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Lynn Johannson, President of E2 Management Corporation and Catalyst for THE Collaboration
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QuadrigaCX Aftermath: The Bigger Picture
Magdalena Gronowska | June 4, 2019
This year’s biggest Canadian cryptocurrency story is the downfall of one of its largest and longest-lived crypto exchanges – QuadrigaCX – where an estimated $250million in funds is owed to 115,000 users.
Inadequate succession and business continuity planning lie at the heart of Quadrigas unraveling. The unexpected death its Founder and sole director, Gerald Cotten, was a crippling blow to the exchange’s ability to conduct normal day to day operations, forcing its closure as the company could not access cryptoasset wallets or company records.
Investigations conducted by Ernst & Yonge into its operations during the course of ongoing legal proceedings reveal more troubling business practices that make QuadrigaCX a perfect case study for regulators of ‘bad'-practices in custody and asset verification, market integrity, internal controls, recordkeeping, and business continuity:
- Despite assurances user cryptoassets would be securely stored in cold wallets, the cold wallets were empty and unused since April 2018 – platform funds were transferred to other exchanges (not always under official accounts of the platform).
- Corporate and personal boundaries were not maintained between the funds of the platform and the Founder and QuadrigaCX’s third party payment providers.
- User funds may have been used to acquire assets held outside of Quadriga.
- Fake accounts were created, funded with artificial deposits and significant trading and withdrawals of cryptoassets occurred on these accounts.
Tracking and recovering user funds has proven to be a difficult endeavour, requiring specialized technical expertise and multiple court orders due to improper records, the co-mingling of funds, banks unwilling to accept deposits (due to perceived high levels of risk), and questions around the identity and ownership of the accounts funds were transferred out to.
See:
NCFA comments to OSC/IIROC Joint consultation paper on Regulatory framework for crypto assets
Canada’s Regulatory System for Fintech is Complex, Costly and Chaotic. It is Stifling Fintech Innovation
Following the $250 million failure of our largest exchange, Canadian Securities Administrators and regulators proposed a regulatory framework for platforms that trade crypto-assets that are securities. This proposal considers rules for marketplaces, dealers and clearing agencies around custody and asset verification, market integrity, business continuity and risk mitigation, price discovery, surveillance, clearing and settlement, and conflicts of interest.
Regulators have turned their sights on implementing a framework that will mitigate the risk of another QuadrigaCX-like collapse – that’s a good step forward. Another positive step is that regulators are aligned across Canada in this proposal – harmonization is critical to reducing legal and compliance costs and regulatory burden for companies operating across Canada.
However, the regulation of platforms that trade securities is only a piece of the puzzle that’s necessary to build a supportive ecosystem for Canadian blockchain and crypto companies. A comprehensive regulatory framework enables companies to operate in a compliant, open and transparent manner, providing the certainty companies need to start-up, relocate, conduct long-term business planning and make capital investments. Companies value certainty over regulatory risk. They want to operate in a environment that is unlikely to change the rules, either raising the costs of doing business or banning the sector or business activities outright.
Greater regulatory clarity is needed around cryptoasset types – definitions under what conditions they are security, utility, or payment tokens (or a hybrid). Canada would also benefit from harmonized and clear rules around token creation, issuance, and distribution mechanisms (ie, mining, ICOs, STOs, airdrops, and forks) – as well as a modernized tax act with clear guidance for companies and investors.
See: Fidelity Will Offer Cryptocurrency Trading Within a Few Weeks
Access to banking services is a significant challenge facing crypto companies worldwide and banking challenges contributed to liquidity and solvency issues at QuadrigaCX. With banks refusing to operate or outright closing accounts of Canadian companies due to regulatory barriers and risk aversion, businesses are leaving for more favourable international jurisdictions, like Liechtenstein, Malta, Bermuda and France which have amended their laws to help crypto companies access banking services; they are also moving to Alberta where ATB Financial and DC Bank have been more open to Canadian crypto companies. Banking restrictions present a competitive disadvantage for jurisdictions and an impediment to economic growth – Canada can do more to support its SMEs.
Canadian regulators and policy makers should also look to their global counterparts like the US and EU where industry and government come together in roundtables, task forces and working groups. And it’s our responsibility as an industry to educate and participate. We have a rich pool of talent and expertise to draw from that can help government understand for which activities regulations, standards or guidelines can work best to protect investors and preserve market integrity, while remaining flexible enough to support the fast pace of innovation.
This is a critical time for Canada's blockchain and cryptoasset sector to mobilize and work collaboratively with industry peers and with regulators to build a regulatory framework that ensures Canada remains competitive globally.
Magdalena Gronowska, Founder, Canadian Digital Asset Coalition
Magdalena advised Government for 10 years on economic and innovation policy and multi-$million tech deployment initiatives. She is active in the Canadian blockchain space – Magdalena founded the Canadian Digital Asset Coalition, consults with Metamesh Group, sits on Quadriga's Official Committee of Affected Users and advises the Blockchain for Climate Foundation.
The National Crowdfunding & Fintech Association (NCFA Canada) is a financial innovation ecosystem that provides education, market intelligence, industry stewardship, networking and funding opportunities and services to thousands of community members and works closely with industry, government, partners and affiliates to create a vibrant and innovative fintech and funding industry in Canada. Decentralized and distributed, NCFA is engaged with global stakeholders and helps incubate projects and investment in fintech, alternative finance, crowdfunding, peer-to-peer finance, payments, digital assets and tokens, blockchain, cryptocurrency, regtech, and insurtech sectors. Join Canada's Fintech & Funding Community today FREE! Or become a contributing member and get perks. For more information, please visit: www.ncfacanada.org
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