WORDS ON WEALTH
Martin Hesse
To say that 2022 was a nightmare for cryptocurrency investors and the crypto industry as a whole may be regarded as an understatement by the many thousands who lost heavily.
First we had a sharp fall in the prices of cryptocurrencies, which more or less coincided with the decline in the global tech stocks. This precipitated a series of collapses of various tokens and platforms culminating in the fall of the second-largest crypto exchange on the planet, FTX, which turned out to be a gigantic Ponzi scheme. The result was an abrupt reversal in any credibility crypto had acquired as an investment and a newfound determination by regulators to clamp down on the industry.
This when crypto was slowly beginning to gain some respectability. In a column back in August 2020, “Signs that crypto is coming of age as an investment”, I noted that, after wild fluctuations, the price of Bitcoin appeared to be stabilising, governments were becoming interested in digital currencies as alternatives to fiat currencies, and, importantly, big institutional investors were dipping their toes in the crypto pond.
The failures behind the demise of FTX in November are mind-boggling. A report by the Financial Times on FTX’s bankruptcy hearings in Washington DC last year quotes John Ray III, a veteran insolvency professional who oversaw the liquidation of Enron. Ray said FTX was the worst case of corporate failure that he had seen in his more than 40-year career. “Never have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information,” he wrote. FTX failed to keep proper books, records, or security controls for the digital assets it held for customers.
Compounding the failures at FTX were the actions of large institutional investors, which ploughed millions into FTX without applying the most basic due diligence measures.
The fallout from FTX continues, with US regulators now looking to root out other risky operators. Latest to come under the spotlight is a crypto exchange called Gemini and its dealings with crypto brokerage Genesis Global Capital, a subsidiary of Digital Currency Group (DCG), one of the largest crypto conglomerates in the US. At Gemini, the accounts of about 340 000 investors, worth about $900 million, were frozen after Genesis, to which the assets were being lent, got into difficulties*.
As far as I see it, the underlying problem in the crypto space is not so much the buying and owning of crypto, which is a risk the buyer takes alone. It’s the borrowing and subsequent investing or trading of crypto assets by brokerages and exchanges on the behalf of owners.
Let’s say you buy a single Bitcoin, which is currently priced at about R400 000. You could sit holding that asset in a personal digital wallet until you wanted to sell it – much as you would with a gold coin, which you could store in a safe. But many platforms entice you with a more lucrative proposition: “Let us borrow that Bitcoin from you. We’ll invest it so that you get an ongoing return on your asset.”
When things are going well, you might get a decent return on an asset that itself is rising in value. But things quickly start going awry if markets turn and when, as Warren Buffett put it, the tide goes out, exposing those swimming naked.
Where to from here?
Tightened regulation is coming, that’s for sure. There’s a lot of cleaning up to be done, but once done, and there are the same controls for digital assets that there are for other types of financial assets, credibility should be restored and investor confidence should return.
Personally, I believe “decentralised finance” in its purest form is a pipe dream. Governments have too much to lose and criminals too much to gain in such a scenario.
Homegrown crypto exchange Luno is now one of the biggest exchanges in the world, having been bought by DCG in 2020. In November, after the crisis at DCG-owned Genesis, Luno shut down its interest-bearing "savings wallets" literally overnight, moving the assets into safer “primary wallets”. It has since released a proof-of-reserves report, so customers can be sure that their cryptocurrency is safely stored on a 1:1 basis and available to them as and when they choose.
Christo de Wit, Luno’s SA country manager, believes that 2022 could mark a turning point for the industry.
“Some of the difficulties experienced in 2022 could turn into positives if the crypto ecosystem takes proactive steps to operate with transparency and a long-term view of developing the industry. Legitimate companies and projects will emerge stronger, which is ultimately good for the industry. In contrast to high demand for speculative meme coins in the past, the industry may go back to its roots, favouring established coins with a solid underlying technology, such as Bitcoin and Ethereum.
“With the industry under intense global scrutiny, we expect regulation to come quickly; this is in line with a demand for increased trust and consumer protection,” De Wit says.
He says that from June 1 this year, cryptocurrency platforms will have to obtain a licence to provide their services to the public. “We are already registered with the FIC as an accountable institution and fully support this new regulatory framework to help protect consumers and foster trust in the industry. Luno operates in over 40 markets globally, a number of which already have regulatory regimes in place. This year, we’ll continue to actively work with governments and authorities to drive forward effective regulation across the globe.”
On restoring credibility after the FTX collapse, De Wit says: “The FTX collapse has had repercussions across the market. It has further highlighted the vital importance of prioritising customer safety and security. Credible crypto exchanges undertake thorough due diligence, and crypto holders should also take steps of their own to verify that they are dealing with a credible exchange.
“The crypto industry is still at an early stage, and platforms that continue to educate customers, adopt a regulatory-first approach and focus on building long-term trust with customers, will flourish.”
TIPS FOR CRYPTO INVESTORS
Luno’s Christo de Wit offers the following tips if you’re looking to buy crypto:
- Identify credible platforms, look for those with a good reputation. How many customers and wallets does it have? How easy is it to find information about the platform? What does the media have to say about it?
- Research whether proof of reserves are regularly published and whether there are proven and stringent safety and security measures in place to keep your money safe.
- Be wary of sites that trade on your behalf and offer trading tips or advice.
- Legitimate exchanges not only support regulation, but actively interact with regulators to bring regulations to the market. In South Africa, the Financial Sector Conduct Authority has classified crypto assets as financial products, which means that providers will need to be licenced. Crypto businesses should also be registered with the Financial Intelligence Centre. A legitimate exchange will offer bank-level security with several layers, including KYC (know your customer) and sanctions screening.
- Any guarantee of earnings should be viewed with suspicion, as returns cannot be guaranteed when it comes to cryptocurrencies. Many financial fraud schemes talk about “bots” that trade on your behalf and present fake testimonials as proof of guaranteed or outsized returns. If something sounds too good to be true, it probably is.
* Since this article was written, Genesis filed for bankruptcy protection in the Manhattan federal court. In a statement, Christo de Wit assured Luno’s cryptocurrency holders that while also owned by parent company DCG, Luno was completely independent.