Coinbase raised a few eyebrows yesterday when the crypto exchange updated their 10Q disclosures. This is the key paragraph 👇
Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.
The full 10Q filing can be found here (the disclosure's on page 84).
CEO Brian Armstrong took to Twitter to reassure everyone that "we have no risk of bankruptcy" 👇
2/ We have no risk of bankruptcy, however we included a new risk factor based on an SEC requirement called SAB 121, which is a newly required disclosure for public companies that hold crypto assets for third parties. https://t.co/lwmgb1kFtA
— Brian Armstrong - barmstrong.eth (@brian_armstrong) May 11, 2022
Which is no real comfort for advocates of the "never believe anything until it's officially denied" method of interpreting public statements.
Anyway, the most striking thing was that anyone was surprised by this revelation when it was raised in the Macrodesiac discord earlier.
Not your keys, not your coins became a mantra for the most hardcore crypto believers precisely because they believe intermediaries such as coinbase aren't to be trusted/aren't safe.
Arguably, crypto only came to exist because people were losing trust in the system (or lost it post-2008 when private losses were socialised).
This Coinbase disclosure basically highlights the downside to non-regulation around crypto assets. Llegal protection might or might not exist, but it's untested.
4/ For our retail customers, we’re taking further steps to update our user terms such that we offer the same protections to those customers in a black swan event. We should have had these in place previously, so let me apologize for that.
— Brian Armstrong - barmstrong.eth (@brian_armstrong) May 11, 2022
To illustrate how this might go wrong, here's an expert mockup of how this could be explained one day in the future. 👇
Just a bit of fun, (and there's no real suggestion Coinbase are on the brink of bankruptcy) but we all know how beliefs can be tested and found to be untrue.
(a lot of people believed that the USD Terra peg was unassailable until this week)
That's basically why regulations and laws exist and evolve over time. Yes, they're imperfect, but they do usually offer SOME kind of protection.
For example, any time you engage in buying or selling shares, you're dealing with your broker as an intermediary/market-maker, but you don't necessarily OWN the shares you're buying.
We covered this here 👇
Tim Vollans
Most of the time, you can’t really own a fractional share of stock. Schwab slice a stock certificate in half and give you one half.
But this is not really a problem because you don’t own any shares anyway.
If you buy stock in a brokerage account, the stock will ordinarily be “owned,” in a technical record-ownership sense, by a weird company called Cede & Co. whose job is to own all the stocks on behalf of all the brokers.
Schwab (or whoever your broker is) will then have an account at the Depository Trust Company (an affiliate of Cede) saying how many of Cede’s shares Schwab is entitled to, and you will have an account at Schwab saying how many of Schwab’s shares you are entitled to.
Confusing right?
Now, most of the time, stuff like this doesn't really matter. For example, if your (SIPC regulated) broker goes bust, you should be able to claim your shares and any cash on deposit up to a value of $500,000, and/or have your account transferred to a new broker.
But when it does matter, it REALLY matters, as customers of MF Global found out in 2011:
"I simply do not know where the money is, or why the accounts have not been reconciled to date. I do not know which accounts are unreconciled or whether the unreconciled accounts were or were not subject to the segregation rules.
Moreover, there were an extraordinary number of transactions during MF Global's last few days, and I do not know, for example, whether there were operational errors at MF Global or elsewhere, or whether banks and counterparties have held onto funds that should rightfully have been returned to MF Global." ~Jon Corzine
See, there are different regulations and backstops depending on the circumstance.
Most people know that any funds deposited in their bank account cease to be "theirs" as soon as the deposit hits the account. That deposit is now 'owned' by the bank.
In the event of a bank run, funds are protected/insured up to a certain level (e.g. $250,000, £85,000 or €100,000 in US, UK & EU respectively).
Above that level, all bets are off.
Reuters Staff
The deposits exceeding 100,000 euros [were] converted to equity, exchanging the seized funds for shares in the lender
There's always plenty of hand-waving about ESMA regulations and protections for retail traders in Europe. They're far from perfect, but at least there's some level of protection.
When MF Global went under, futures accounts didn't have that luxury 👇
MF Global's collapse affected not large financial institutions, but smaller clients, such as individual investors and small business clients (farmers, ranchers, financial advisors) who used commodities to diversify portfolios and hedge risk.
Unlike bank deposits or brokerage accounts, futures accounts carry no backstop akin to FDIC insurance or SIPC coverage.
For this reason, account segregation is deemed sacrosanct.
Which is why it pays to know who you're depositing your funds with, where they're regulated, and the leverage they offer.
The biggest benefit of leverage is that you don't have to deposit all of your funds with the broker and take that risk of losing it all (or having it wrapped up in bankruptcy proceedings) if the worst were to happen.
The moral of the story? Know your counterparty risk. Know who you've deposited money with. The business and financial world operates on trust. Most of the time, everything works as it's supposed to.
Sometimes it doesn't. Even if you still trust the counterparty, others might not.
By then, it's usually too late.
Due diligence might be boring, but if people have been doing it for over 500 years, maybe there's something to it... 👇
“due diligence” means "required carefulness" or "reasonable care" in general usage, and has been used in the literal sense of "requisite effort" since at least the mid-fifteenth century.
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