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Unregulated players in the crypto industry: 4 red flags to look out for

Cryptocurrency has always had a reputation for being volatile and risky, but its notoriety seems to have reached new heights recently.

The bear market of the past few months, dubbed the “crypto winter of 2022”, has stress-tested the entire crypto ecosystem and resulted in some worrying developments.

The catastrophic collapse of unregulated crypto entities, such as Celsius, Voyager and Vauld, has prompted calls for better and more stringent regulations to protect investors. Recent proponents include financial leaders from the Bank of England and the Federal Reserve.

Let’s take a closer look at these fallen crypto players and identify which red flags to avoid (and understand why regulations are so important).

1. Using customers’ funds for risky activities

Unregulated crypto players such as Celsius, Voyager and Vauld generally worked like banks, only without all the safeguards and regulations that apply to traditional finance.

Take Celsius for example. The firm’s business model was supposed to get customers to deposit their crypto assets on the platform, and then lend them out to counterparties who would pay interest in return. Celsius then gave customers a cut of that revenue.

However, Celsius lent out customers’ funds on irresponsible terms, often to risky counterparties and in the form of under-collateralised loans as well as ”deployed customer assets in a variety of risky and illiquid investments, trading, and lending activities”, as one of its investigators characterised it.

During the bull market of 2021, everyone profited from this arrangement. But when the crypto market crashed in 2022, the value of collateral plummeted, resulting in massive losses.

This dire situation could have been avoided with better risk management practices such as over-collateralised loans, which is what we do with our Bitcoin collateralised loans.

This means the lender requires the borrower to provide significantly more collateral than the loan amount. Not only does this filter out higher-risk borrowers, but it also provides a buffer in case of major price fluctuations in the collateral.

2. Poor organisational governance

As if using their client’s funds for high-risk investments wasn’t bad enough, another sign of poor risk management was Celsius’ lack of corporate governance.

According to the Financial Times, the CEO, Alex Mashinsky, overruled his senior investment team and took over the firm’s trading strategy in January 2022. His actions allegedly caused Celsius to lose US$50 million that month.

Such abuses of power are virtually unheard-of among regulated financial institutions. Properly licensed companies are required to adhere to corporate governance protocols, with clear demarcation of power and mechanisms of checks and balances.

3. Disregarding KYC and AML measures

Another red flag is the lack of compliance with KYC (Know Your Customer) and AML (anti-money laundering) protocols, which are standard practices in banking but not taken all that seriously in the unregulated crypto ecosystem.

This particular pitfall was the nail in the coffin for Vauld. In August 2022, shortly after it suspended all activity and froze customer funds, India’s anti-money laundering agency investigated almost US$50 million of assets suspected to be tainted by money laundering or other criminal activity.

Asked to furnish the authorities with financial records, however, Vauld’s India arm was revealed to be cavalier about these fundamental risk management practices.

The agency’s report described Vauld India as having “lax KYC norms, no EDD mechanism, no check on the source of funds of the depositor, no mechanism of raising STRs” which ultimately allowed a shell company called Yellow Tune Technologies to abscond with suspicious funds in the form of digital assets.

Digital assets run the risk of being untenable in the long run if money laundering practices become prevalent. That’s why regulations to enforce KYC/AML compliance are important for the crypto ecosystem.

4. Lack of transparency and disclosure

Investors should be on guard against firms that do not communicate truthfully and regularly with their customers.

Voyager, for example, allegedly misled customers into believing their funds were insured by the FDIC (Federal Deposit Insurance Corporation), like bank deposits, leading some customers to put their life savings on the platform. Unfortunately, once the funds were converted to crypto, customers lost much of their claim on their assets.

A more common complaint is that the unregulated firm did not communicate that it was in financial trouble. Celsius’ customers complained that they “did not receive critical disclosures about its financial condition, investing activities, risk factors, and ability to repay its obligations to depositors and other creditors.”

Some even go to the extent of making misleading announcements. “We remain liquid despite market conditions. Over the last few days, all withdrawals were processed as usual and this will continue to be the case in the future,” assured Vauld’s founder and CEO… mere days before it went bust.

Safeguard your digital assets with a regulated entity

The above scenarios illustrate why regulations are crucial in the crypto ecosystem. It’s become too easy for unregulated firms to conduct dubious practices, and, too often, investors are the ones who bear the costs.

As we wait for industry-wide compliance frameworks to get implemented, investors should, in the meantime, look for entities that are licensed by local regulators.

Fintonia Group, for example, is a regulated fund management company in Singapore as well as in Dubai, with a provisional virtual assets license. We comply with some of the most stringent industry standards in the world and have best practices in place to protect our clients’ interests.

As regulations look to become exponentially more important in the digital assets ecosystem, Fintonia Group is ahead of the curve as a licensed entity with professional investment expertise, proper risk management and custodial services.


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