The collapse of the FTX crypto exchange is a milestone event for cryptos, in large part because of its size and importance.
With close to one million users, it was seen as a safe anchorage for those entering the often opaque world of crypto assets.
FTX is claimed to have lent customer funds to a sister company, Alameda Research, which used that money to make risky leveraged bets. Its balance sheet was crammed with its own house token called FTT, which peaked at $80 in 2021 before collapsing to a little over $1 this week.
What lessons can we take away from this collapse?
“Don’t treat your crypto exchange as a bank,” says Matt Visser, co-founder of crypto investment company Pet Rock Investments.
“Get your cryptos off these exchanges into a wallet that you control. What we’ve learned so far from FTX is that client funds that were left on the exchange were being lent to a sister company, and then leveraged, to make very risky bets.
“People are treating crypto exchanges as places where they can buy and sell cryptos, and they expect the exchanges to provide them with safe custody. FTX has shown us the danger of doing that.
“Exchanges are places for onboarding to cryptos. Thereafter, the custody of those cryptos becomes your problem. There’s a saying in crypto: ‘Not your keys, not your coins’ which essentially means if you do not control your crypto, they do not belong to you. People expect these exchanges to do a lot of things for them.”
The crypto market still has a lot to learn from the traditional financial markets. For example, virtually all fund managers in SA employ independent administrators to report directly to clients on the monthly or quarterly net asset value of their holdings. The fund manager has no right to interfere in this process.
Proof of reserve audits are becoming more commonplace in the crypto space, as these provide a level of assurance that the company’s assets are fully accounted for.
This still won’t solve the problem of undisclosed liabilities which aren’t independently reported to clients. The solution points to what the traditional fund managers do – allow an independent firm to report directly to clients each month.
This is where financial advisors in partnership with their selected asset and fund managers can play a crucial role in cryptos going forward. They can assist clients in choosing an appropriate allocation to cryptos as part of diversified portfolio planning, and provide proper accounting and reporting processes.
“Financial advisors are key to the growth of the crypto industry,” says Visser.
“They can include tax and estate planning as part of a comprehensive financial advisory service, but they are not going to enter the crypto space by purchasing crypto on an exchange and leaving it there. Quite apart from the risks of doing this, it is not financially remunerative for them. What they want to do, and we know this from speaking to hundreds of them, is they want to participate in crypto in a legally-compliant fund.
“At Pet Rock, we’ve taken all the best practices we learned from the traditional fund management space and introduced it to the crypto space.”
Recent research by Pet Rock Investments contains some fascinating insights into crypto investment trends in South Africa. For example, up to two-thirds of South Africans are investing in cryptos on their own without consulting their advisors.
What’s also interesting is that nearly two-thirds of financial advisors own cryptos themselves, and that’s a higher percentage than financial advisors in the US.
Financial advisors see cryptos as a key part of their financial planning going forward. It’s no longer good enough to know about stocks, bonds and unit trusts. They’re going to have to brush up on cryptos too. Pet Rock Investments believes that financial advisors will play a key role in the next wave of crypto adoption.
The recent decision by the Financial Sector Conduct Authority (FSCA) to declare crypto a financial asset, and requiring crypto companies to become financial services providers (FSPs) is a major step forward for the industry, says Visser. “Many advisors and institutions have been waiting for this.”
Four crypto-based funds
Pet Rock Investments offers four distinct crypto funds:
- A USD digital asset fund, comprising USD-pegged stablecoins;
- A Bitcoin (BTC) fund, which is high risk (due to the often extreme price movements in BTC) – the Pet Rock philosophy is asset preservation first, which means yield-earning opportunities are pursued very selectively to minimise risks;
- An Ethereum (ETH) fund, which is also high risk – the emphasis is on asset preservation before seeking yield-earning opportunities through the ‘staking’ (or locking up) of coins; and
- A Fantom (FTM) fund, which is also high risk, and provides investors with exposure to Fantom’s decentralised finance (DeFi) platform at the cutting edge of new blockchain innovations.
A monthly email that helps clients make sense of crypto markets is available for free at Petrock.com.
How secure are your cryptos?
It was reported recently that crypto investors are racing to move their assets off exchanges, and onto hardware wallets such as Ledger or software wallets such as MetaMask, in response to the collapse of FTX. These bring new risks of self-custody and security.
Visser says Pet Rock uses the highest grade institutional custody for its crypto assets. A key part of that solution is known as Fireblocks, the same tech that Bank of New York uses for its custody solution. Bank of New York (BNY Mellon) is the largest provider of custody solutions to the financial services market.
“When we hunt for crypto yield, we use Fireblocks as our custody and authorisation tool,” says Visser.
“Our systems are heavily vetted. We know the safest places to find yield, and that’s our secret sauce.”
One of Pet Rock’s advisors is Andre Cronje, the legendary Ethereum developer and DeFi architect.
The future of crypto
Visser is no starry-eyed ‘to the moon’ evangelist for cryptos. In fact, he sees some difficult times ahead.
“We think a lot of hedge funds are heavily exposed to cryptos, and now that crypto is taking a deep bath, there will be contagion. There will be more such cases as FTX.
“There will be good opportunities in the weeks and months ahead, but above all, you are going to have to trust where your money is.”
Brought to you by Pet Rock Investments.
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