Bitcoin Exchange Custody Risks

Counterparty Risk in Exchange-Held Bitcoin

This memo is published by CustodyStress, an independent Bitcoin custody stress test that produces reference documents for individuals, families, and professionals.

What Exchange Custody Means

Bitcoin sits on an exchange. The holder uses the exchange for buying, selling, and storing bitcoin. The exchange controls the private keys. The holder controls an account. When stress occurs, the holder or their heirs interact with the exchange rather than with the bitcoin directly.

This document addresses how bitcoin exchange custody risks emerge under death, incapacity, account restriction, and legal complexity. The exchange acts as an intermediary between the holder and the bitcoin. The memo observes how this intermediation behaves under stress without evaluating whether exchange custody serves any particular purpose.

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What Exchange Custody Means

Exchange custody means the exchange holds the private keys. The holder has an account. The account shows a balance. The holder can request withdrawals. The exchange decides whether to process those requests. The holder depends on the exchange to honor the displayed balance.

This differs from self-custody where the holder controls the keys directly. In self-custody, no intermediary exists between the holder and the bitcoin. In exchange custody, the exchange sits between them. Every action passes through the exchange.

Leaving bitcoin on exchange risks creating dependency on a single institution. The institution's policies, solvency, and responsiveness determine access. The holder's ability to move bitcoin depends on the exchange's willingness and ability to process requests.

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Bitcoin Exchange Custody Risks: Counterparty Dependence

Bitcoin exchange custody risks begin with counterparty dependence. The exchange is a counterparty. The holder depends on the exchange remaining solvent, operational, and cooperative. If any of these fail, access becomes constrained or blocked.

Solvency risk means the exchange might fail financially. Exchanges have failed before. When they fail, customer funds may be frozen, delayed, or lost during bankruptcy proceedings. The holder becomes a creditor waiting for resolution rather than a bitcoin owner with immediate access.

Operational risk means the exchange might experience technical problems, security breaches, or service interruptions. During these periods, withdrawals may be paused. The holder sees a balance but cannot move it. The bitcoin exists but access is blocked by operational circumstances.

An exchange experiences a security incident. Withdrawals are halted while the exchange investigates. The halt lasts three weeks. During those weeks, holders can log in and see balances. They cannot withdraw. The bitcoin price moves significantly. Some holders want to sell. They cannot. The exchange controls the timeline.

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Exchange Custody Bitcoin Risk: Account Restrictions

Exchange custody bitcoin risk includes account-level restrictions that can occur without exchange-wide problems. A specific account may be flagged, frozen, or placed under review while other accounts operate normally.

Compliance reviews happen for various reasons. The exchange's systems flag unusual activity. Regulatory requirements trigger enhanced verification. Law enforcement requests information. The account holder may not know why the review started. The account holder waits while the exchange conducts its process.

A holder makes a large deposit followed by a withdrawal request. The exchange flags the transaction for review. The holder receives a notice that the account is under compliance review. The holder provides requested documentation. The review takes eight weeks. During those weeks, the holder cannot withdraw bitcoin. The review eventually clears. The holder regains access. The delay was not related to any wrongdoing by the holder.

Account restrictions can occur suddenly and without warning. The holder logs in one day and discovers withdrawals are disabled. No advance notice was given. The reason provided may be vague. The timeline for resolution may be unclear. Exchange custody bitcoin risk includes this uncertainty about when restrictions might appear and how long they might last.

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Bitcoin Exchange Inheritance Risk: Death of Account Holder

Bitcoin exchange inheritance risk describes what happens when the account holder dies. The bitcoin remains on the exchange. Heirs or executors attempt to claim it. The exchange requires documentation before releasing funds.

The exchange does not automatically know the holder has died. The account sits unchanged until someone contacts the exchange. That contact begins an estate process specific to each exchange. The process requires proving death and proving authority to claim the assets.

Common requirements include death certificates, probate court documents, letters testamentary, and identity verification for the claimant. Each exchange has its own forms and procedures. Some exchanges respond quickly. Others take months. The timeline depends on the exchange, not on the heir's urgency.

A man dies with bitcoin on two exchanges. His wife begins the estate process. Exchange A has a clear estate claims process documented on its website. She submits documents and receives the funds in seven weeks. Exchange B has no documented process. She calls customer support multiple times. She receives conflicting instructions. The process takes five months. Same death, same wife, same legal authority. Different exchanges, different experiences.

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Incapacity and Access Gaps

Incapacity creates different problems than death. The holder is alive but cannot manage the account. A stroke, dementia, accident, or mental health crisis may leave the holder unable to log in, respond to verification requests, or communicate with the exchange.

The account requires the holder's credentials. Two-factor authentication requires the holder's device. Security questions require the holder's memory. The exchange built these protections to prevent unauthorized access. They now prevent authorized family members from accessing the account.

A daughter holds power of attorney for her incapacitated father. She contacts the exchange to access his bitcoin. The exchange requires verification from the account holder. The account holder cannot respond due to his medical condition. The daughter provides power of attorney documents. The exchange requests additional documentation. The process extends for months while the daughter navigates the exchange's requirements for incapacity situations.

