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Comment by jacquesm | Hacker News Reader

For now at least with Coinbase it is the investors funds at risk, not the customers funds. And that example shows how hard it is to run such a business profitably.

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> ... with Coinbase it is the investors funds at risk, not the customers funds

Oh boy are you in for a surprise:

"In its quarterly report, Coinbase added a risk disclosure: if the company were to file for bankruptcy, the court might treat customer assets that the exchange is custodian for -- their Bitcoin, Dogecoin or whatever -- as Coinbase’s assets. And they’d be at the back of the line for repayment, forcing normal people, unaccustomed to the ins and outs of federal bankruptcy court, to claw back their money along with everybody else owed money by the exchange."

From Bloomberg: https://www.bloomberg.com/news/articles/2022-05-11/coinbase-...

Here's the un-editorialized full text from their SEC filing:

> Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors. This may result in customers finding our custodial services more risky and less attractive and any failure to increase our customer base, discontinuation or reduction in use of our platform and products by existing customers as a result could adversely impact our business, operating results, and financial condition.

> Further, we place great importance on safeguarding crypto assets we custody and keeping them bankruptcy remote from our general creditors, and in June 2022 we updated our Retail User Agreement to clarify the applicability of UCC Article 8 to custodied crypto asset — the same legal protection that our institutional custody and prime broker clients also rely upon. UCC Article 8 provides that financial assets held by Coinbase are not property of Coinbase and not subject to the claims of its general creditors. In light of UCC Article 8, we believe that a court would not treat custodied crypto assets as part of our general estate; however, due to the novelty of crypto assets, courts have not yet considered this type of treatment for custodied crypto assets

Source: page 96: https://s27.q4cdn.com/397450999/files/doc_financials/2022/q3...

You call it uneditorialized, but it is simply editorialized in a different direction.

Everything is literally editorialized (first by your brain, then by institutions). A charitable interpretation of the parent comment is that it is not editorialized relative to the original source.

I fail to see what this contributes.

I'll expand: it is in the interest of the writer of this "uneditorialized" document to downplay the risk.

Ouch. Thanks for that. I wonder why the normal customer funds segregation rules do not apply to crypto assets.

See the full text from the SEC filing: "due to the novelty of crypto assets, courts have not yet considered this type of treatment for custodied crypto assets"

Basically, there's no legal precedent. It's anyone's best guess.

> Basically, there's no legal precedent.

We’re about to find out soon.

Go read FTX's statement to Congress from a few months back on why crypto exchanges should not be hobbled by all those old rules about separation of functions.

There's nothing prohibiting a crypto exchange from having a separate company to hold customer's assets. In a bankruptcy, the custody company should still be solvent. That's required in Japan.[1] Customers of FTX Japan still have their assets.

[1] https://www.coinfirm.com/blog/japan-crypto-asset-regulations...

I work a lot with trustees that hold third party funds, there isn't a single one of them that would ever commingle funds to the degree that these exchanges do (or even any degree at all other than to separately invoice customers for work and fees), and all of the rules around such third-party monies should be mandatory for any exchange. But as was pointed out elsewhere in this thread even that may not be enough if an exchange goes bankrupt.

Japan had the first real test of this with Mt. Gox. Regulations are written in blood, unfortunately

Basically, because cryptocurrencies aren't considered "money", and what they are is still kind of up in the air...and because, as so many of its proponents are so proud of (despite it being extremely obviously a temporary state of affairs), cryptocurrency is not yet subject to very many laws and regulations.

You can't have the protections of "money" without the regulations of "money". As long as everything was going fine and government was still dragging its feet catching up to technology, the people who got in early got to pretend there was something special about cryptocurrency that made it possible to have their cake and eat it too.

Now, they're starting to find out why that's not the case.

It may not hold up in court. But at that point, you’re trying to claim assets back from a bankrupt entity.

The disclosure isn’t a statement of what Coinbase would want to happen, but rather what a bankruptcy court might do. Bankruptcy law is very pro-debtor. An entity in bankruptcy court is like a Hoover, aggressively sucking any nearby assets into the bankruptcy estate.

For all brokers, margin accounts can be rehypothecated if broker fails. This is as true for Fidelity as for Coinbase.

This isn’t true in the case of bankruptcy. Note that in early 2022, Coinbase updated it’s disclosures to include that customer coins could be used as collateral to pay debts. That would leave customers as unsecured creditors (ie, stuck at the back of the bankruptcy line).

https://finance.yahoo.com/news/coinbase-keep-customer-balanc...

Yes, Polygamous_bat below made the same observation, I wasn't aware of this at all.

So what does that tell about the exchanges that are managed in an unauditable way...

Essentially that they are most likely dipping in to support either their operations or other projects from the customer funds. That's not proof, but I would not at all be surprised if there isn't a single one of them that is clean.

I mean, being the custodian of funds actually costs money, one should wonder about the motives of the exchanges offering custody for the funds.

There are many banks in europe that will not open accounts for people who just moged there, unless they bring along plenty of money.

This simply means that having your coins on an exchange is the same a forfeiting them unless otherwise proven.

But the crypto exchanges double down on that, they speculate like the banks do, but with zero risk managment and oversight, the biggest accounting firms do not want to offer their services to them.

They have also leveled up their exit strategies, instead of the plain old run away, they run the business while they can extract money and then later they seek legal cover under the umbrella of bankruptcy laws.

There is also the possibility that they have too many assets due to participating in money laundering or tax evasion.

There really aren't a lot of good possibilities here, how did these exchanges get so large before anyone thought of audits?

> how did these exchanges get so large before anyone thought of audits?

Who said no one thought of this? There was simply no one to enforce this.

Look at Coinbase. They made a point of being “regulated in the US”. They’re audited. They’re legit (most likely. I’m not the auditor). They’re complying with disclosure laws as a publicly traded company.

Look at Patio11, he’s been publicly making claims about tether and the crypto ecosystem for years. If it all blows up and his speculation /research was right, then who is to blame? We’ll have years of boy crying wolf and we thought it was a sheep.

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