Editor’s Note: This is an updated version of an article that first published on June 13, 2022.
The “crypto winter” that hit earlier this year walloped digital asset prices and served as a healthy reminder that cryptocurrencies are highly risky, volatile investments.
But now, in the wake of crypto exchange FTX’s implosion, crypto investors were reminded of another risk they face: Crypto accounts lack guaranteed protections when the exchange or platform provider goes belly up.
Traditional savings and investment accounts can never be 100% safe in the event an institution becomes insolvent, either. But most banks and brokerages, as well as 401(k) plans, do provide federally guaranteed protections and other insurance.
Crypto custodial accounts, however, do not enjoy those same safeguards, in part because the legal, tax and regulatory frameworks – to say nothing of the legal definitions of what a specific cryptocurrency is – are still being worked out. They’re not legal tender and they’re not always viewed as securities.
What’s more, customers may unwittingly agree to let the company running an exchange or platform use their digital assets. “There are some platforms that have agreements which essentially say that ‘by depositing your crypto with us, you are granting us the authority to use, transfer, invest, do whatever we want with your crypto,’” said Florida-based bankruptcy attorney Alan Rosenberg.
And if the company goes bankrupt, then customers may be treated as unsecured creditors – meaning they may not get anything back.
So Rosenberg’s best advice is to read the legal fine print before buying, selling or storing digital assets with any company facilitating crypto trading to see what protections they do offer.
For investments and savings in which you’d like to have a greater sense of security, here are some of the key protections offered by traditional financial accounts.
If you have a checking or savings account, a money market deposit account or certificates of deposit at a bank or credit union, make sure the institution has deposit insurance.
Banks typically are insured by the Federal Deposit Insurance Corporation (FDIC). Should your bank fail, that coverage will protect up to $250,000 per depositor for each account ownership category at an FDIC-insured bank. There are several types of deposit accounts you may have at one bank (e.g., personal account, business account, etc.) and each would be covered separately. Plus, if you own an account jointly, each owner is covered up to $250,000. (Use this FDIC calculator to figure out your coverage given the particulars of your situation.)
And if you have deposits in a self-directed retirement account at a federally insured bank, they would also receive up to $250,000 in protection.
Credit unions that are federally insured offer the same level of coverage through the National Credit Union Administration (NCUA).
If you have an IRA or a taxable account of stocks and bonds with a registered broker-dealer that is a member of the nonprofit Securities Investor Protection Corporation, you will receive up to $500,000 of protection should that brokerage go bankrupt.
Up to half that amount can be used to protect cash in your account associated with your securities – for example, if you just sold some stocks and left the proceeds in your account with the brokerage.
On top of the SIPC insurance, a brokerage may provide additional protection to its customers through private insurers like Lloyd’s of London.
In addition, the Securities and Exchange Commission issued a Customer Protection Rule that requires registered broker-dealers to safeguard customer securities and cash, prohibiting the dealers from using any customer money to fund the firm’s overhead or activities.
If your employer goes belly up, legally the money in your 401(k) cannot be treated as the company’s assets by a bankruptcy court.
”[The Employee Retirement Income Security Act] protects 401(k) assets that have been deposited and are fully vested if the employer files bankruptcy,” said Hattie Greenan, spokesperson for the Plan Sponsor Council of America.