Thread by @CaitlinLong_

1/ SO MANY TRUTH BOMBS in this terrific blog post.🧐MUST READ for US customers of #crypto exchanges/custodians (hint:😱, if yours goes bankrupt). Note @AdamLevitin analysis applies US-wide *EXCEPT* in #Wyoming bc it mostly fixed the very issues he lays out creditslips.org/creditslips/20…

2/ Truth bomb #1: "I do not think customers understand the legal nature of the custodial relationships, and exchanges have no incentive to make the legal treatment clear to customers." ...

3/ "In bankruptcy, it is likely to be treated as a debtor-creditor relationship, not a custodial (#bailment) relationship. That means that customers are taking on REAL CREDIT RISK with the exchanges, which is a particular problem because of the opacity of the exchanges..."🎯

4/ My comment: great commercial for why custody in #bailment offers more legal protections than those standard in the mkt today. That doesn't exist in most places tho, except Wyoming (via SPDI banks, which are allowed to offer custody in bailment on an underlying #crypto asset)🤠

5/ What is custody as #bailment? Same laws as for coat checks/valet parking--basically you drop off your property for safekeeping, but you still own it. Custody for #crypto & securities doesn't work this way tho--instead, you lend your asset to your intermediary, which owns it.☠️

6/ Where can you get custody as #bailment for your #crypto? In #Wyoming SPDI banks. Wyoming enacted legal framework for it in 2019. No SPDIs are operating yet (incl @AvantiBT). Once they are, it'll be interesting to see if custody market bifurcates to prefer custody in bailment🤔

7/ Truth bomb #2: "But wait, you bluster, the custodial agreement clearly says that I am the owner, that it’s my property, that I retain title to it. Yup, but that’s not how the law actually works. Just because they wrote that doesn’t mean it’s true."

8/ "Once deposited with the exchange, the customer does not have the possessory interest and, as explained below, the customer might not have any interest at all, because the transaction could well be deemed a sale, not a deposit."🎯

9/ "At the very least, the cryptocurrency exchange has a possessory interest in the cryptocoins. If that’s all there is, you might get your coins back, but it won’t be immediate or automatic, and you won't be able to trade in the interim."😲✅

10/ Truth bomb #3: "Things get much worse, however, if the exchange has any right to use the cryptocurrency—to #rehypothecate it or to use its staking rights—that too is property of the estate."😱✅🎯

11/ Truth bomb #4: "Here’s why it matters whether the crypto is “property of the estate.” When the exchange files for bankruptcy there is a stay that goes into place automatically of almost all attempts to collect from the property of the estate."

12/ "Unless the crypto exchange’s customers have a right to get back the specific cryptocurrency they deposited with the exchange (coin #25601), however, they are not likely to succeed because the court is likely to say that they do not “own” the coins. They are just creditors"

13/ Truth bomb #5: "Not only are the customers likely mere creditors, but they are also likely general unsecured creditors, which means they will have to wait at the back of the line for repayment with everyone else."

14/ "They will share on a pro rata basis whatever assets are leftover (if any) after secured creditors & priority creditors (incl bankrupty expenses) get paid, & any payment might not be for quite a while. That’s not a happy to place to be. Recoveries could be pennies on the $."

15/ "That’s not the end of things, however. Once in bankruptcy, the crypto exchange can clawback certain pre-bankruptcy transfers, like redemptions by its customers as voidable preferences."

16/ "The big point here is the if you are a customer of a cryptocurrency exchange, you risk being a general unsecured creditor of the exchange if it should file for bankruptcy. It doesn’t matter that the exchange’s contract with you says that you “own” the currency."🎯

17/ My comment: All of the above issues are real & weighed heavily in #Wyoming's decision to fix them (which it did in 2019).🤠

@AdamLevitin also adds a CRUCIAL distinction:

"These exchanges are not banks..."💯

Why does that matter--what's so special about BANKS???🏦😉😉😉

18/ Banks (+securities firms) have special receivership laws that generally protect consumers better than the bankruptcy laws that apply to #crypto exchanges/custodians, + asset segregation is often protected by statute📈, not by contract📉. Fiduciary asset managers really care.

19/ Wouldn't it be great if there were a type of #crypto custody BANK that offered customers the superior protection of special receivership laws/statutory asset segregation/option of custody in #bailment, required bank-level capital/reg rqmts + req'd it to have a living will?🤔

20/ That type of #crypto custody BANK exists in #Wyoming. When Wyoming addressed the above issues, many people helped craft its new laws, rules & supervisory exam manual (incl UCC & bankruptcy law scholars). If you'd like to dig in, it's all here: 🤠wyomingbankingdivision.wyo.gov/banks-and-trus…

21/ PS--I've studied these issues for yrs bc there's a lot of unfairness in status quo securities custody too. Even tho securities custodians are BANKS, consumer rights aren't as clear as you'd think--securities are IOUs legally, which clouds receivership. jstor.org/stable/23527077

22/ This is where there's a real oppty in #crypto to upgrade current custody laws & practices so they're fairer to consumers/investors--bc crypto is natively a bearer asset. It doesn't need to be an IOU like securities are (per UCC Art. 8). Crypto custody can be so much better!!

23/ But it isn't, yet. @AdamLevitin is right. Note: custodians (#crypto & securs) may try to offer bailments on IOUs.🤪 But do the legal analysis. Do u gain much from a bailment on an asset that's an IOU on the real thing, vs bailment on the real thing? Follow the property right.

24/ Of course, nothing in this tweet 🧵is legal advice. Make sure you get your own attorney!

But if they do dig in, I think they'll see #Wyoming did a nice job addressing the issues in @AdamLevitin's post & produced the most investor-friendly #crypto custody regime in the US.

25/ The incumbent system for custody (both #crypto & securities) has MANY flaws that favor the intermediary over the consumer. There's no reason why the incumbent system's flaws need to be repeated for the #crypto system.

Better tech+better laws=😊!

#NotYourKeysNotYourCoins🤠