Have cryptocurrencies lost their shine?

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The recent bankruptcy announcement from cryptocurrency exchange FTX is the type of news that has kept some family offices out of the crypto space.

Campden Wealth’s 2022 North America Family Office Report says that just 35 per cent of North American family offices have invested in cryptocurrency, typically at less than one per cent of their portfolio. Non-investors in North America cite volatility (54 per cent), lack of regulation (46 per cent), and lack of understanding (42 per cent) as their top three reasons for avoiding the space.

However, Karim Hamasni, director of crypto asset innovation at RBC Global Asset Management, notes that the cryptocurrency market continues to mature and that the failure of FTX may provide an opportunity to point regulators in the right direction.

Cryptocurrency exchanges are a means of acquiring and selling crypto and operate like a spot commodity market. Orders are placed and then completed when buyers and sellers agree on a price. Specific crypto assets can be exchanged with one another in “trading pairs.”

“So far, some of these centralized exchanges have proven themselves to be quite battle tested and they’ve been able to execute trades without any significant issues,” Hamasni says.

So what happened with FTX? Hamasni explains that FTX minted 350 million units of its own cryptocurrency — the FTT — but released only 25 million units into the open market to create an illusion of scarcity. When the token reached high values of approximately US$85 in November 2021, the exchange held FTT tokens with a paper value of more than US$27 billion. That made the company appear solvent, even as it used bad tokens to balance against reported loans of tokens like Bitcoin and Ethereum, which held value.

FTX worked closely with sister company Alameda Research, which traded in crypto markets. A November 2022 article in crypto publication CoinDesk noted that a large portion of Alameda’s balance sheet was held in FTT tokens and used in collateral against company loans. This aroused the suspicions of Changpeng Zhao, chief executive officer of the world’s largest cryptocurrency exchange Binance, an early investor in FTX.

“Zhao took a ‘kill shot’ a few days after the article was published, by announcing on Twitter that he was going to sell all US$580 million of his FTT holdings,” Hamasni says. “That created a market panic, spurred a good old-fashioned bank run and caused the price of FTT to collapse. When customers went to withdraw their Bitcoin and Ethereum, it wasn’t there and FTX filed for bankruptcy.”

Even Binance now faces increased scrutiny over its finances, including the role that its own Binance Coin plays on its balance sheet.

“French audit firm Mazars Group had previously created a ‘proof of reserves’ statement for Binance,” Hamasni says. “However, it wasn’t an audit because there was no number representing the exchange’s liabilities. They removed that report from their website and suspended all work on cryptocurrency because they didn’t want their name to be used to imply that a full audit had been conducted.”

He notes, however, that Canada is moving toward more uniform rules for cryptocurrency exchanges. For example, Canadian regulators have settled on the notion that cryptocurrencies are derivatives, rather than commodities, because traders can’t make an immediate withdrawal of the coins they buy. That places crypto coins firmly in the securities camp.

In the U.S., both the Securities and Exchange Commission and the Commodity Futures Trading Commission continue to vie for the right to become the regulator of choice for cryptocurrencies — and both have laid separate charges against officers of FTX.

“In Canada, there are several exchanges that are going through a securities registration process to get onside with regulators,” Hamasni says. “But Ontario residents are unable to trade on Binance today because Binance refused to register with the Ontario Securities Commission.”

Hamasni sees the willingness of crypto exchanges to register with Canadian securities regulators as a positive step for the industry, allowing compliant firms to make a name for themselves among many players in a saturated market.

The FTX/Alameda — and now Binance — sagas also provide additional and even welcome guidance for where regulators could go next.

“With crypto exchanges, a single company might do custody, trading, accounting and so on,” Hamasni says. “It would be low-hanging fruit for regulators to move quickly to create regulations to segregate those duties, so that all assets are held by a third party and auditable at all times. That would provide greater trust and safety for investors and help make the crypto space more reflective of the traditional finance world.”

This story was created by Content Works, Postmedia’s commercial content division, on behalf of RBC Investor Services, which is a member and content provider of this publication.