The global popularity of digital assets is paving the way to a more open financial system. However, market participants who do not fully understand how their assets are held are unknowingly putting those assets at risk.
While regulators require regulated service providers such as Paxos to hold customer assets bankruptcy remote, some market participants have only a vague understanding of how crucial this is in protecting their assets.
Paxos’ regulatory status protects customers
Paxos Trust Company LLC (“Paxos Trust”) is a regulated financial institution with a primary prudential regulator, which means every aspect of Paxos Trust’s operations is supervised by the New York State Department of Financial Services (NYDFS).
NYDFS sets standards that Paxos Trust must comply with, and this obligation supersedes our goals of deploying safe, regulated financial tools at scale for the Web3 ecosystem and everyday finance.
These are some of the actions our regulator requires of Paxos Trust:
- Ensure all stablecoins issued by Paxos Trust are fully-backed 1:1 by cash and cash equivalents (i.e., US Treasuries with a maturity of less than 90 days and overnight loans secured only by US Treasuries).
- Hold all customer funds segregated from company funds, which helps protect them in the unlikely event of Paxos bankruptcy.
- We avoid the risky business practices of lending off-platform, borrowing against customer funds or speculating.
Web 3.0 or Web3 is the third generation of the World Wide Web (WWW). Currently a work in progress, it is designed to be a decentralized and open web with greater utility for its users. 1
1 Investopedia, Web 3.0 Explained, Plus the History of Web 1.0 and 2.0, Investopedia team devices.
In addition to meeting our regulatory obligations, Paxos Trust extends protection to our enterprise customer funds in several overlapping ways:
- Paxos Trust has been regulated in the US since 2015 and that experience gives us unique market insights.
- Paxos Trust earns money on transaction fees; Paxos Trust is never allowed to lend out customers’ funds (and, for clarity, no Paxos entity ever lends out customers’ funds).
- Paxos Trust is transparent about third-party audits and examinations.
This overlap in protections ensures money held in customers’ accounts is protected in various ways, but one of the the foundations of that protection is in holding assets bankruptcy remote.
Regulators require regulated service providers such as Paxos Trust to protect customer assets from bankruptcy.
Paxos Trust protects customer assets from bankruptcy
The term “bankruptcy remote” means that in the unlikely event of Paxos Trust’s insolvency, customer assets are protected.
When a bankruptcy occurs, customers can be unsecured creditors of a crypto trading platform, thus exposing their funds to an often lengthy bankruptcy liquidation process, which means waiting behind creditors with secured claims. Unsecured creditors share whatever is leftover after secured claims are paid, which is often less than they are owed and can be nothing at all.
One of the primary reasons for some of the high-profile market collapses is that other platforms are not holding customer funds fully segregated. If they are not a Trust company, they are not required to do so. Therefore even if a non-trust company says they are holding assets fully segregated there still is no legal or regulatory obligation—or accountability—for customer assets to be held protected from bankruptcy.
Paxos Trust is legally obligated to hold assets fully segregated and thus bankruptcy remote such that customer assets are always protected under New York law.
“Bankruptcy remote” means that in the unlikely event that Paxos Trust should become insolvent, customer assets are protected.
Regulators enforce customer protections
Although Paxos Trust is built to protect customer assets, the fact that we are required to do so by our prudential regulator reassures our clients in the unlikely event of a Paxos Trust bankruptcy.
Paxos Trust is required to operate differently than a bank, and in particular, does not hold fractional reserves and instead holds all customer assets 1:1, ensuring customer funds are always available for redemption. Paxos Trust will never lend out customer assets.
In the evolving digital asset ecosystem, choosing the right partner to custody your assets is paramount. A company that is required by a primary prudential regulator to hold assets bankruptcy remote is the highest standard in customer protection.
When searching for a digital asset provider, it’s best to opt for a trust company that is required by regulators to hold assets bankruptcy remote, thus protected from bankruptcy. Understanding the ways in which your customers’ assets are protected—or not—is the key to choosing a service provider who makes protecting your customers’ assets the standard.