While the collapse of Terra threatened part of the crypto ecosystem, the exchange platform Coinbase announced that in the event of bankruptcy, it would be possible to consider the loss of cryptocurrencies stored in the name of customers. At the same time, ECB President Christine Lagarde told German television that she was worried about people “who has no understanding of risks, who will lose everything, and who will be terribly disappointed, that’s why it should be regulated”.
In this context of uncertainty, investors are seeking both a framework of trust from crypto exchange platforms and legal responses from the authorities. Decryption of risks in case of bankruptcy of exchange platforms or security issues for virtual currency investors.
Cryptocurrency: What is the legal framework in France?
In France, activities related to services in the cryptocurrency sector are regulated by the AMF (Autorité des Marchés Financiers). In particular, AMF grants its PSAN approval to providers of digital assets for trading platforms. This authorization allows the various platforms to carry out their activities, in particular with regard to “storage of cryptocurrencies or access to cryptocurrencies (via private encryption keys, for example)”, purchase and sale of cryptocurrencies, etc. It can also be portfolio management, advising clients on cryptocurrencies or even “secured or unsecured investment of crypto assets”.
To date, more and more exchange platforms have PSANs like Litebit, Coinhouse, Bitpanda and Binance for example. The list of assigned PSAN approvals is available on the AMF website. This regulation, introduced in 2019 by the PACTE Act, aims to establish a framework for trust, but the AMF reminds us that we must monitor “the measures taken by the platform to secure its own equipment, as it may also be the victim of malicious acts”.
For financial products derived from cryptocurrencies, the service provider must also have PSI approval as an investment service provider. We must remember that in the case of derivatives, the investor is in no way the holder of the cryptocurrencies. Similarly, ETFs that reproduce the movements of cryptocurrencies also require approval from the AMF. It is therefore now possible to trade cryptocurrencies from traditional stockbrokers via derivatives, and the risk of bankruptcy is subject to the same legal restrictions as equities. For example, it is possible to trade cryptocurrencies via Futures contracts listed on the Chicago Mercantile Exchange, which clearly defines the terms of the contract and the risks are known by the investor. In this sense, the issue of the risk of losing its portfolio in cryptocurrencies is rather relative to the issuer of the derivative product and the regulation of transactions.
Thus, buying cryptocurrencies live through stock exchange platforms does not have the same legal guarantees as trading cryptocurrencies with derivatives through traditional stockbrokers.
Is crypto exchange secure?
The famous exchange platform Coinbase, which has a balance sheet of almost $ 20 billion, recently questioned in a document intended for the SEC the security of guarantees to customers. This challenge in the event of Coinbase’s insolvency comes as Coinbase has fallen by more than 75% since the start of 2022. Profit for the first quarter of 2022 has fallen by more than 26% year-on-year to $ 1.16 billion. The company, which has been listed on Nasdaq since 2021, said in its report submitted to the SEC that the platform’s cryptocurrencies “can be treated as assets subject to bankruptcy proceedings and customers can be treated as ordinary unsecured creditors. This can make customers find our custodian services more risky and less attractive”. In other words, the risk of bankruptcy would not provide customers with security.
Fast, the Coinbase CEO Brian Armstrong responded to the networks by specifying that there was “no risk of bankruptcy” and further adding that “This disclosure makes sense insofar as these legal protections have not been tested in court specifically for crypto assets and it is possible but unlikely that a court may decide to treat client assets as part of the company in bankruptcy proceedings … even if it is unlikely to harm customers ”. Therefore, this raises the question of the solvency of all other cryptocurrency exchange platforms in case of bankruptcy.
As Martin Finnegan, COO of the British law firm Punter Southall Law, reminds us, most trading platforms state in their terms the presence of risk of loss. It is stated in the conditions “you accept that all your funds may be lost and you can not only do something about it, but we (the platform) will under no circumstances be liable”.
Nevertheless, some platforms like Binance would have chosen to secure a portion of the dollar deposit with the FDIC (Federal Deposit Insurance Corporation). In France, it does not appear that any Deposit Guarantee has been taken out of the Platforms Guarantee Fund (FGDR). FGDR guarantees € 100,000 to savers in the event of traditional banks going bankrupt. However, these deposit guarantee measures for cryptocurrency would be essentially arbitrary and almost non-existent.
The risk of crypto exchange
This legal clarification from Coinbase reminds us that crypto exchange platforms are above all there to provide a service with democratization and flexibility. However, security issues reappear, whether it’s the risk of hacking or the solvency of the platforms.
The first crypto players still have in mind the bankruptcy of the Japanese exchange platform Mont Gox, which operated from 2009 to 2014. In 2014, the platform suffered a hack, which caused the disappearance of more than 700,000 Bitcoins and caused the platform to go bankrupt. Examples of theft are numerous in the financial industry. Recently, the perpetrators behind the Bitfinex platform hacked in 2016 for 120,000 Bitcoins were found, and U.S. law seized the equivalent of more than $ 3 billion worth of Bitcoin after a lengthy investigation in 2022.
From now on, the risk of loss develops due to the democratization of the market. The risk of hacking is quite limited, but we now see the emergence of solvency risks closer to the risks of bank transfer traditional finance from the 19th century. In this sense, certain regulatory measures have been revealed since 2021, in particular by the Bank of International Settlements concerning e.g. stablecoins.
The different ways to secure your cryptocurrencies
As we have seen, AMF communicates its white list in France of all players who benefit from PSAN approval. However, this is not enough to establish sufficient legal basis to answer questions from clients of cryptocurrencies in case of bankruptcy. Coinbase recently raised this issue in terms of its exposure to the stock market and to investors. So far, it is likely that a bankruptcy of the exchange platforms will not give rise to additional guarantee from institutions or dedicated funds. In this sense, stock exchanges can expose their clients to the risk of losing their deposits in the event of insolvency.
Today, no serious case of stock market platform bankruptcy has been registered since the broad democratization of the market began in 2017. But the context of tensions in the cryptocurrency market raises many security issues. It is therefore always preferable to diversify the means of holding cryptocurrencies. The use of a hard wallet like Ledger, Trezor or Ngrave makes it possible to physically hold the keys that guarantee the ownership of virtual currencies. In addition, it is always possible to use online or mobile wallets like Metamask.
What are the future guarantees for cryptocurrencies?
In any case, the restriction of the ownership of cryptocurrencies in possession of a digital key does not yet make it possible to rule on the conditions for the recognition of ownership. AMF recalls the practical precautions to optimize the security of its investments and legally regulates many services provided by trading platforms to date.
Moreover, this link with market uncertainty was recently emphasized by the President of the ECB, Christine Lagarde. The President of the ECB did not fail to clarify this “The day we have the digital currency of the central bank, any digital euro, I will guarantee it. […] That is why the central bank will be behind it. I think it’s very different from some of those things. “. This statement comes after both the collapse of Terra and the fall of Bitcoin, which called into question the solvency of certain players in the system.
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