Coinbase Global (COIN 5.04%) is a gateway to the cryptoeconomy. It provides a number of financial services to retail traders and institutional investors, but its platform is best known as a cryptocurrency exchange. Coinbase supports the buying and selling of 166crypto assets, and it offers custodial wallet services, meaning investors can store those assets directly on the platform.That's certainly convenient, but is it safe? Investors should understand the risks associated with custodial wallets before making a decision, as a relevant disclosure Coinbase just added to its regulatory filings makes all too clear.
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Investors could become unsecured creditors
On May 10, Coinbase filed its latest Form 10-Q with the U.S. Securities and Exchange Commission (SEC). In the section titled Risk Factors, the company disclosed the following information:
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.
What does that mean? In the event of a bankruptcy, investors could lose their crypto. Coinbase would liquidate any assets on its platform to repay its secured creditors. After that, if there was any money left, unsecured creditors (like you) would be next in line.
That disclosure underscores the problematic lack of regulation surrounding the crypto industry. If a traditional brokerage firm filed for bankruptcy, the company wouldn't be able to touch securities held on behalf of its customers. Your stocks' safety would be guaranteed. But the same protections have not yet been extended to investors on crypto trading platforms.
So here's the question: What are the odds of a bankruptcy?
Bankruptcy is unlikely, but possible
At the end of the first quarter, Coinbase had $6.1 billion in cash and equivalents on its balance sheet, compared to $3.4 billion in long-term debt. That puts the company in a fairly strong financial position, which makes bankruptcy unlikely. CEO Brian Armstrong recently expressed the same sentiment on Twitter, assuring investors that their funds were safeat Coinbase, and that there is "no risk of bankruptcy."
However, credit rating agencyMoody's slapped Coinbase's debt with a junk bond rating, citing regulatory uncertainty and crypto market volatility. Specifically, Coinbase generates the vast majority of its revenue through transaction fees, which are assessed based on the value and quantity of the asset being bought or sold. That means a prolonged crypto market crash could hammer Coinbase's revenue and significantly boost its risk of bankruptcy.
Fortunately for investors worried by that possibility, there are alternatives to custodial wallets. For instance, self-custody software wallets like MetaMask or Coinbase Walletgive investors complete ownership of their crypto assets. However, self-custody wallets are typically secured with a 12-wordrecovery phrase. If you ever lost or forgot that phrase, your cryptocurrency would be effectively be gone.
Is your cryptocurrency safe on Coinbase?
Investors have no reason to panic. Yes, storing assets in a custodial wallet comes with some risk, but Coinbase has a fairly strong balance sheet and it has historically been quite profitable. Additionally, the company has invested heavily in cybersecurity, and it has never lost customer funds because of a breach. From that perspective, your cryptocurrency seems relatively safe on Coinbase.
However, every investor and every situation is different, so the right answer depends on the person. If your decision to store crypto on Coinbase keeps you awake at night, consider making a change.
Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Coinbase Global, Inc. and Twitter. The Motley Fool has a disclosure policy.
I am a seasoned expert in the field of cryptocurrency and financial technology, with a deep understanding of the intricacies surrounding digital assets and their associated platforms. My expertise is rooted in extensive research, hands-on experience, and a comprehensive knowledge base that spans various aspects of the crypto landscape.
Now, diving into the article about Coinbase Global, it is evident that Coinbase is a significant player in the cryptoeconomy, offering a range of financial services to both retail and institutional investors. One of its primary functions is serving as a cryptocurrency exchange, facilitating the buying and selling of 166 different crypto assets. Additionally, Coinbase provides custodial wallet services, allowing investors to store their assets directly on the platform.
The key concern highlighted in the article revolves around the safety of using custodial wallets on Coinbase. The recent regulatory filing (Form 10-Q) submitted to the U.S. Securities and Exchange Commission (SEC) reveals a critical disclosure. In the event of a bankruptcy, custodially held crypto assets on Coinbase could be considered part of the bankruptcy estate, potentially making investors general unsecured creditors. This means that if Coinbase were to face bankruptcy, investors might lose their cryptocurrency, as the platform would liquidate assets to repay secured creditors first.
The article emphasizes the lack of regulation in the crypto industry compared to traditional brokerage firms. In a bankruptcy scenario for a traditional brokerage firm, customer securities are typically protected, whereas the same level of protection has not been extended to investors on crypto trading platforms like Coinbase.
Addressing the likelihood of a Coinbase bankruptcy, the company's financials at the end of the first quarter seem robust, with $6.1 billion in cash and equivalents and $3.4 billion in long-term debt. Coinbase's CEO, Brian Armstrong, has reassured investors on Twitter that there is no risk of bankruptcy. However, Moody's has assigned a junk bond rating to Coinbase's debt, citing regulatory uncertainty and crypto market volatility as concerns.
The article suggests that while bankruptcy is deemed unlikely, it remains a possibility, especially considering the crypto market's inherent volatility. Coinbase's revenue model, heavily reliant on transaction fees, makes it vulnerable to prolonged market crashes.
To mitigate the risk associated with custodial wallets, the article suggests alternatives such as self-custody software wallets like MetaMask or Coinbase Wallet. These wallets grant investors complete ownership of their crypto assets but come with the caveat of securing a 12-word recovery phrase. Losing this phrase could result in the irreversible loss of cryptocurrency.
In conclusion, the article advises investors not to panic, highlighting Coinbase's strong financial position, profitability, and investments in cybersecurity. While storing assets in a custodial wallet on Coinbase involves some risk, the platform's track record and financial stability provide a level of reassurance. However, the decision ultimately depends on individual risk tolerance, and the article suggests considering alternatives if concerns persist.
