As cryptocurrency moves further into the financial mainstream, investors are paying closer attention not only to which digital assets they own, but also to how those assets are stored. Cryptocurrency custody has become a critical consideration, particularly as more consumers rely on exchanges to safeguard their holdings. Understanding the difference between custodial and self-custody wallets can help investors better protect their assets and avoid unexpected risks if a service provider experiences financial distress.
We have urged crypto buyers to make sure they receive and hold the private key and avoid exchanges that hold your private keys for you. I thought this was to avoid the exchange being hacked, and now this Fortune article indicates that Coinbase, and probably other exchanges, suggest that “the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings.” That isn’t possible if you are holding the private key, not a token that represents your private key that is held by the exchange. We translated this into an opportunity for banks in “How Banks Can Safely Do Cryptocurrency,” published April 2019. Do your due diligence, people!
“Hidden away in Coinbase Global’s disappointing first-quarter earnings report—in which the U.S.’s largest cryptocurrency exchange reported a quarterly loss of $430 million and a 19% drop in monthly users—is an update on the risks of using Coinbase’s service that may come as a surprise to its millions of users.
In the event the crypto exchange goes bankrupt, Coinbase says, its users might lose all the cryptocurrency stored in their accounts too.
Coinbase said in its earnings report Tuesday that it holds $256 billion in both fiat currencies and cryptocurrencies on behalf of its customers. Yet the exchange noted that in the event it ever declared bankruptcy, “the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings.” Coinbase users would become “general unsecured creditors,” meaning they have no right to claim any specific property from the exchange in proceedings. Their funds would become inaccessible.
That shouldn’t happen.
An individual’s ownership of cryptocurrency is supposed to be immutable and absolute; that’s one of the key selling points touted by blockchain evangelists everywhere. But when a user creates a Coinbase account, they often end up storing their cryptocurrency in a wallet controlled by Coinbase, which means the individual is giving away at least part of their control over their own funds.”
The recent attention surrounding exchange custody highlights why cryptocurrency custody should be a central part of every investor’s due diligence process. While custodial platforms offer convenience, they also introduce risks that may not be immediately apparent, including the potential treatment of customer assets during bankruptcy proceedings. As digital assets continue to gain broader adoption, investors should carefully evaluate custody options, understand who controls their private keys, and select a cryptocurrency custody approach that aligns with their security needs and long-term investment strategy.
Overview by Tim Sloane, VP, Payments Innovation at Mercator Advisory Group
