By AAT Comment Cryptocurrency Is the collapse of crypto giant FTX a warning to accountants? 28 Nov 2022 FTX’s collapse – with an $8 billion hole – has accountants considering their duty of care The collapse of one of the world’s largest digital currency exchanges in November highlighted its financial mismanagement. That’s led to widespread calls for tougher rules and regulations on cryptocurrency. FTX, founded in 2019, was initially very successful thanks to high-profile acquisitions, celebrity endorsements and low trading fees. But a leaked balance sheet of its sister company Alameda earlier this month brought all that crashing down. In a series of dramatic developments over just a few days, FTX experienced the crypto equivalent of a bank-run by panicked consumers, competitor firm Binance walked away from a deal to purchase the disgraced firm and evidence came to light that FTX had ‘lost’ $8 billion in customer deposits. To top it all off, shortly after FTX filed for bankruptcy, hackers stole $477 million. The Alameda balance sheet revealed several areas of concern: The majority of Almeda’s assets were in cryptocurrency, in FTT digital tokens created by Almeda and used by FTX – a huge risk factor in itself.The balance sheet had never been audited.There was a lack of corporate controls.Neither company had followed standard financial reporting procedures. Jargon-buster FTT tokens can be bought by holders to gain privileges on the exchange, including trading fee discounts. In general, the more tokens a user holds, the more privileges they can access. Their worth isn’t created by selling equity or issuing debt but by creating excitement among users to up demand. Although the collapse of FTX was due to a lack of due diligence and adequate governance, it raises questions around the security and trustworthiness of cryptocurrency in general. We spoke to accountants and financial professionals specialising in cryptocurrency for their views on whether we can we still trust the asset. There’s risk in the entire crypto system from end to end John Leyden, CEO Carbon Accountancy Crypto is still a bit of a Wild West – plenty of opportunities and plenty of risk. There are lots of people wanting to make money and a few sharks preying on them. The Exchanges will gradually become more regulated, but until then it’s a matter of time before there’s another FTX. Some accountants are afraid of crypto, so avoid giving any advice. Others see it as a chance to charge exorbitant fees. But crypto is just a taxable asset like any other. What accountants need to do is understand crypto and how it works, as well as understand the different tax points on transactions and the streams of revenue and gains. Some streams are income (like mining and staking) and some are capital gains. Some are taxable and some are not taxable (say, cash back on crypto credit cards or airdrops). Given the volatility of crypto, accountants need to advise clients not to risk money that has to be paid in tax on speculating – the tax money should be cashed out and held in fiat. Verdict: There is risk in the entire crypto system from end to end and people need to be careful. Even then, they still won’t be able to get enough transparency to make an informed decision. Lack of regulation means crypto must be approached with caution Shukry Haleemdeen, Founder, MyCryptoTax The FTX collapse was not a weakness in cryptocurrency itself, but due to malpractice, mismanagement and misuse of customer funds. The main area of concern was around the fact that the sister company was holding the majority of the assets in FTX native FTT cryptocurrency which is highly proven for market loss. This resulted in rival Binance selling their FTT tokens, resulting in price drop. Consumer protection is also an important element. Many of those who invested were blindly following the crowd. This has really highlighted the need for regulation, but there’s a balancing act between not wanting to stifle innovation, and ensuring there’s adequate consumer protection and proper governance. Moreover, there are of course risk factors associated with cryptocurrency in general: how are cryptocurrency assets taxed, where are they regulated? There are also concerns about money laundering enforcement due to crypto’s decentralised anonymous nature, as well as frauds and scams targeting inexperienced users. Verdict: Cryptocurrency is a very lucrative industry that has huge potential. But it’s still in its infancy and there are a lot of problems that need to be ironed out from regulation to governance. With crypto, a single corporate entity controls an entire currency Miles Brooks, Accountant and Director of Tax Strategy, CoinLedger The FTX debacle shows the inherent weakness of centralised crypto exchanges – those controlled by a single corporate entity. It shows a huge gap in matters of regulation and the protection of