Report: Bankruptcy Law Can Be Unclear When Crypto Custodians Go Belly Up

Monday 10 June 2020, 10:08 PM AEST - 1 month ago

A paper recently published by the Law Faculty of the University of Oxford examines the legal risks of depositing cryptocurrency with custodians in the event of insolvency. The paper, featured in a June 1 blog-post by the faculty, also suggests ways that regulation and practice can help to mitigate this risk.

Disintermediation failed

Cryptocurrencies were initially created as a way to be free from the interference of governments, banks and other intermediaries. However, the reality is that a large proportion of Bitcoin (BTC) and other cryptocurrencies is currently held through custodians such as exchanges, rather than by investors themselves.

This creates significant risks related to the possible insolvency of these custodians, and the rights of customers with regard to their held assets in such an event. Exchange insolvencies are common, and it can take years before customers find out what will happen to their funds.

Determining jurisdiction

The paper states that customer rights ultimately depend on the applicable insolvency and property law. However a lack of international standards related to the legal status of cryptocurrency, along with the global nature of blockchain-based transactions, can make it hard to determine which laws apply.

Ideally, the paper suggests, priority would be given to the contractual law agreed between custodian and customer, with local law applying at the custodians place of corporation serving as a fallback. So a custodians terms and conditions should be essential reading before depositing or purchasing tokens.

Pooled funds or segregated addresses

Cryptocurrency custodians generally store customer assets in one of two ways: a pooled blockchain address, or segregated blockchain addresses. The former option presents a greater risk, as it makes it more likely that the individual tokens originally deposited by or allocated to a customer will be used for the benefit of another customer.

This can often be crucial in regaining assets in the case of insolvency. If individual assets can be proven to still reside at the blockchain address of the custodia ...

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