Corporate Finance, DeFi, Blockchain, Web3 News
Corporate Finance, Fintech, DeFi, Blockchain, Web 3 News

What happens when your exchange rips you off?

By Ilias Louis Hatzis.

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This week’s post was inspired by “What happens when the bank robber is the bank” an article posted by Chris Skinner last week. He’s talking about the situation in Lebanon where people are robbing their banks to get their own money.

Let me start with a couple of stories.

EminiFX was an online investment platform promoted by its CEO, Eddy Alexandre, as a “double your money” crypto and foreign currency exchange that used proprietary technology. He promised at least 5% weekly earnings and explained that investors could take their profits and use the money to pay their house mortgage, car loan, and other bills or reinvest the profits to make even more money. The proprietary technology that guaranteed these returns was a smoke screen and Alexandre scammed hundreds of investors out of at least $59 million.

Greed makes people gullible and plugs into our most basic instinct, which is to get something for nothing. People naturally want to do the least amount of work for the most amount of money and will trust a “grifter” that looks the part and comes along with a get-quick-rich scheme.

A grifter is a “confidence man”, someone who tries to gain your trust only for their financial benefit and theirs alone. Anything and anyone can be a grifter trying to take your money —governments, organizations, companies, and people— that you put your trust in and take advantage of that trust to rip you off.

Now, what happens when you can’t trust a company and the technology that holds you’re digital assets?

Have you ever thought about that?

I don’t know if you heard of this story, but in April 2021 Thodex, one of Turkey’s largest crypto exchanges suddenly went offline. Its founder and CEO, Faruk Fatih Özer, disappeared leaving almost 400,000 customers in the dark and without access to their funds. Customers had deposited $2 billion in cryptocurrencies on the exchange. This past August he was found and arrested in Albania. Now he’s facing 40,000 years of jail time.

The truth is you don’t know whether to look left or right anymore.

People that are building these platforms, thieves hacking into these platforms, and everyone in between is trying to steal your money.

Εxchanges are used by just about everyone who uses cryptocurrency. While it is possible to manage your keys and transactions, in most cases doing so is difficult and error-prone. Even if you can manage your keys, 99% of everyone else will not be able to, which means that practically everyone has an account with one or more crypto exchanges.

Throughout the years, exchanges have had a shaky track record. MtGox, the first big exchange, went bankrupt due to fraud. QuadrigaCX, Canada’s largest exchange, went bankrupt when its founder died and was the only one holding the keys to the hundreds of millions of dollars.

When crypto exchanges vanish or fail, either because their founders are scammers engaged in “rug pulls” or because they are incompetent and in over their heads, the result is always the same —users lose everything with little or no recourse.

When you deposit cryptocurrency with an exchange, it’s a sale rather than a deposit. You are a creditor, not a depositor for the exchange and the exchange receives the “possessory interest” instead of you.

If the exchange collapses, like any other business, a bankruptcy estate is created and all the exchange’s assets, including your coins, become the property of the estate. The trustees who oversee a bankruptcy, prioritize the creditors (secured, unsecured) based on their liquidation preference and start to liquidate the assets to pay back the creditors. Venture capital funds, investors, and financial institutions are usually the secured creditors.

Who are the unsecured creditors? You and me and everyone else who deposited their crypto in the exchange.

I assume you can figure out the rest.

Once the secured creditors get their money back, what’s left is paid to the unsecured creditors. What does that mean? It means that we are the last in line to get our money back and if the assets run out before it’s our turn, we get nothing.

If we are lucky enough to get something, the assets will be frozen until the finalization process is completed. Now if the exchange had shady and opaque practices to avoid taxation and regulation, you’ll be waiting for years, many years.

The bankruptcies of Voyager and Celsius are recent examples that highlight these risks. To give you an idea, it’s taken more than eight years for customers affected by the MTGox hack to make a claim —the deadline was September 15, 2202.

It gets even better.

When you get paid you’ll be paid at the dollar value of your crypto when the exchange collapsed. Even if your coins quadruple in value from the collapse until everything gets resolved, your pro-rated share will be based on the value of your coins at the time.

For most of these services, the fine print in their terms states that they own the funds their customers deposited with them. When customers deposit their coins, they transferred the ownership of their coins to these services and the coins became their property.

To lure in customers, Celcius promised to pay up to 18% interest on “Earn” accounts, when customers deposited their crypto. Voyager took it a step further, giving users the false impression (the tweet has been deleted, but you’ll find it on the Internet Archive) that their money was insured by the FDIC.

What a sweet deal. Give me your money and I promise to keep it safe and pay interest on it, but if anything goes wrong, I owe you nothing —not your capital or any interest. I don’t know about you but that sounds like a scam to me.

When you give someone your money and they agree to invest it to make more money and pay you interest, that’s an investment contract.

If you go to your bank and deposit $100, you expect to be able to withdraw your $100 at any point, right? You expect your bank to be managing that $100 responsibly. If you go to your bank and the bank says, ‘Sorry, we made some bad investment with your money and you now no longer have $100, you’d be pretty upset, right?

Even Coinbase the poster child for crypto, in an eerie case of foreshadowing for the crypto market, disclosed in its first quarter 10-Q filing with the SEC that crypto held for its customers potentially could become the property of a bankruptcy estate should the exchange file for bankruptcy.

Do you still want to put your money on an exchange or some kind of centralized platform?

Ilias Louis Hatzis
Ilias Louis Hatzis
Ilias Louis Hatzis is the Founder & CEO at Mercato Blockchain Corporation AG.

Ilias Louis Hatzis is the founder and CEO at Kryptonio wallet. Create your wallet in less than a minute, without seed phrases, private keys, passwords or documents. Keep your bitcoin and digital assets always secure and recoverable:

I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.

Lundi 26 Septembre 2022