Commercial – Crypto & NFTs
What are the biggest investment opportunities in digital – and how can clients decide on the best entry point for them?
I do not participate in the cryptocurrency investment market and therefore do not counsel my clients about investment opportunities in cryptocurrencies. I have focused my digital assets practice on understanding what the digital assets are and how the underlying technology may be regulated as a more decentralised economy is created. I have been advising clients about the regulatory and procedural requirements to establish decentralised autonomous organisations (DAOs). My approach is to help build organisations that will participate in the regenerative Web3 economy
In my experience, cryptocurrencies are the outgrowth of crowdfunding various start-ups that were designed to provide value through development, services, NFTs or other means. The tokens generated by these start-ups have been a means of crowdfunding the early stages of the companies’ development. Once the token becomes traded, the value of the token is not clear to me other than as a representation of a small ownership interest in the venture, much like a share of stock, which is a simple explanation of why the Securities and Exchange Commission deems most cryptocurrency tokens to be securities.
The best entry point into investment, in my opinion, is with the bigger, established digital asset firms that operate in a truly decentralised manner, so that all transactions are visible on a blockchain that is accessible to members and customers of the firm, if not the public. Newer players that are seeking to build a regenerative Web3 economy are also likely to be engaged in more transparent and non-speculative business.
Crypto can be a volatile market: how do you advise your clients to mitigate risk when trading in digital currencies?
The implications for the digital assets sector of the sudden collapse in November 2022 of FTX, the second largest cryptocurrency exchange, are obviously important. Based on press reports, the nearly complete lack of financial controls, record-keeping, or responsible fiduciary behaviour, if not outright criminal fraud, by the owner and employees of the exchange is shocking. The self-dealing between related companies and the obvious “pump and dump” approach to building value in FTT, the native token of the exchange, should have raised red flags long before the exchange collapsed. The fact that the Chairman of the SEC was familiar with the owner and viewed the firm as worthy of advising Congress and regulators about how to regulate digital assets raises a major question as to what the SEC was actually doing to oversee FTX. This financial disaster is likely to influence potential legislation, regulation and oversight that can and should be brought to bear to curb such obvious abuse. So, anyone trading in cryptocurrencies should be aware of both the transparency of the token, but more importantly, the transparency offered by the exchange on which the token is traded. If the exchange is centralised and the transactions are not visible on a blockchain for the members or customers of the exchange, then beware of doing business with that firm.
“The obvious “pump and dump” approach to building value in FTT, the native token of the exchange, should have raised red flags long before the exchange collapsed”
TOP TIPS
Exploring digital asset investments
- Perform stringent due diligence before purchasing tokens. Look at the underlying fundamentals of the organisations, at the team that is promoting the investment, and avoid any firm that is operating in a “black box” outside the scrutiny of investors and users of the tokens. If a firm is shielding its users from information that they need to truly assess the value of the token, do not invest because there have been so many frauds committed in the name of cryptocurrency that would have been avoided if the information was more readily available on a blockchain.
Is private equity widely available in your jurisdiction? What are the advantages and drawbacks of financing a deal using equity, in your experience?
There is an effort in the United States to develop regulations for the digital assets sector. The President issued an Executive Order on Ensuring Responsible Development of Digital Assets in March and nine reports have been published from several federal agencies to provide ideas and approaches for both regulation and the development of a central bank digital currency (CBDC). Several draft bills have been introduced in Congress in the session that will end in December, and the next session of Congress, beginning in January 2023, will likely see those bills, and perhaps others, introduced to provide some clarity in the digital sector. The state of New York has a very comprehensive approach to digital assets that may influence federal legislation.
What is important is that digital assets are not just cryptocurrencies. While the fraud and hype surrounding cryptocurrencies may drown out other efforts, digital assets include non-fungible tokens (NFTs) which offer an interesting approach to managing and protecting intellectual property. The new decentralised firms being created as DAOs also offer an on-ramp into digital assets and decentralised approaches to performing work and accomplishing projects that are not best accomplished with centralised, national organisations.
