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From FTX to FOMO: Protecting Your Crypto From the Next Exchange Meltdown

Last Updated December 31, 2023 2:57 PM
Teuta Franjkovic
Last Updated December 31, 2023 2:57 PM

Key Takeaways

  • The recent bankruptcies of several crypto firms have exposed the risks and challenges facing investors.
  • Investors need to be cautious and carry out due diligence before investing in any cryptocurrency exchange or platform.
  • Recent events have highlighted the need for increased crypto regulations.

Tumultuous events in cryptocurrency industry in 2022 cast a spotlight on the inherent risks and challenges facing investors. The decentralized nature of cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH), which emerged as alternatives to traditional financial systems since 2009, also brought with it a largely unregulated environment.

This lack of regulation has exposed investors to potential fraud, scams, and financial instability. This has been especially true when it comes to less reputable crypto exchanges.

A Year of High-Profile Failures and Lingering Uncertainty

The past year has been challenging for the crypto sector, marked by a series of high-profile failures among centralized crypto custodians, hedge funds, and exchanges. Notable names such as FTX, Voyager, Celsius, 3 Arrows Capital, BlockFi, and Genesis have faced bankruptcies. This has been due to a combination of poor management decisions and, in some cases, alleged criminal activities. These companies were guilty of major financial missteps, including excessive leveraging, high-risk investments, and misuse of user funds.

The collapse of these entities had far-reaching consequences, resulting in the loss of billions of dollars for their customers. More than just financial losses, these events have significantly tarnished the reputation of the cryptocurrency industry, reinforcing skepticism and distrust among the general public and investors. The fallout created a ripple effect, affecting other projects and their investors and leading to a broader crisis of confidence in the sector.

Heading into 2024, these events continue to haunt crypto investors, causing apprehension and uncertainty about the safety and security of their assets stored on various crypto trading platforms. The lingering effects of these bankruptcies serve as a stark reminder of the vulnerabilities within the crypto market. They might well also justify growing concerns among investors regarding the stability and reliability of their chosen platforms.

This scenario underscores the need for increased regulatory oversight, better risk management practices, and more transparency within the cryptocurrency industry. It also highlights the importance of due diligence and cautious investment strategies for individuals navigating this volatile and evolving market.

Recovering Funds from a Bankrupt Crypto Exchange

When a centralized crypto exchange (CEX) goes bankrupt, users’ digital assets, held in custodial wallets controlled by the CEX, become part of the bankruptcy estate. This legal situation often positions investors as unsecured creditors, entitling them only to a share of the estate after debts are paid.

Recovery processes vary by jurisdiction and specific bankruptcy conditions. Investors can file a claim in bankruptcy court to potentially recover their assets. While each crypto firm may have a process for fund distribution, it’s crucial to act promptly and follow the firm’s guidelines. Completing and submitting necessary paperwork promptly is key in this often lengthy and complex process.

The United States’ Chapter 7 and 11 bankruptcy processes follow a general sequence of steps. It’s important to note that specific details may vary, and consulting a legal expert is advised.

  • Filing for Bankruptcy Protection: The cryptocurrency exchange acknowledges its financial distress and files for bankruptcy under either Chapter 7 or Chapter 11.
  • Appointment of a Trustee: The court appoints a trustee who is responsible for overseeing the asset liquidation process.
  • Asset Evaluation: The trustee takes control of the exchange’s assets and assesses their current value.
  • Communication with Creditors and Investors: Throughout the bankruptcy proceedings, the trustee keeps creditors and investors informed about the potential returns they can expect.
  • Payment Hierarchy: The order of disbursing the remaining assets typically prioritizes creditors first, followed by secured investors, and then unsecured investors.
  • Submitting Claims for Asset Return: Depending on the type of bankruptcy filing, investors can file claims to potentially recover their assets.
  • Distribution of Remaining Assets: After all debts and payments are resolved, the trustee allocates the residual assets among investors. This distribution is usually based on a pro-rata share relative to each investor’s involvement.

The Most Notable Cryptocurrency Bankruptcies in History

The cryptocurrency world has witnessed its share of financial disasters, leading to significant losses for investors and reshaping the industry. Here are some of the most important crypto bankruptcies:

Exchange Date Description
FTX November 2022 Filed for bankruptcy due to liquidity issues and financial mismanagement, with $11.6 billion in debts against $4.8 billion in assets.
Celsius June 2022 Centralized lending platform that filed for Chapter 11 bankruptcy following the May 2022 crypto market crash, leading to liquidity crisis.
FCoin February 2020 Chinese exchange that declared insolvency and bankruptcy, failing to repay over $130 million in user assets due to technical and system failures.
Cryptopia May 2019 New Zealand-based exchange for altcoins went bankrupt after a hack resulting in a $16 million loss and the subsequent liquidation of customer assets.
Quadriga CX 2019 Canadian exchange filed for bankruptcy after the death of its CEO, Gerald Cotten, who was the sole holder of the cold wallet access, containing about $190 million.
Mt. Gox 2014 Lost around 850,000 bitcoins in a security breach. A lengthy bankruptcy process followed, with a portion of the recovered BTC set to be distributed in 2023.


Strategies to Mitigate Bankruptcy Risks

Cryptocurrencies, originally conceived as a safeguard against financial crises like the 2008 banking meltdown, now face similar risks. To protect your crypto assets, consider using a self-custody or non-custodial wallet. This will let you manage your private keys and keep full control of your assets.

These wallets come in two forms. There are hot wallets (software-based, like MetaMask) and hardware wallets (cold storage, like Ledger and Trezor). The latter keep your keys offline. However, using a private wallet means you bear full responsibility for your assets. Losing your keys or seed phrases, or exposing them to a third party, can result in total loss. The collapse of platforms like FTX is a stark reminder of crypto’s unpredictability.

To mitigate risks, diversify your investments across different exchanges and wallet types. You should also invest only what you can afford to lose. Always conduct thorough research on companies and products to ensure their credibility and reliability.

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