations in 2023. The bank faced significant losses following the 2022 crypto market crash, particularly due to its ties to FTX and other failed crypto firms. A bank run in late 2022 depleted its deposits, leading to its voluntary liquidation and subsequent bankruptcy filing to manage remaining debts.
• Genesis Global Capital (2023): Genesis, a major crypto lending subsidiary of Digital Currency Group, filed for Chapter 11 bankruptcy in January 2023. The collapse was triggered by exposure to the FTX and Alameda Research failures, with $175 million in assets locked on FTX, and losses from loans to the bankrupt hedge fund Three Arrows Capital. Genesis owed over $3.4 billion to creditors, including Gemini, which claimed $765.9 million. The bankruptcy plan aims to repay creditors through asset sales, with some recovery progress reported by 2024.
• FTX (2022): Once regarded as a cornerstone of cryptocurrency trading, FTX went bankrupt in November 2022 after it was suspected that customer funds were misused. The loss of billions of dollars left users entangled in a complex bankruptcy lawsuit. Investigations revealed that user funds were not properly segregated, exacerbating losses.
• Celsius network (2022): Due to severe market conditions, cryptocurrency lending platform Celsius filed for bankruptcy in July 2022. In this case, user deposits were deemed part of the company’s assets due to the terms of service, meaning users were classified as unsecured creditors with limited recovery prospects in the bankruptcy process.
• Mt. Gox (2014): One of the earliest and most dramatic exchange failures, Mt. Gox lost over 850,000 Bitcoins due to hacks and mismanagement. After years of legal battles, partial repayments to users began in 2024 through court-approved settlements, though many users have yet to be fully compensated.

How Global Regulations Protect (or Don’t) Your Digital Assets?

As cryptocurrencies gain traction, understanding the patchwork of global regulations and limited insurance protections is crucial for investors facing exchange failures.

United States

• Securities Investor Protection Act (SIPA): SIPA provides limited protection for customers of failed broker-dealers (including centralized crypto exchanges if they are regulated as brokers). SIPA covers up to $500,000 per customer, including up to $250,000 in cash claims. However, SIPA’s coverage does not extend to cryptocurrencies unless the exchange is registered as a broker-dealer and the crypto assets are classified as securities. The classification of crypto as securities is determined by the SEC’s application of the Howey Test. Many cryptocurrencies are not considered securities, limiting SIPA’s applicability. Also, you must be aware that SIPA does not cover losses from hacks or operational failures.
• FDIC insurance: The Federal Deposit Insurance Corporation (FDIC) insures deposits at participating banks, but cryptocurrencies are not covered under FDIC insurance. If a crypto exchange partner is FDIC-insured, the insurance would only apply to USD deposits and not to the crypto assets held.
• CFTC and SEC regulations: The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) may offer some oversight on crypto exchanges offering derivatives or securities. However, insurance protection for digital assets in the event of a bankruptcy is still under discussion and is limited in the current legal framework. Notably, the CFTC’s oversight is limited to exchanges offering leveraged trading or futures contracts, and its consumer protections are minimal compared to traditional financial markets. The SEC’s enforcement actions (e.g., against unregistered exchanges) may not directly benefit consumers in bankruptcy cases.
• State-level consumer protection: States like New York have enacted stringent consumer protection regulations (e.g., New York’s BitLicense) which could offer certain protections for crypto investors in the event of an exchange bankruptcy. However, these protections would vary by state and are generally not as comprehensive as traditional insurance mechanisms.

United Kingdom

• FSCS (Financial Services Compensation Scheme): The FSCS provides compensation to customers if a regulated financial firm, such as a bank or an investment firm, goes bankrupt. However, cryptocurrencies are not covered under the FSCS if a crypto exchange fails. If the exchange operates under the FCA’s (Financial Conduct Authority) regulation and holds client funds in segregated accounts, there might be some legal avenues to recover funds, but not through traditional insurance.
• FCA regulation: Crypto exchanges that are registered with the Financial Conduct Authority (FCA) in the UK must adhere to Anti-Money Laundering (AML) and Know Your Customer (KYC) regulations, but there are no specific insurance protections for clients’ crypto assets if the exchange fails. The FCA has been cracking down on unregistered crypto firms, and since January 2020, crypto businesses must register with the FCA. However, this registration does not equate to deposit insurance or comprehensive consumer protection.

