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What happens to your funds if a crypto exchange like FTX collapses

November 9, 2022, 7:50 PM UTC
Photo illustration of a large Bitcoin with a saw cutting a hole in the floor underneath it.
What happens to your funds in the event of a bankruptcy is ultimately up to your individual exchange.
Photo illustration by Fortune; Original photos by Getty Images

It’s been a busy week for crypto, and investors who have their funds tied up in one of the best-known exchanges could have an uphill battle ahead. On Tuesday, Binance—the world’s largest cryptocurrency exchange signed a letter of intent to acquire FTX, the second-largest crypto exchange. 

This move shook the crypto world (and its investors) to its core. The decline of what seemed to be one of the most promising exchanges, followed by the sharp drops in some major cryptocurrencies like Bitcoin and Ether in response to this news has many investors feeling uneasy. 

Now, many may be asking: So what exactly happens to your assets in the event that the worst case scenario becomes a reality and your crypto exchange goes under?

Cryptocurrency doesn’t have the same level of protection as your other deposits   

Cryptocurrencies are not federally protected or regulated in the same way the funds in your deposit accounts may be guarded in the event that your bank or credit union fails. While the FDIC and NCUA insurance protects funds in a traditional savings account, certificate of deposit, money market account, etc. up to $250,000 per depositor, per bank, for each account ownership category, the government does not step in to help investors recoup any funds they’ve put into a cryptocurrency exchange. 

What happens to your funds in the event of a bankruptcy is ultimately up to your individual exchange. Different exchanges have different rules about what would happen to their customers’ funds in the event of a bankruptcy, with some exchanges listing in their terms that the funds may not be recoverable. 

“You need only read the news to know that these risks are very real. After the bankruptcies of crypto–asset platforms earlier this year, there have been numerous stories of consumers who have been unable to access their funds or savings,” said FDIC Acting Chairman Martin J. Gruenberg in a speech on the [hotlink ignore=true]Prudential Regulation of Crypto-Assets.

In September, the Securities and Exchange Commission (SEC) announced plans to add an Office of Crypto Assets in an effort to provide investors with an added layer of protection. And in a recent address by SEC Chair Gary Gensler, it’s clear that this is an ongoing fight. 

“Investors deserve disclosure to help them sort between the investments that they think will flourish and those that they think will flounder. Investors deserve to be protected against fraud and manipulation. The law requires these protections,” said Gensler. 

But these moves are still in their early stages, and federal regulation and protections may not come soon enough to cover investors in the near-term.  

How can I protect my crypto?

Start by re-evaluating how and where you’re storing your crypto.

When you purchase cryptocurrency on a crypto exchange, your funds are immediately stored in your exchange-hosted wallet (a custodial wallet), meaning that that specific exchange controls your “private key,” which is the password that gives you the power to access and manage your crypto. 

A non-custodial wallet, on the other hand, gives users full control over their private key through storage via a browser-based software or on your computer’s hard-drive. The catch: web-based wallets through a crypto exchange make it easy to access your funds and password if you forget it. However, when you opt for a non-custodial “hardware” wallet, forgetting your private key could mean losing your funds forever. 

 Even if you purchase your crypto on an exchange, it doesn’t have to stay there. In the event of a bankruptcy, keeping your crypto in a web-based wallet could mean having your funds frozen or losing them altogether.

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