The Crypto Chaos Survival Guide

November 12, 2022
Crypto Chaos Survival Guide

It’s been a busy week in the world of crypto, and you’re likely hearing a lot from crypto, blockchain, and Web3 companies about how they are keeping you (and your assets) safe.

We know there is so much reaction to the FTX collapse because we’ve heard all of this before — promises of security and safety, guarantees that it won’t happen again — and at this point it’s hard to tell the truth from the bullsh*t (if you’ll pardon our language). That’s where Fortress comes in. We’re here to help translate the jargon, clarify the inconsistencies, and ultimately empower you to keep yourself safe.

This post is not meant to be self-serving, rather an external reiteration of the work we do internally — building and scaling Web3 in a safe, compliant manner. No fluff, no BS, and no unnecessary jargon. Remember, ‘crypto’ is not Web3 – it’s a byproduct of blockchain technology.

Let’s get started.

FTX FAQs

Isn’t it my money? How does this keep happening?

Sure, it’s technically your money – but keep in mind not every crypto exchange is a qualified custodian of your assets (meaning they may not be qualified, or even encouraged to act in your best interests). In the US we see crypto exchanges and others obtaining simple money-transmitter licenses and holding investor assets (cash, crypto, securities, NFTs, etc) on their balance sheets. This means those assets are the property of the exchange (or lender). 

Why are balance sheet assets a bad thing?

Since these are company assets the company can use those for its benefit. They can lend them, invest them, and do other things to juice corporate returns…which, of course, can go down in flames. And if a company goes out of business then others may have a superior claim on those assets over investors, including the government (taxes, fines), debt holders, and secured vendors. Customers get whatever might be left, if anything.

Is this what happened at FTX?

Yes, and…In the case of FTX, they are short $10B. This means that they made investments with the assets on the balance sheet to try and make money for the company (not customers), then those investments obviously went south and now there aren’t enough assets to cover investor accounts (unsecured liabilities on the balance sheet).

The CEO says “oops, sorry, I f***’d up“, which is true to the tune of $10B…but never should have been permitted by regulation in the first place.

Should I worry about other crypto exchanges?

Ah, the multi-billion dollar question. There will be others. FTX is a big shoe, as was Celsius and BlockFi. Let’s start with another behemoth industry player and see what we can learn.

First, ask what the exchange does with customer assets. In this case: “a note to the financial statements explains that as of June 2022, Coinbase has taken all customer assets on to its own balance sheet…it still has $12bn of its own and customers’ cash (both on its balance sheet).” 

To Fortress, this is a red flag (more about why in our CEO Scott’s blog). Coinbase owns a trust company, so they could keep all customer cash and crypto at their trust company to ensure it’s safeguarded and protected. The question to ask then is “okay, so what exactly are they doing with those customer assets?” Possibly no different than what FTX was doing, maybe not – but there is no regulation that controls the decision they make, and if they aren’t directly telling customers then there is no way of knowing. 

TL;DR – all crypto exchanges who don’t use a trust company could be operating in a way similar to FTX. 

So how do I identify a trustworthy exchange?

Look for a Trust company. A chartered, regulated entity that is beholden to the safety and security of their customers’ assets. 

Is crypto chaos bad news for Web3?

Not at all! The tokenization of rewards programs, real estate, healthcare records, insurance receivables, securities, event tickets, estate records, music, film, sports, photography, books, art and everything else electronic in the world is continuing without any delay or negative impact. These things, tokenized so the blockchain acts as the ledger of record, are not cryptocurrency. Every company has Web3 initiatives, and this will utterly transform the world just as the internet did beforehand. If anything, we’re looking forward to the regulation that will surely follow such a tumultuous week.

Does Fortress have a Trust?

We absolutely do. Fortress Trust is a wholly-owned subsidiary of Fortress Web3 Technologies and a chartered, regulated entity purpose built to ensure that every product and service we have is built, launched, and scaled with safety and compliance.

One more time for the folks in back: if it isn’t regulated, you only have their word to go off of.

Glossary of Crypto-Jargon

There are a lot of emails and corporate statements coming out in response to the news this week, and rather than add to the noise, we want to help you sort through it so you can make informed decisions about your assets. A breakdown of standard jargon and “red flag” / “green flag” indicators below.

🚩 Red Flags 🚩

A firm can say anything they want, but if they aren’t regulated it may just be talk. It’s hard to know where truth and transparency stand, but here’s what we look out for:

🚩 Balance Sheet

A business’s assets, liabilities, and owner’s equity as of any given date. Customer cash or assets on a company’s balance sheet can put consumers at risk — if assets are on a balance sheet, the company can lend or invest them, they can be seized in case of a bankruptcy or lawsuit, or any number of risks that can lead to “not enough cash in the bank to cover the customer liabilities”. 

🚩 “We share the belief that it should be necessary for crypto platforms to publicly share proof of reserves, we will be publishing our audited proof of reserves.” 

This company is telling you that your assets may be commingled with theirs, and is working to show you that they have not used your assets for anything else. Showing you haven’t yet touched — or worse, lost — customer assets doesn’t mean you won’t.

🚩Merkle Tree

A computer science term for how an exchange that keeps assets in many different wallets could show how much crypto it holds for proof of reserves. Just like ‘Proof of reserves’, it shows that the exchange currently has your deposits but nothing stops them from doing something in the future

🚩“[BRAND] holds customer assets 1:1, and we won’t lend those assets without your consent. This means funds are available to our customers at any time.” 

These companies are telling you that they have enough liquidity to cover your funds. They are saying it, but there is no regulation behind the statement ensuring that it’s true. Without insight into the precise numbers, it’s up to the individual to determine if they trust the company.

🚩“In response to recent developments in the crypto markets, we want to assure you that the assets in your [BRAND] account are safe and secure. Additionally, [BRAND] does not have any direct exposure to FTX, Alameda or FTT (FTX Token).”

This doesn’t tell you what the company is doing to protect your held assets in the immediate and distant future. While FTX was in breach of their customer agreement, there was no regulation for them to follow that barred them (or others that are saying they don’t have from lending out customer assets. Thus, exposure to FTX is not the only concern. 

🟢 Green Flags 🟢

These are some indicators of a ‘safe’ partner that is beholden to your best interests (spoiler alert – regulation required). 

🟢 Trust Company: A trust company is a legal entity that acts as a fiduciary, agent, or trustee on behalf of a person or business for the purpose of administration, management, and the eventual transfer of assets to a beneficial party. The trust company acts as a custodian for trusts, estates, custodial arrangements, asset management, stock transfer, beneficial ownership registration, and other related arrangements.

🟢 Custody Solution: Custody solutions are independent storage and security systems used to hold large quantities of tokens. Simply put, crypto custody means securing the private key that proves you own the funds held in your wallet.

🟢 Qualified Custodian: A qualified custodian is a regulated entity that has a fiduciary duty to act in the best interests of their clients. A qualified custodian holds client funds in separate accounts that can never be commingled with company cash or assets. A qualified custodian also has rigorous standards in place (as required by regulation and audits) to protect client funds and assets against loss, theft, abuse, or misuse.

We’re here to help

What else do you want to know about FTX, industry impacts, and what this means for Web3 moving forward? Send us your questions, curiosities, and concerns to [email protected] and they may be added to this Survival Guide!

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