European Union

• MiCA (Markets in Crypto-Assets Regulation): MiCA is a key regulation that the EU is introducing to provide clearer rules for crypto-assets, including stablecoins, and establish consumer protection. While MiCA introduces a licensing framework for crypto service providers, it does not offer specific insurance compensation in the case of bankruptcy. However, the regulation is designed to give users more clarity and potentially easier recourse if an exchange fails.
• EBA Guidelines on Crypto Assets: The European Banking Authority (EBA) provides guidelines for crypto-asset service providers, which could help customers in the event of a collapse. But like MiCA, it focuses more on transparency and security rather than providing direct compensation.

Global Outlook

• No universal insurance mechanism: Globally, most crypto exchanges do not have insurance coverage akin to traditional financial services for customer deposits. Some exchanges (e.g., Coinbase) offer private insurance for assets held in their custody, but this insurance does not cover losses from hacking or insolvency. It may only cover specific risks related to employee theft or breaches of security. Some exchanges (e.g., Binance) have created “SAFU” (Secure Asset Fund for Users) funds to partially compensate users for losses, but these are not regulated insurance products.
• Regulatory push for insurance and consumer protections: Many countries are beginning to discuss or implement regulations for better consumer protection in the crypto industry. Some jurisdictions (e.g., Japan and Switzerland) have more robust frameworks for ensuring transparency and protecting user funds, though comprehensive insurance solutions for crypto holdings are still in early stages. Japan’s 2019 amendments to the Payment Services Act and Financial Instruments and Exchange Act require crypto exchanges to hold client assets in trust, offering stronger protections than most jurisdictions.
• Private insurance policies: In some instances, exchanges may offer private insurance products that cover a portion of customer assets in the event of theft or bankruptcy, but this is not universal. Such policies are still rare and often limited in scope.

Gaps in Current Regulations

The lack of comprehensive insurance coverage for digital assets in the event of an exchange bankruptcy is one of the major risks associated with centralized exchanges.

• Gap in protection: Unlike traditional banks or investment accounts, crypto exchanges do not offer the same level of depositor insurance protection. This creates a huge vulnerability for consumers in the event of exchange bankruptcy or financial collapse.
• Calls for reform: Regulatory bodies in both the U.S. and the EU have been moving toward more robust frameworks for consumer protection, and some are exploring the possibility of establishing clearer rules for insurance products specific to digital assets.

How to Protect Your Crypto Assets from Exchange Failures

While the risk of exchange failure is real, there are several proactive measures you can take to protect your digital assets:

•  Use cold wallets: Keeping your cryptocurrency in a hardware wallet or another cold storage system where you have control over the private keys is the safest option. By doing this, exposure to exchange-related risks is minimized.
• Diversify your holdings: Avoid storing all of your assets on a single platform. To spread your risk, use several wallets or exchangers.
• Choose reputable exchanges: Choose platforms that have insurance, a license, and frequent audits. An additional degree of security and accountability is provided by regulatory compliance.
• Review terms of service carefully: Reviewing the terms of service can tell you how your assets will be handled in unfavorable circumstances, even though it can be time-consuming.
• Stay informed: Monitor the financial health of exchanges you use. Watch out for abrupt modifications to withdrawal guidelines, technological difficulties, or insolvency-related media coverage.

Steps to Take if Your Exchange Fails

• Stay informed: Monitor official communications from the exchange and legal proceedings.
• File claims promptly: Take part in the bankruptcy procedure by delivering the required paperwork so that you can retrieve your possessions.
• Seek legal advice: To learn about your rights and choices, speak with professionals who specialize in cryptocurrencies.
• Document everything: Maintain a record of all of your communications, transactions and other pertinent data.

Conclusion

The collapse of a cryptocurrency exchange serves as a stark reminder of the unique risks involved in owning digital assets. While blockchain technology promotes transparency and decentralization, exchanges—and other centralized platforms—can become critical points of failure.

If an exchange goes bankrupt, users may face lengthy legal proceedings, partial recoveries, or even total losses, particularly if they misunderstand the custodial nature of their accounts or overlook the platform’s terms of service.

The best protection is a proactive approach: understand how exchanges operate, store assets in private wallets when possible, choose reputable platforms, and stay informed about regulatory and financial changes.

In the fast-evolving world of cryptocurrency, due diligence isn’t optional—it’s essential.

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