Law Bites – August 2022
Following from the fall of the TerraUSD algorithmic stablecoin, there has been much talk on the risks faced by the various stakeholders in the crypto space. In particular, retail investors looking to purchase cryptocurrencies are a segment of the market who are particularly vulnerable. A more detailed discussion on this can be found here.
Since then, the crypto carnage has claimed more victims – cryptocurrency exchange Zipmex and crypto lender Hodlnaut have been the latest casualties to the downturn. Both sought creditor protection from the Singapore High Court in a bid to restructure and sort out matters with their creditors.
In light of the fallout of the crypto market, Mr Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), did acknowledge that the MAS has to date focused on containing money laundering and terrorist financing risks, and that MAS regulations has not expanded to cover consumer protection, market conduct or reserve backing for stablecoins. That will soon change, Mr Menon said.
Currently in Singapore, the type of regulations which apply to crypto businesses and whether such businesses need to be licenced, depend on the business activities intended and the type of digital assets involved.
Given that the myriad of crypto products and services are constantly evolving, the regulators will have to strike a balance between protecting the various retail investors from the multitude of unknowns, but at the same time, avoid stifling the development and growth potential of the industry. Reaching a sweet spot will be a challenging balance.
However, not everything is doom and gloom.
Venture capitalists and other financiers alike have been pouring investment funds into the blockchain and crypto space at a swift pace, signalling strong faith in the underlying technology and long-term industry prospects. According to data from PitchBook, venture capitalists have invested US$17.5 billion in companies in the crypto space, exceeding even the investment amounts pumped in last year. Cryptocurrency exchange KuCoin raised US$150 million in a Series B funding round, giving it a mammoth valuation of US$10 billion. In Singapore, a new fund has been set up by investment company Tangent to provide financing for early-stage crypto projects.
The common thread underpinning such funding notwithstanding the bear sentiment? The conviction that crypto and blockchain technology are here to stay.
Nonetheless, investments into companies in this space come with great risks.
For one, the information asymmetry between the founder and the investor is quite apparent. Most of these enterprises are still in their nascent stages of business, bringing with it much uncertainty as to whether they would be part of the pool of players which would thrive in the long term. Investors would also have to contend with the fact that the highly specialized technological nature of the business of such companies they are investing in would invariably have a complex business model. A well thought-out investment decision would therefore require a deep understanding of the technology at hand.
Identifying a valuable crypto project could also be challenging. There aren’t yet standard metrics that can be used to predict success, nor a market standard used to evaluate crypto assets. This leaves room for founders to exploit the ambiguity by overstating future business prospects.
Regulatory uncertainty is also another risk area for investors. Investors providing funds to businesses operating in traditional markets can almost always get a good sense of regulatory roadblocks by doing proper and forward-looking due diligence. The same is hard to say in the case of investments into companies involved in the crypto business. History has shown that governments are willing to drastically change their regulatory stance to address issues not foreseen previously – and it is highly likely that this approach will continue given the unpredictability and rapid pace at which the space is moving.
It would be prudent for investors to conduct more in-depth due diligence before making a decision to invest. However, there is good likelihood that due diligence would have its limitations for the reasons mentioned above.
Investors providing funding to crypto companies will do well to consider ways to structure their investment deals in a manner that mitigates against the heightened risks inherent in the crypto space.
JTJB Singapore Office