Crypto’s major demise holds major industry lessons

For the cryptocurrency industry to grow, the sector’s weaknesses cannot continue to look so inevitable in retrospect.

This, as a recent class-action lawsuit filed in California against failed crypto exchange FTX’s blue-chip venture backers claims it’s inexcusable that everyone involved didn’t know better.

After all, FTX’s exchange, along with other former billion-dollar crypto companies including FTX peers Genesis and Celsius, was destroyed by a combination of alleged executive mismanagement of funds internally, and misrepresentation of business practices externally.

Venture capital (VC) firms are supposed to back the businesses they invest in – but so far none have stepped up to help those businesses’ customers, leaving millions of creditors, shelled out billions of their hard-earned dollars, with little recourse but to chase it down they can from wherever they can.

“One hundred and fifty million dollars out of a $6.3 billion fund, if you lose some zeros, one zero, it’s $15 million out of a $630 million fund,” is how Alfred Lin, the partner responsible for leading Sequoia Capital’s investment in FTX, described the firm’s view of their losses on FTX.

“If you look at it that way, which is how we looked at it from a risk management perspective for Global Growth Fund III, we can take a $15 million loss on a $630 million venture fund.”

This cavalier approach is probably not the same tune sung by FTX’s 9 million creditors.

Some of whom were no doubt lured in by another Sequoia partner who called FTX founder Sam Bankman-Fried quite possibly “the world’s first trillionaire.”

The curious cases of vaporized customer funds have become so serious that the former founders of failed crypto hedge fund Three Arrows Capital (3AC) are themselves launching a new crypto exchange platform that will allow users to trade bankruptcy claims from insolvent crypto companies, according to a Wall Street Journal (WSJ) report Monday (13 . February).

Claims from 3AC’s own customers are among those that can be traded, alongside claims from creditors to FTX, Genesis, Celsius and others.

While US residents are not eligible for the platform, the WSJ article notes that it already has several thousand sign-ups from other countries.

When does internal abuse become culpable?

A lengthy report by the independent investigator appointed to oversee the Celsius bankruptcy revealed the former crypto lender’s business model as “conducted in a completely different way to how it marketed itself to its customers in all important respects”, noting in particular the staff’s own disbelief in his employer’s business.

Celsius executives allegedly kept an internal list of company CEO Alex Mashinsky’s false or misleading statements, per the investigation’s findings, even going so far as to edit the CEO’s comments out of promotional video footage without issuing corrections to inform the public that may have heard the misinformation in real time, much less inform regulators.

PYMNTS was not immediately able to reach Celsius or Mashinsky for comment. Mashinsky has previously denied the charges against him.

Over at FTX, bankruptcy registrations from the “personal fiefdom” of Sam Bankman-Fried, who in the face of eight criminal charges maintains his innocence from house arrest, show that the defunct digital exchange regularly misused and mixed customer funds throughout the business. group of companies to plug ongoing gaps in its own balance sheet.

Beware the flywheel of crypto customer acquisition, even when the hype cycle is supported by the likes of Sequoia Capital, Thoma Bravo, Paradigm or even Tom Brady and Larry David.

Financial services regulations do not only apply to financial institutions

Financial services regulations apply to any business that offers these financial services in markets where they are regulated, and this includes crypto – as some industry players are beginning to find out.

Still, that hasn’t stopped the world’s largest exchange, Binance, from claiming that “while the company wants to hire an auditor, big accountants are still gaining control of the crypto sector.”

The discrepancies over operational transparency come at a time when many leading accounting firms including both Deloitte and Grant Thornton regularly conduct audits for public crypto firms such as Coinbase and CoinShares.

As a whole, the crypto industry is not being asked to follow new rules – although some are in development – ​​and it is becoming clear that crypto businesses hoping to continue operating in the US need to strengthen their legal and compliance teams. to rebuild trust.

Especially if they want to regain the trust of key banking partners who have been increasingly spooked by government regulatory crackdowns and the crypto industry’s poor performance with leading companies that have been in business for more than a few years.

In these challenging times, where it may well take several business failures to convince the crypto industry to engage more seriously with its emerging regulatory reality, a little good faith can go a long way.

For all PYMNTS crypto coverage, subscribe to the daily Crypto newsletter.