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Streaming services might not be the obvious place to start conducting research about cryptoassets and crypto exchanges, but that would be an incomplete view. The recent release of a Netflix original documentary centering around the saga and intrigue that continue to surround QuadrgiaCX has reignited discussion around this topic. As institutional adoption of cryptoassets continues to accelerate, nation-states are actively allocating people and resources to developing sovereign backed crypto, and investors become more comfortable with crypto, QuadrigaCX should continue to be viewed as a cautionary tale.
Investors are no strangers to volatility, and crypto has definitely had its fair share of volatility and headline-driven themes during the last several years. Especially as newer iterations of cryptoassets create complicated and intriguing headlines from tax, valuation, reporting, and custodial perspectives, it can be easy to overlook the fundamentals that underpin this trillion dollar asset class. Non-fungible tokens have achieved sky-high valuations, and decentralized finance continues to deliver outsized returns to investors while also bringing increasing amounts of scrutiny from regulators.
In other words, as crypto continues to mature, become more complicated, and debut flashier applications, investors at all levels should remember the valuable lessons taught through the failure of QuadrigaCX. Let’s take a look at a few of them.
Crypto is not autonomous. Much heralded as the decentralized aspects of cryptoassets are, and rightly so, there is an unavoidable element in the vast majority of projects, products, and services; they are developed and managed by people. This is especially true for the more centralized exchanges and cryptoassets, which are also the applications that tend to be easier for retail investors to utilize. Stated another way, even if there is no sign of human influence or interaction on the crypto products themselves, or the advertising of these products, there are almost always people involved.
Performing research on the management team of an organization is just as important as researching the specific product itself. Highlighted in the many revelations that surfaced as QuadrigaCX unraveled following the passing its co-founder and CEO, this singular individual exercised far too much control over the back-office components of the organization. Automation and reducing the need for human touchpoints creates tremendous promise, but must be counterbalanced with policies to prevent abuse.
No matter what the background of a certain individual is, questionable or not, there is always a need for strong internal controls.
Internal controls matter. Moving fast and breaking things might be the motto that many technology-themed startups have embraced, but this should be balanced against the reality that handling custodial funds must change this mindset. With approximately $150-200 million lost in what turned out to be a blatant fraud and Ponzi scheme, the lack of internal controls – highlighted at QuadrigaCX – is an issue that has cropped up as the leading cause behind other crypto hacks. Admittedly never the hottest topic or most exciting part of the crypto conversation, focusing on internal controls – especially when customer funds are involved – is essential.
For example, it would seem reasonable to expect that any organization handling customer funds and offering custodial services – fiat or crypto denominated – to have a robust system of controls over who has access to funds, how trading activity is reconciled, and how records are audited. As individuals and institutions continue to treat crypto like an asset class, and various cryptoassets are allocated to portfolio positions, it makes perfect sense that internal controls should keep pace.
Investors might look back on QuadrigaCX as an out-of-date example, but given the rapid growth of the DeFi and NFT sector, are investors truly confident that every exchange handling millions or billions in transactions has controls that are up to par?
Equivalent regulation makes sense. All of this leads to the following point; if crypto exchanges and crypto organizations are seeking to offer products and services mirroring those of incumbent organizations, the regulations must also be equivalent. For all of the talk about how blockchain and cryptoassets will revolutionize the global payments and financial system – which it will change significantly – there need to be safeguards for investors of all sizes.
In just the past two years there have been dozens of hacks, with billions of losses accrued by investors, and many of these investors are retail individuals who are left without many ways to recoup these losses. Alongside these hacks and breaches, and subsequent scrutiny from regulators, some in the cryptoasset sector are pushing back with arguments stating that new regulatory paradigms are needed.
That may very well be so, but if organizations are handling customer funds, holding customer funds, and conducting transactions on behalf of these customers, these organizations must be held to the highest possible market standard.
The saga, scandal, and controversy around QuadrigaCX is both a tale from the earlier days of crypto, and also a warning for newer investors to the space. While crypto trading has certainly become more mainstream, with publicly regulated and audited organizations dominating large swaths of the space, many emergent areas have regulators playing catch-up. Something that investors should always keep in mind is that, no matter how innovative or creative a certain product, service, or organization may be, internal controls and investor protection always matter.