The Coinbase Insurance Problem

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About: Bitcoin Investment Trust (GBTC), Includes: BTC-USD, COIN
by: John Rhodes
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Summary

Are your Bitcoins more "safe" when you directly own through a major company such as Coinbase?

Surprisingly, although Coinbase has insurance, coverage is extremely limited and not much better than that of Xapo (which has zero insurance).

Safety, security, and basic Bitcoin insurance matters are discussed relative to Coinbase, Xapo and Grayscale Bitcoin Investment Trust.

As I've already explained in "Why Are GBTC Bitcoins Naked?" the Bitcoins for the Grayscale Bitcoin Investment Trust (OTCQX:GBTC) are not covered by insurance. That's because Xapo is the Bitcoin custodian and it doesn't have any insurance. I also briefly explained that you can quickly and directly own Bitcoin through a company like Coinbase or Kraken.

The gears started turning in my mind about insurance of Bitcoin. That is, we can ask: Is there "insurance safety" in directly holding Bitcoin?

Other people started asking me about Bitcoin insurance, specifically with Coinbase. In light of that, here's a posting worth seeing:

Coinbase Insurance

It seems like Herbert is onto something here.

Before we get too far, we need to step back and ask a fundamental question: Does Coinbase have insurance?

The answer is "Yes." Take a look, and then I'll explain the two things that matter to investors, especially those interested in GBTC.

Limited Coverage

So, Coinbase does have insurance which seems far better than what we see with Xapo and GBTC on the surface. But, take a look at the situation. While it's true that there's insurance, it's only true for the Bitcoin online. As indicated in #1, just 2% of Coinbase funds are online, so fully 98% of all Coinbase funds are NOT insured.

See #2 in the image above. For the 2% that is covered, the policy doesn't protect individual accounts. In short, if hackers go after "Coinbase" online, then you might be covered. But, if hackers go after your personal account or "wallet" online, or any of the remaining funds offline, then there is no insurance in place. You're barely covered even though you directly own your Bitcoin via Coinbase.

And what about Grayscale Bitcoin Investment Trust?

Coinbase barely has more insurance than Xapo, and therefore, it barely has more insurance than GBTC. Even a well-funded (see here and here) and well-known Bitcoin company barely has insurance coverage.

It gets a bit more interesting in terms of security, insurance, coverage and vulnerability when you read this from Coinbase:

Coinbase stores all customer fiat currency (government-issued currency) in segregated, custodial bank accounts. The funds held in those accounts belong to Coinbase’s customers - not to Coinbase.

If you are a United States resident, your Coinbase USD Wallet is covered by FDIC insurance, up to a maximum of $250,000.

It looks like you can sleep safe and sound with your government-issued money at Coinbase via FDIC insurance. By keeping your money in U.S. dollars, you've got that extra safety and it goes pretty deep. But your Bitcoin, not so much.

Summary

We explored the idea that perhaps Xapo might want to follow Coinbase in terms of insurance, since Xapo is the custodian of Bitcoin for GBTC. That is, could the Coinbase insurance model work for GBTC? The answer is that maybe it could, but the coverage would be so limited as to be nearly pointless. In fact, the coverage Xapo previously had was limited and was mostly likely similar to the current Coinbase coverage. Furthermore, this exploration demonstrates that GBTC, like most things Bitcoin related, is still operating in Wild West mode.

Can GBTC use the Coinbase insurance strategy? Yes, maybe, if GBTC pushed Xapo really hard to get insurance, or if it switched Bitcoin custodians. But the Coinbase approach seems so limited as to be useless. Why bother?

These are early days still, and risks are high for Bitcoin and GBTC, and these are outside of the second-by-second price changes we can all see on the screen. Maybe there's a bubble, and maybe there's not. Either way, risks are very high right now. Caveat emptor!

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.