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Cryptocurrency is a hot topic. The market is growing rapidly, and investors are eager to get in on the action. However, it’s essential to understand the risks before you jump into this risky market. While cryptocurrency has been around since 2009, it’s only recently that people have become aware of its potential as an investment vehicle. Cryptocurrency has grown by leaps and bounds in the past several years, with some currencies increasing in value by thousands of points. But there’s also severe volatility, with some currencies losing up to 90% of their value overnight.

The truth is that no one knows what will happen with cryptocurrency – or the exchanges where these digital assets are stored. But investors must be wary of the risks, or they may lose millions.

FTX crumbles over a 72-hour period

Just this week, what was once one of the largest cryptocurrency exchanges in the world collapsed. FTX crypto exchange was founded in 2019. The collapse of FTX occurred in 72 hours, making it one of the worst collapses in the history of cryptocurrency. 

Initially, clients began to flee after it was announced that FTX was being sold to its rival, the number one cryptocurrency trading firm, Binance. While conducting its due diligence review, the deal fell through. The surge of investors pulling their cryptocurrency from FTX highlighted a fatal flaw: the exchange did not have enough cash on hand to meet the demand for withdrawals.

As a result, the company filed for bankruptcy. In its bankruptcy filing, FTX’s assets were valued between US$10 billion to US$50 billion. A handful of FTX’s 130+ affiliated companies filed for bankruptcy as well. Amid these filings, the company’s CEO stepped down.

Crypto exchange crashes are not new

Earlier this year, another one of the largest cryptocurrency exchanges, Coinbase, reported a US$430 million loss in its first quarter as two million clients jumped ship. This was in lockstep with the drop in price of Bitcoin and Ethereum, marking a time of panic for investors.

Closer to home, Quadriga was a Canadian cryptocurrency exchange that collapsed in 2018. Clients of that exchange lost CA$169 million in the fallout. An investigation by the Ontario Securities Exchange revealed that the founder had engaged in fraud and that the company was running a Ponzi scheme.

What sets the FTX collapse apart

What sets the fallout of FTX apart from other collapsed cryptocurrency exchanges is the concern that FTX was hacked. This past weekend, FTX confirmed that there had been unauthorized access to some of its accounts after its bankruptcy filing. While the amount of money implicated in the hack is yet to be confirmed, it has been estimated that a whopping US$477 million has gone missing.

It is a reminder that while cryptocurrencies are secured by blockchain technology, cryptocurrency exchanges can be more vulnerable. Being the custodian or “bank teller” of these funds, the security of digital assets stored with FTX is not as airtight. It is up to the exchange to protect itself from potential hacks through its own technology.

That said, there is some evidence that FTX was using its clients’ funds to back its own investments. As the exchange moved its headquarters to the Bahamas last year, investigations by the US Department of Justice, the Securities and Exchange Commission, and the Royal Bahamas Police Force are underway.

Who in Canada will be affected?

One of Canada’s biggest pension funds, the Ontario Teachers’ Pension Plan, invested US$95 million in FTX between October 2021 to January 2022. Despite this, the fund has reported that the impact of the collapse would be limited. Other Canadian businesses that will be impacted are the Kevin O’Leary-backed WonderFi Technologies, which invested $617,650 in the exchange, and Bitvo, a Calgary-based company which FTX had been set to acquire. The deal with Bitvo had not yet closed, so the impact overall has been minimal.

Generally, Canadians should be wary when engaging with the cryptocurrency space due to the high risks and developing regulatory landscape that may affect future investments. It is crucial not only to expect volatility in the value of any cryptocurrency but also to be aware of the security risks of storing that cryptocurrency in an exchange.

What options do clients have when a cryptocurrency flatlines?

Like money service businesses, Canadian regulations set requirements for reporting, record keeping, and due diligence by cryptocurrency exchanges. Exchanges must register with the Financial Transactions and Reports Analysis Centre of Canada, widely known as FINTRAC. FINTRAC is an independent government agency that provides law enforcement with financial intelligence, such as information about money laundering or financial terrorism. Reporting to FINTRAC is typically required by the entity and its employees, who are obligated to report suspicious activity under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act.

While cryptocurrencies remain “commodities” under the Bank of Canada Act, cryptocurrency exchanges are classified as securities and subject to various securities requirements. Clients who feel that a cryptocurrency exchange has violated securities laws (which are provincial) should report it to their local securities exchange for investigation.

Contact the Lawyers at Bader Law in Mississauga for Comprehensive Fintech and Crypto Legal Guidance

The business lawyers at Bader Law have decades of experience assisting with corporate structuring, financing, and secured lending throughout Mississauga and the Greater Toronto Area. We provide dynamic business law advice and solutions for companies working within the crypto and fintech sectors. To speak with a member of our talented business law group, contact us online or at 289-652-9092.