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Bankruptcy law may be unclear when crypto custodians sink

June 1, 2020

A recent document published by Oxford University School of Law examines the legal risks associated with depositing cryptocurrencies with custodians in the event of bankruptcy.. The document, which will be featured on a college blog on June 1, also highlights ways that regulation and practice can help mitigate this risk.

Disintermediation failed

Cryptocurrencies were originally created to be free from interference from governments, banks and other intermediaries. However, the reality is that a lot of bitcoin (BTC) and other cryptocurrencies currently is held in custodian banks such as stock exchangesinstead of being the investors who keep them.

This harbors considerable risks in connection with the possible insolvency of these custodian banks.and the rights of customers in relation to their assets held in this case. The bankruptcies of the stock exchanges are common and it can take years for clients to figure out what will happen to their funds.

Determination of jurisdiction

Bankruptcy law may be unclear when crypto custodians sink
Bankruptcy law may be unclear when crypto custodians sink

The document claims that the customer’s rights ultimately depend on applicable bankruptcy and property law. However, The lack of international standards regarding the legal status of cryptocurrencies, as well as the global nature of blockchain-based transactions, can make it difficult to determine the applicable laws.

The idealas suggested in the document would be to give priority to the contractual law agreed between the custodian and the customerAs an alternative, the applicable local law would serve instead of the custodian. Consequently, The terms and conditions of the custodian should be read before depositing or buying tokens.

Common funds or separate addresses

Cryptocurrency managers generally store customer resources in two ways: as a grouped blockchain address or as separate blockchain addresses. The first option is more risky because it is more likely that individual tokens originally deposited or assigned by one customer will be used for the benefit of another customer.

This can often be crucial to recover assets in the event of bankruptcy. If it can be demonstrated that individual assets are still at the custodian’s blockchain address, in most cases the customer has a much greater right to these assets.

Once again, Information on how the deposited tokens can be used should be included in the documentation of the custodian.

A reuse regulation could protect customers

The document also suggests that Regulations that prohibit or restrict the reuse of client assets could further protect clients in bankruptcy situations. Once again, If the funds are kept in separate directions, there is less risk of violating this regulation.

These regulations already exist for traditional systems that are held by brokers or intermediate companies for customers. These must:

“Take appropriate measures to protect customers’ property rights, especially in the case of […] Bankruptcy and prevention of the use of a customer’s financial instruments for their own account, except with the express consent of the customer. “

Some custodian banks may already be following these recommendations. So ultimately, according to the document, The security of your tokens at a stock exchange or a custodian largely depends on your care in selecting the tokens to be used.

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