Centralized Exchanges (CEX) offer a user-friendly, simple to navigate platform for buying and selling crypto assets, which for most beginners is an ideal starting point. However, with no government or middlemen to rely on in the decentralized ecosystem, its important to consider what comes next. Centralized exchanges will hold your assets in custody on your behalf, but have you considered your next move - how to transfer these assets safely to your own crypto wallet?
The bankruptcy and collapse of major crypto exchange FTX in 2022, where over $8 billion of customer assets held with FTX were lost, left many people wondering if their own crypto investments were at risk and whether they were insured in case of a future crypto platform collapse.
Keep in mind: Digital assets are not FDIC insured / What amount, if any, does a crypto exchange protect? / What happens to your assets if a CEX goes bankrupt?
There are numerous popular centralized crypto exchanges, Binance, Coinbase, Crypto.com, Gemini, to name a few, but after the FTX collapse there was a lot of chatter about what protections Coinbase had in place. With over 108 million* verified users, it's one of the most well-known. (*Coinbase Jan 2023)
So, in this post we are going to use Coinbase, for reason of its popularity, as an example and investigate whether your digital assets held on a CEX are insured or not?
So, how safe is my crypto?
Unlike traditional banking, crypto exchanges are not required by regulators to insure either your fiat currency, or your digital assets held on an exchange. In fact, in the U.S., digital currencies are not defined as legal currency, so your coins and tokens are given no insurance protections at all.
Coinbase has put out clarifying statements explaining that Coinbase carries crime insurance that protects a portion of digital assets held across their storage systems against losses from theft, including cybersecurity breaches. We believe the amount insured to be in the region of $255 million. So, Coinbase has insurance covering around $255 million of the approximate $2.5 billion they hold in Coinbase hot wallets, and this insurance is provided to cover cybersecurity breaches against the exchange.
How safe is my cash?
Coinbase has provided further clarity and explained that in addition to the insurance it has in place, U.S. customer cash funds are pooled in custodial accounts at one or more banking institutions insured by the FDIC. So, should any of those FDIC insured banks fail, each Coinbase U.S. customer's funds are protected up to the FDIC protection maximum of $250,000.
However, one key point to note is that for FDIC coverage to be enforced, it requires the provider, such as Coinbase to actively deposit that customer USD into an FDIC institution and keep accurate records. While we feel confident that Coinbase has strict processes and measures in place to ensure that their user's USD is deposited with FDIC institutions on a frequent basis, this safety does rely on the good practice of the CEX itself.
Outside the U.S. we don't have a clear indication that such protections are in place for customers' cash. So, if we take the U.K. Financial Compensation Scheme, U.K. customer funds held at a licensed financial institution are protected up to £85,000. However, Coinbase is not a licensed U.K. financial institution and therefore it is unlikely that this protection applies.
Coinbase Account Protection
Coinbase is offering its Coinbase One customers a product called Coinbase Account Protection. This offers eligible customers a one-time reimbursement up to $1,000,000 on actual losses of U.S. Dollars, or the Dollar equivalent if these losses were in the form of digital currency, due to vulnerability, or deficiencies in Coinbase's systems and/ or security protocols.
To qualify there are a number of criteria you need to fulfill, including:
· You must be a Coinbase One customer for at least 30 days before the loss
· You must have completed all steps in the Photo ID verification process
· You must have 2-Factor authentication in place on your account
industry-wide, there is limited to no regulatory obligation on crypto exchanges to protect or insure either your digital assets or your cash held on their platforms. Established platforms such as Coinbase have made efforts to offer a level of protection to their users, but in the event of a crypto exchanges' collapse, the digital assets you leave on-exchange will most likely be lost, and if you do have any chance of claiming them back, you will be far down the list of creditors, so it is unlikely you will see those assets returned.
Crypto investors should always ask themselves the question "am I doing enough to keep my crypto assets safe?" Its good practice to move your crypto assets to your own wallet, not controlled by an exchange and if you need to leave crypto or cash on-exchange for ease of transacting, leave the least amount you need to, therefore the risk of potential loss is limited as far as possible.