Wrapping up the Year in Tech, Crypto and Digital Assets
Some key lessons we can learn from the events of 2022
By Stuart Peter
2022 was a challenging year for digital assets; From the Terra Luna crash in March 2022, to the recent crash of FTX, which took both individuals and major institutional investors by surprise, it has become clear that the issues and risks that present themselves in the industry warrant a re-examination of the approaches we take when viewing digital assets. To end off the year, we take a look at some of these issues and risks, as well as some of the things that can be done to manage these as a consumer or investors.
#1: Understanding the risks connected with insolvency of platforms/exchanges
The recent insolvency of platforms/exchanges such as Vauld.com, BlockFi, and FTX show that even if an exchange purports to be “holding” assets on your behalf, the process of retrieving your digital assets held on an exchange once insolvency proceedings have been commenced against it can be challenging and is by no means straightforward. This is because, first, many exchanges have the right under their terms of service to suspend trades or withdrawals at their own discretion. This has been a common approach taken by exchanges when facing a situation of being overleveraged or where mass withdrawal requests are being received at the same time.
Second, once an exchange is under bankruptcy and/or insolvency processes (whether in Singapore or in another jurisdiction), it is commonly the legal position that they may or will be subject to a moratorium, where no legal actions can be commenced against the company without the permission of the Court. This is to ensure that proper and equitable distribution of assets amongst creditors can be achieved in accordance with existing insolvency laws. In such a situation (as has been the case for many of the collapsed exchanges this year), account holders essentially have to wait for a long drawn-out process of debt restructuring before even being informed of the prospect of retrieving the digital assets they are alleged to be the owners of.
Accordingly, it becomes all the more important for persons using online exchanges to obtain reliable and accurate information on the financial situation of the exchange on a regular basis. Some relevant considerations to consider are the asset backing policy of the company for customer funds/assets, and whether the exchange makes proper disclosures of its audited financials (and what these show).
Further, it is also worth considering whether or if you want to keep a portion of your digital assets offline (also known as ‘cold storage’). While this may inhibit your ability to make quick trades, it does improve the degree of control that you have over your digital assets.
#2: A smart contract =/= a good contract
With the rise of digital asset transactions also has come the rise of ‘smart contracts’, which are generally described as self-executing contracts using visible code to complete transactions. These are frequently used in transactions taking place on blockchain ledgers (such as those involving digital assets). Under a smart contract, contracting parties agree to a set of conditions and the contract self-executes when these conditions are met, eliminating any possible voluntary breaches. This has been lauded as being able to usher in a new era of contractual certainty for transacting parties since once deployed, smart contracts cannot be stopped or tampered with.
However, this also means that where the code for the smart contract does not perform in an intended manner, undoing or preventing a transaction from being completed in such a manner becomes challenging. For example, earlier this year, an apparent error in the smart contract system for the NFT Project known as “Akutars” resulted in S$34 million worth of Ethereum being ‘locked up forever’; the issuers themselves could not access or withdraw these digital assets due to the ‘immutable nature’ of the contract, the protocols of which could not be varied.
The long and short of it is therefore that a smart contract is only as smart as it is programmed to be – while smart contracts can improve contractual efficiency and certainty, it is possible that (especially in cases of complex contracting) these contracts could perform in a manner that was not anticipated and/or intended, in which case rectifying and/or reversing completed transactions becomes challenging due to the immutable nature of smart contracts.
Conclusion
2022 has been an interesting year in technology, in particular in blockchain and smart contracting – as we move into the new year, it is important that we learn from the events of 2022 so that we can face the issue that the new year has to offer in this ever-changing and evolving world. As always, Covenant Chambers would be pleased to offer our assistance with any matters you may have.