US lawmakers propose rules to safeguard crypto investors when exchanges collapse

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A bipartisan duo of US senators introduced a bill that would aim to protect investors in the event that a cryptocurrency exchange files for bankruptcy by ensuring that their digital assets would be held separate.

The Responsible Financial Innovation Act, introduced by Senators Kirsten Gillibrand and Cynthia Lummis on 7 June, would provide legal clarity for investors, creditors and crypto exchanges about the treatment of digital assets in bankruptcy, ensuring that assets are appropriately safeguarded in an insolvency, according to an overview of the legislation.

The bill would bring digital assets under an existing framework established by the Commodity Futures Trading Commission, a government agency that regulates the market for financial derivatives. It would also require digital assets to be segregated from the assets of the custodian, according to the legislative text.

The legislation was introduced following the uproar created by Coinbasesdisclosure that in the event of a bankruptcy, the exchange believes that the crypto assets it holds in custody for its customers would no longer really belong to them anymore. The exchanges statement was made after the Securities and Exchange Commission said in March cryptocurrency exchanges would have to report the digital tokens they hold for customers on their balance sheets and the holdings would effectively be treated as unsecured loans to the exchanges.

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Although the bill is regarded as having a limited chance of passage and other lawmakers havent signed on to it, it is the first legislation that attempts to address how investors digital assets may be treated in the event of bankruptcy.

Financial securities such as stocks and bonds are held by customers at a registered brokerage and are kept separate from the brokerages own assets, meaning they are protected even if the brokerage files for bankruptcy. But the rapidly proliferating crypto exchanges lack such investor protections.

If one of them were to file for chapter 11, the digital assets they hold would be treated as part of the bankruptcy estate, the pool of value that creditors try to get their money back from in a financial restructuring. Account holders would likely be unsecured creditors in this scenario, and could face an uphill battle to recover the money they invested.

Daniel Kahan, a partner at law firm King & Spalding, who co-leads the firms cryptocurrency practice, said that providing clarity on the bankruptcy issue in particular is important not just for understanding the business condition of various digital asset companies and exchanges, but also for encouraging and facilitating capital formation in the space.

The bill also contains a number of other provisions concerning how digital assets should be accounted for and subject to taxation, as well as requirements that exchanges provide information to investors regarding their source code and legal treatment.

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Critics of the bill said that it would take some aspects of crypto regulation out of the purview of the SEC and would allow some issuers of digital currencies to be subject to weaker disclosure requirements than public companies face.

Adam Levitin, a professor of bankruptcy and financial regulation at Georgetown Law, said that the bill would not relieve crypto investors of all bankruptcy risk, but would reduce the risks that they face.

There would still be liquidity problems if a crypto exchange fails. And if the exchange fails because it is hacked, this bill does nothing, Levitin said, adding that one solution would be to have an insurance requirement protecting investors in the case of a hack.

Lummis is known as one of the most enthusiastic advocates of cryptocurrency in the Senate, and said in her 2022 financial disclosures that she owned between $100,000 and $250,000 of bitcoin.

Write to Alexander Gladstone [email protected]

This article was published by Dow Jones Newswires, a fellow Dow Jones Group service

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