Incapacity often lacks the clear documentation that death provides. Death certificates are definitive. Incapacity determinations may be contested, partial, or unclear. The exchange may not know how to evaluate medical documentation or legal authority short of full probate.

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Leaving Bitcoin on Exchange Risks: Jurisdictional Exposure

Leaving bitcoin on exchange risks exposure to jurisdictional complications. The exchange operates under the laws of its home country. The holder lives somewhere. The heirs live somewhere. These locations may all differ, creating overlapping legal requirements.

An exchange based in one country may not recognize probate documents from another country. Estate processes valid in the holder's home jurisdiction may be meaningless to the exchange. The heir may need to obtain additional legal documents, translations, or apostilles before the exchange will act.

Cross-border inheritance adds time and cost. Attorneys in multiple jurisdictions may be needed. Documents may require notarization, authentication, or translation. The exchange may have limited experience with foreign estates and may not know what to request or accept.

A U.S. citizen dies with bitcoin on an exchange based overseas. His children live in the United States. They obtain U.S. probate documents. The exchange does not recognize U.S. probate. The exchange requires documents from its home country. The children hire a foreign attorney to navigate requirements they do not understand. The process takes over a year. The bitcoin sits inaccessible throughout.

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Legal Disputes and Account Freezes

Legal disputes can freeze exchange accounts. Divorce proceedings may result in court orders freezing assets. Creditor actions may attach exchange balances. Government investigations may require asset preservation. The holder may lose access not because of the exchange but because of external legal process.

The exchange complies with legal orders. If a court orders an account frozen, the exchange freezes it. The holder cannot withdraw regardless of their own intentions. The dispute may take months or years to resolve. The bitcoin remains frozen throughout.

Disputes among heirs can also freeze access. If multiple people claim the same account, the exchange may refuse to release funds until the dispute is resolved. The exchange protects itself from liability by waiting for legal clarity. The heirs wait while attorneys argue.

Two siblings both claim to be the rightful heir to their father's exchange account. Each provides different estate documents. The exchange cannot determine who has authority. The exchange places the account on hold pending resolution. The siblings litigate for eighteen months. The bitcoin does not move until the court decides who inherits it.

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Credential Loss and Recovery Barriers

Exchange accounts require credentials: usernames, passwords, two-factor authentication devices, email access, and security question answers. Loss of any of these creates recovery barriers.

When the account holder is alive, they can usually recover access through identity verification. The exchange has processes for forgotten passwords and lost devices. These processes assume the account holder is available to participate.

When the account holder is dead or incapacitated, credential recovery becomes more complex. The heir may not know the email address used. The heir may not have the phone that receives authentication codes. The heir may not know the answers to security questions. Each missing piece adds friction to the recovery process.

The exchange balances security against estate access. Making access too easy would expose accounts to fraud. Making access too hard blocks legitimate heirs. Different exchanges strike different balances. The heir navigates whatever process the specific exchange has established.

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Partial Access Patterns

Heirs sometimes achieve partial access. They can log in to the account. They can see the balance. They cannot withdraw. The exchange has restricted the account pending estate verification. Observation without control.

Partial access can persist for extended periods. The heir watches the bitcoin price change daily. They can calculate exactly what the inheritance is worth at any moment. They cannot touch it. The value is known. The access is blocked.

A widow has her late husband's phone and laptop. She can log in to his exchange account. She sees his bitcoin balance. She attempts a withdrawal. The exchange flags the account because the withdrawal pattern differs from the deceased's history. The exchange requires estate documentation before processing withdrawals. She has view access. She does not have transfer access.

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What Does Not Change

Exchange custody does not eliminate the need for estate planning. The bitcoin may be easier to locate on an exchange than in self-custody. The exchange still requires documentation before releasing it. Legal authority still matters. The route differs from self-custody, but the need for preparation remains.

Exchange custody does not eliminate loss risk. The exchange may fail. The account may be frozen. The estate process may take longer than expected. The heir may face jurisdictional barriers. Different risks apply, but risk does not disappear.

Exchange custody does not change tax treatment. Estate taxes apply to exchange-held bitcoin the same as self-custody bitcoin. The value on the date of death determines inclusion in the estate. The custody method does not alter the tax obligation.

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Assessment

Bitcoin exchange custody risks describe the survivability surfaces that emerge when bitcoin is held on an exchange rather than in self-custody. The exchange acts as an intermediary. Access depends on the exchange's solvency, policies, and responsiveness. Heirs and executors interact with compliance processes rather than cryptographic recovery.

Bitcoin exchange inheritance risk routes through institutional documentation requirements. Leaving bitcoin on exchange risks jurisdictional complications when exchanges and heirs operate in different countries. Account restrictions, legal disputes, and credential loss all create barriers that differ from self-custody failure patterns.

This memo describes modeled behavior of exchange custody under stress. The observations remain descriptive of how exchange custody operates and do not assert that any custody method produces particular outcomes under any particular circumstance.

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System Context

Examining Bitcoin Custody Under Stress

When to Move Bitcoin Off Exchange

Bitcoin Allocation Hot vs Cold Storage

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