crypto investors. Accountants should familiarise themselves with how and in what circumstances cryptocurrency assets need to be taxed. In essence, any income needs to be disclosed to HMRC. Crypto income is taxed every time a user sells, trades, or purchases using digital assets. If this is a personal investment, capital gains tax on profit must be made. The tax-free allowance for capital gains tax is £12,300 per year. Verdict: The FTX debacle highlights the weakness of centralised crypto exchanges. Imagine traditional finance without the regulation – that’s crypto Kayvan Khoroosi, Partner, Peter Jarman & Co Accountants The FTX story just shows how fundamentally close crypto is to a traditional financial system. It is open to abuse and fraud just like traditional systems and maybe even more as it’s less regulated. This should act as a reminder to all investors of the risks of crypto assets. Crypto has reaffirmed the human desire to make quick money and break rules, hence the need to research where you hold your crypto as well as what crypto you invest in. It’s important for accountants to familiarise themselves with the different ways in which clients will receive and use cryptocurrency. Cryptocurrency is most commonly taxed through capital gains, but can be taxed as income tax depending on how it is used and received. It’s essential that accountants have a true understanding of how their client is involved with cryptocurrency. Once they understand the involvement, they can then begin to assist clients with their tax matters relating to cryptocurrency. Verdict: FTX collapse should act as a reminder of the risks associated with crypto assets’ lack of regulation. The FTX collapse highlights importance of auditing Andy Sullivan FMAAT, Founder, Complete HQ My feeling is that the collapse of FTX reflects many weaknesses in various systems, but I don’t believe it is necessarily linked to crypto. It does however highlight some key areas including: Public perception. The assumption being that, as it has been able to raise capital from many of the world’s top institutional investors, it was low risk.Lack of regulation. There’s no government-backed deposit protection against crypto assets like the FSCS guarantee for deposits with banks. We’re a long way away from being in that position, due to the lack of understanding of crypto by lawmakers – and the industry is moving so quickly that it’s hard to keep up!Lack of checks and balances. The company was required to complete an audit, yet no flags were raised at the time. Overall, the primary weakness is clearly the lack of regulation and filing requirements for exchanges. All this reinforces the phrase ‘not your keys, not your crypto’, which is quite often used when people leave their crypto assets on an exchange, rather than holding them in their own digital or hardware wallet. The collapse of an exchange, almost like the collapse of a bank (minus the FSCS guarantee mentioned above), puts any assets that are left on the exchange at risk. Verdict: The FTX collapse highlights many weaknesses with regulation rather than cryptocurrency itself. Accountants must get to grips with basic taxing principles of crypto assets given rising popularity Zoe Wyatt, Head of Crypto and Digital Assets, and Laura Knight, International and Crypto Tax Director, Andersen LLP. FTX’s model was not sustainable. Lending and borrowing against volatile assets was always going to lead to disaster. Even lending against what are considered more secure cryptoassets, Bitcoin or Eth, will end badly when the loans are under-collateralised. The issue, however, is one of reporting and transparency. It’s not for the user to assess the nature of the FTX model. It is for the regulator in the user’s country to ensure they are protected. If the UK regulator had a clear and certain framework, exchanges like FTX would be incentivised to be regulated here. It is not good enough for the UK (and other) regulators to simply wash their hands of the problem, forcing exchanges and other crypto projects offshore to opaque and lax jurisdictions. Crypto assets are just another class of assets and accountants will need to get to grips with the basic taxing principles given that 10% of adults in the UK have either held or traded them, according to HMRC’s commissioned research in February 2022. Where accountants don’t have relevant crypto sector expertise in-house, they absolutely must buy this in. There are so many nuances and complexities to each client case and without specialist support opportunities will be missed and more issues arise. Verdict: Accountants must get to grips with basic taxing principles of crypto assets given 10% of adults in the UK have traded them and without specialist support issues will arise. AAT Comment offers news and opinion on the world of business and finance from the Association of Accounting Technicians.