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Unregulated Crypto Custodians Are Not Reliable for Your Digital Assets, Here’s Why


By Denis Goncharenko, editor at Cryptonews.net

Financial failures are not uncommon within the global economic landscape. However, thanks to the many advancements made by the banking industry over the last couple of decades, it is unacceptable to ignore these improvements and recreate past mistakes in the context of today’s burgeoning Web3/blockchain economy. 

For example, when something in the world of traditional finance goes wrong, more often than not, it is the bank that is at the receiving end of the blame. But when it comes to digital assets, where does one point the finger? 

That said, 2022 has been tumultuous for the cryptocurrency industry, thanks to the slew of insolvencies witnessed by the market. One collapse, in particular, that everyone is talking about is that of FTX, a cryptocurrency exchange that, before its downfall, was valued at a whopping $32 billion. Its founder, notorious Sam Bankman-Fried, was even considered the most talked crypto person of the year

The trading platform’s downfall resulted in its clients losing approximately $8 billion, raising the question, “When will unregulated custodians involved with firms like FTX start to be held accountable when things go wrong with an exchange?”

The crypto market needs to change its ways. Here’s why

It is no secret that most banks have, at one point or other, employed poor governance practices, such as improper account management, co-mingling of funds, custodial failures, etc. The blurring of the fine line between banking and securities was the reason behind the housing crisis witnessed a little over a decade ago. Despite these lapses, the traditional finance (Trad-Fi) sector has continued to enjoy the confidence of the masses.

When talking about the crypto sector, things are very different since most entities operating within this space are unregulated, even though they manage billions of dollars in user funds. And, while these firms are under no legal obligation to protect their client’s money, it is only fair that they would be accountable when things go awry.

Narrowing down on the FTX saga, the exchange and sister firm Alameda Research illegally siphoned hundreds of millions of dollars when the company collapsed. The reason given for the move was to protect $400-odd million from bad actors. However, the fact that company personnel who had resigned from the firm (such as founder Sam Bankman-Fried (SBF) and CTO Gary Wang) could move so much money irked investors and showed an apparent lack of reasonable controls on the part of FTX and their partners.

The FTX saga and the role of its custodial partners

While SBF and co. were busy misappropriating client funds for their personal use/gains, all of these transactions were being vetted by Fireblocks, an unregulated crypto custodian. At the end of 2021, the firm was able to accrue a sum of $550M from a Series E funding round, bringing its total valuation to a staggering $8B.

When it comes to traditional finance, institutions bound by the Bank Secrecy Act are required to identify and report any instances of money laundering. In the case of FTX, Fireblocks’ operations were completely unregulated, resulting in the company not having to investigate the movement of funds carried out by SBF and his associates.

Moreover, a media report suggests that representatives for Fireblocks received a call on Nov 12 from SBF, Gary Wang, etc., to set up several different emergency wallets. Such a move should have raised a red flag in the eyes of anyone; however, the Fireblocks team acted without checking in with FTX’s new management — including new CEO John Ray III — and without inquiring about the source of funds. 

Lastly, on the above date, Gary Wang and his team minted new FTT tokens worth approximately $380M and sent them (along with 2000 ETH) to Fireblocks’ hosted wallets, suggesting more foul play. As per a court filing, FTX’s newly installed management noted that Mr. Wang and Mr. Bankman-Fried took the funds “custodied on FireBlocks under the control of the Bahamian gov’t” on their own accord.

Such blatant fund misappropriation would have been impossible if more regulatory oversight was pervading the digital asset market, especially concerning custody firms like Fireblocks. Moreover, Fireblocks’ case isn’t helped by instances of the firm onboarding other clients with a shady past. For example, after Celsius was dropped by its regulated custodians, they migrated to Fireblocks.

Lastly, it is worth mentioning that due to its poor governance and lackluster customer fund management, at least one client is suing Fireblocks for losing $75M in client assets.

What lies ahead for the crypto market?

Over the last couple of years, many pro-crypto proponents have called upon regulators to provide more clarity regarding the space. This is because entities within the digital asset realm strongly desire to operate as freely as traditional financial institutions do. 

With the long-term viability and utility of crypto/DeFi still being debated, the crypto market must take note and adhere to the same standards of reliability and accountability as traditional finance. Moreover, it would benefit the market if custodians acted as fiduciaries and maintained transparency regarding their relationships with exchanges and market makers, much like banking institutions do.

And, while some people continue to argue that introducing heavy regulation would not be considered as positive crypto news, having unregulated custodians run amuck in the market poses a significant risk to the adoption of this asset class. To this point, just as banking regulation was critical to the growth of the financial system we have in place today, regulated crypto custodians are essential to the development and maturation of the industry.

Therefore, as we head into a future driven by decentralized technologies, it is of utmost importance that the crypto market stays with the times and welcomes regulations to ensure the safety and well-being of all its participants.

About the author:

Denis Goncharenko is editor at Cryptonews.net, one of the most popular global media platforms about digital assets. He started his journey in crypto in 2016, and has been a keen follower ever since. Amid being a crypto enthusiast, Denis also writes about ESG and digital economy in general.



Read More: Unregulated Crypto Custodians Are Not Reliable for Your Digital Assets, Here’s Why

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