We’ve seen some of the biggest names in crypto crash and burn in recent weeks and there will probably be more to come. But what’s clear is that it’s more important than ever for investors to know whether a company has a sound financial footing or is simply another cowboy outfit. What this all boils down to are several simple things, like segregation of funds.
Why we’re talking about this
Last week, the publicly-traded cryptocurrency broker Voyager Digital filed for Chapter 11 bankruptcy protection. Voyager is the latest victim of the fallout from the collapse of Terra’s $4bn algorithmic stablecoin.
This filing comes days after Voyager halted all trading, deposits and withdrawals for customers. The funds at Voyager dried up after disgraced hedge fund Three Arrows Capital, itself a major casualty of the Terra collapse, defaulted on a loan of more than $650 million. According to Bloomberg, customers shouldn’t expect to get all their crypto back.
But it’s not just lending platforms and brokers that are caught up in this latest revelation of mass financial mismanagement. Thanks to Coinbase’s legal status as a publicly listed company on Nasdaq, they are under strict disclosure requirements.
In one of the company’s regulatory filings, this statement jumped out and played a role in the firm’s crypto trading market share slipping to 4.8%:
“Custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”
This statement, buried on page 89 of a 142 page document, lays bare the reality of storing your funds with Coinbase. If the firm goes bankrupt, your funds are legally considered theirs by a bankruptcy court.
For any people still on the fence about where to park their crypto, this is yet another reason to keep your funds clear of both Coinbase and the United States.
Guarantees of safety are essentially superficial if companies like Coinbase and Voyager can sail through to public listing and still have unrestrained access to customer funds.
Here’s the bottom line:
In America, along with many other jurisdictions, there is no legislation that requires digital asset companies to segregate customer funds from their own. In other words, if your funds are on an exchange in America, the company is free to take those very same funds and lend them out or invest as it sees fit. And if that company goes bankrupt and funds are not returned by their lender? You can kiss your money goodbye as it is considered property of the exchange.
What needs to happen next
For digital assets to grow even more popular and achieve their true potential, customers must feel able to trust protocols, exchanges and other institutions. For this to happen, we need the segregation of funds to be a legal requirement everywhere. The first step is for investors to check where exchanges and other platforms are registered. The next step is to investigate whether there is legislation in place to regulate digital asset exchanges in that territory, with a special focus on the segregation of customer funds.
When we set up SMART VALOR, Europe’s first Nasdaq-listed digital asset exchange, we made a conscious decision to choose jurisdictions that already have a strong, customer-focused regulatory environment. That’s why we’re headquartered in Switzerland and registered in Liechtenstein, two of the world’s leading financial hubs.
The FMA, along with the Government of Lichtenstein, started work on creating a comprehensive regulatory framework for blockchain as early as 2016. The Blockchain Act went live in 2020 and SMART VALOR became one of the first exchanges to receive authorization as a custodian and exchange operator that same year.
This was not an easy task. The list of requirements to qualify is long and includes review of management and board members, robust AML measures and secure custody of assets. One of the key requirements under the Blockchain Act is the segregation of funds, which means that we cannot use customers funds. Customer funds must be kept in separate accounts and can only be touched when customers withdraw or buy crypto.
It sounds simple, right? A common-sense piece of legislation to keep crooked companies from abusing customer funds. Unfortunately, this fundamental requirement is often not implemented in other territories due to a lack of proper regulation. It goes without saying that there are some restrictions in place for crypto companies, but, as the unlucky Voyager customers came to learn, not for the segregation of funds.
We need segregation to make crypto safer for everyone
I believe that digital assets are the future of finance and my mission in life is to implement that change for the benefit of wider society. I’ve been lucky enough to go through that life-changing experience and had to learn the hard lessons myself. Now I want to make it accessible and secure for everyone else.
For some founders, taking a company public is a milestone that leads to a big payday and an opportunity to their foot off the gas. For me, SMART VALOR becoming the first listed exchange on Nasdaq in Europe is a commitment to living out our belief in industry best practices in a public forum. In fact, in our very IPO announcement, I stated that we want to represent industry best practice for governance and investor protection through regulation.
Transparency is one of the fundamental pillars of digital assets and one of the most powerful tools in making cryptocurrency an accessible industry for anyone. Being a public company means we have the opportunity to set a benchmark for how funds should be managed and create trust through our commitment to regulation and transparency.
The most important lesson of this latest bear market is not that companies fail or that digital assets are volatile. It’s that we need to do more as an industry to make uniform legal requirements such as segregation of funds a standard for digital asset companies around the world. Serious breaches of trust happened across the industry in the past few years. It’s our responsibility to lock out the cowboy companies and make sure the industry matures and such things never happen again.
Disclaimer: The data provided in this blog is for information purposes only and should not be construed as investment or tax advice nor as a recommendation to buy, sell, or hold any particular security. SMART VALOR believes the data in this blog is accurate, but does not verify its accuracy independently and does not warrant or guarantee that it is accurate or complete. SMART VALOR has no obligation to provide any updates or changes to the data. No investment decisions should be made using this data.
Risk Disclosure: Cryptocurrencies can fluctuate widely in prices and incur permanent loss of capital and are therefore not appropriate for all investors. Trading cryptocurrencies is not supervised by any EU regulatory framework. Past performance does not guarantee future results. Trading history presented is less than 5 years and may not suffice as basis for investment decision. More information is available under Risk Disclosure.