What are the rights of customers in case of bankruptcy of cryptocurrency exchanges?

A new paper published by Oxford University Law School examined the legal risks of depositing money into custodial services in the event of bankruptcy. The article, which the faculty included in its post dated 1 June, stated that regulation and enforcement can help mitigate the risk.  Cryptocurrencies first emerged as a solution to get rid of the intervention of government, banks and other intermediaries.  Bitcoin (BTC) and most other cryptocurrencies are currently stored in custodial services such as exchanges instead of investors.  This leads to the possible insolvency of exchanges and significant risk to customer rights in relation to their held assets. It is common for exchanges to fail, and it can take years for customers to learn what happened to their money.

Setting the Law

The article shared on the blog states that customer rights are ultimately based on applicable bankruptcy and property laws. The lack of international standards regarding the legal status of cryptocurrency, combined with the global nature of blockchain-based transactions, makes it difficult to determine which laws apply. The article states that ideally, the contractual law between the custodian and the customer should be prioritised, while the local law of the region where the custodian's company is located should be the next option.

Pooled Funds or Segregated Addresses

Cryptocurrency custody services generally store clients' assets in two ways: A pooled blockchain address or segregated blockchain addresses. The first option carries a great risk, as it is possible that cryptocurrencies deposited by one client could be used for the benefit of another client. This could be vital for recovering assets in the event of bankruptcy. If the individual assets are still located at the blockchain address of the custodian, the client's claim to these assets will be more valid in most cases.