Rapidly evolving and notoriously volatile, the cryptocurrency market is never far from the headlines and public scrutiny. While creating a culture where those savvy, or perhaps brave, enough to invest can create and lose fortunes hour by hour, speculative gains and losses are just one side of the crypto coin. 

Established as a medium of exchange, cryptocurrency was sold on a promise of low-cost transfers and transactions on a decentralised platform outside of traditional banking routes. While originally deemed to be a fringe investment, cryptocurrencies catapulted into the mainstream and allowed for the creation of multi-billion-dollar companies, which, until last month, included the second-largest cryptocurrency exchange, FTX.

Among countless high-profile examples of crypto-gone-wrong, from phishing scams to forgotten passwords, the collapse of FTX is undoubtedly one of the biggest and has drawn the eyes of the world back onto the risks of the largely unregulated crypto market. A testament to the unpredictability associated with cryptocurrency, FTX was valued at an estimated US$30bn in early November 2022 but was filing bankruptcy proceedings two weeks later.

Rather than a reflection of the precarious nature of cryptocurrency investments, the collapse of FTX has been reported as “one of the biggest financial frauds in American history” and has raised important questions about the regulation of the crypto market.

The downfall of FTX started when allegations arose that the exchange had loaned customer assets to Alameda Research - a cryptocurrency hedge fund who shared its founder Sam Bankman-Fried with FTX - to engage in risky trades without the permission of its customers. Claims were also made that FTX issued its own cryptocurrency for Alameda to use as collateral, resulting in scrutiny by regulatory investigators and a subsequent “bank run” on FTX.

Unable to meet the demand for withdrawals, FTX halted trading. Reportedly then falling victim to an unconfirmed theft of over US$400m of crypto assets on 14 November, FTX filed for bankruptcy the same day, along with Alameda and 130 other companies founded by Bankman-Fried.

Bankman-Fried was arrested this week, charged by the US Securities and Exchange Commission (SEC) for alleged fraud and violating campaign finance laws.

The collapse of FTX and its affiliated companies has the potential to see over a million stakeholders who transacted through the exchange, or held investments in any of the companies that initiated bankruptcy proceedings, left empty handed.

Outside of financial loss, arguably one of the biggest impacts of the fall of FTX is that of public perception of and confidence in the, largely unregulated, cryptocurrency market. While the SEC is reportedly investigating a ‘perceived crypto-asset regulatory gap’, the Congressional Research Service suggests the regulation of cryptocurrency is dependent on whether it is classed as a ‘security’ and that ‘the current regulatory landscape for crypto-assets is fragmented’.   

Whether classifying cryptocurrencies as “securities” is the most appropriate position remains to be seen. The uses of crypto assets vary on a case-by-case basis and, as such, it is not an asset class where one-size will necessarily fit all. Even as legal precedents are set, it will still be important for each case to be looked at on individual merit and for deep consideration to be given to the intricacies of this different asset class.   

While investigations continue into FTX, nine prominent exchanges - including Binance and Crypto.com – have pledged to provide proof of reserves to evidence their liquidity. Volunteering this proof is an advance in providing some peace of mind to investors and regulators alike that such platforms would not collapse under any hypothetical ‘bank run’ such as FTX experienced, but also marks a considerable step forward towards transparency in what could otherwise be argued to be a relatively opaque market.  

The collapse of FTX has left many questioning what affected cryptocurrency owners could have done to prevent their losses. Although it is never possible to predict the unpredictable, our experience in structuring digital assets has highlighted the importance of security and stability when it comes to the growth and preservation of digital wealth.

Having first been approached by a digital asset client in 2017, I was immediately driven to explore, what was, a relatively unknown area when it came to wealth structuring. Although we were not in a position to support the client immediately, we invested a great deal of time undertaking research into the digital asset market, building relationships with trusted, specialist advisers and identifying where we were best placed to add value. Our dedicated digital asset teams support clients on their digital wealth journey across our Cayman, Geneva and Guernsey offices.

Our approach as early adopters of digital wealth clients has resulted in Safferys being seen as one of the primary service providers for digital asset structuring. In structuring digital assets for our clients - including cryptocurrencies and NFTs - we have kept abreast of the ever-increasing regulations as governing bodies around the world each take their own view on the future of digital assets. Although intervention from regulators could by some be seen as narrowing the freedoms of the digital market, some regulation is a necessary step in protecting stakeholders without stifling innovation

Though cryptocurrency companies rise and fall daily, the legacy of FTX is likely to be as a textbook example of the dangers of unregulated, or partially regulated, cryptocurrency exchanges. While the pledge of some exchanges to provide their proof or reserves is promising, it also brings into question whether such requirement should be mandatory to better protect investors. 

Some jurisdictions are ahead of others when it comes to clamping down on the threats posed to consumers. For example, in Europe, cryptocurrency exchanges were brought under EU Anti-Money Laundering legislation in 2020 and as such require KYC/CDD on customers and tighter reporting requirements.

As regulated trustees in the Cayman Islands, Guernsey and Switzerland with years of experience working in partnership with clients with digital asset portfolios we are very alert to the risks connected to cryptocurrency platforms and exchanges. By committing ourselves to undertaking research, complying with stringent due diligent processes and asking the right questions, we have established a network of well-regulated third-party intermediaries. This ensures our clients’ assets are better protected, while assuming the risk and responsibility of compliance on their behalf.

Ultimately, an investment in cryptocurrency, like any stock or share, can be more than a guessing game built on a foundation of luck. For those who have taken the time to analyse and educate themselves in this space - perhaps using the basics of traditional markets and investments to help – and have successfully filled bulging crypto wallets, there is a recognition that digital wealth structuring can help to safeguard their assets.

Was FTX the canary in the cryptocurrency coalmine in its entirety? Perhaps not, but it certainly was in the mine of unregulated activities.