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Why regulation is essential for mass adoption of cryptos

It will help build the trust that reputable crypto operators are seeking – and help prevent the next MTI scam.
There are various ways in which MTI’s fraud could have been prevented or limited with the use of formal structures. Image: Chris Ratcliffe, Bloomberg

The infamous case of South Africa’s Mirror Trading International (MTI) has been crowned as the world’s largest cryptocurrency Ponzi scam. A total of around $589 million was lost, affecting hundreds and thousands of investors, according Chainanalysis’ 2020 Crypto Crime Report.

Read: MTI was by far 2020’s biggest investment scam – Chainalysis

Unfortunately, MTI’s illicit scheme using cryptocurrencies to commit fraud has overshadowed the thriving cryptocurrency industry in South Africa and the rest of the world – and has given credible and reputable virtual asset service providers and participants in this alternative financial system yet another hurdle to overcome on the road to mass adoption.

The Financial Sector Conduct Authority (FSCA) and other regulators across the world are constantly warning crypto asset investors to be extremely cautious and vigilant when dealing with, or investing in these digital assets.

Read:

In most circumstances, regulators are issuing these warnings due to a lack of formal regulations – as is the case in South Africa, where cryptocurrencies remain unregulated. This lack of regulation requires investors to do their own extensive research before investing in cryptocurrencies, but also offers opportunity for fraudsters to prey on uninformed investors.

Regulation ensures market stability

Bitcoin, by its nature, was originally designed to facilitate peer-to-peer transactions across the internet. This meant there was no need for any intermediary or monetary regulations that come with commercial and central banks. The notion of being free from regulations has led people to believe that cryptocurrencies should operate completely independently from any form of regulation; they fail to realise that certain regulations are in fact imposed to protect consumers and economic stability.

It is for these reasons that publicly accountable businesses are vigorously regulated and required to be audited. Independent audits are conducted to protect the interest of all stakeholders, ensure that the applicable laws and regulations are adhered to, and that the financial statements are free from material misstatement, as well as fraud (to a certain extent).

Regulation for fraud prevention

Fraud and error can usually be mitigated by prevention, detection, and recourse.

The introduction of regulations to govern the industry will mean preventative measures are put in place to ensure fraud of this magnitude doesn’t occur again – and that there is appropriate legal recourse for victims.

In addition to regulations, the role of the forensic and financial auditor would be to detect possible instances of fraud and error, as well as assisting with the recourse process.

At Mazars we have made cryptocurrencies a specialised focus area and have designed specific procedures to audit virtual asset service providers using a combination of ITGC (information technology general controls) assessments, application control testing and data analytics to obtain the required assurance.

In addition to this, we are able to use our available resources and expertise on cryptocurrencies to obtain and analyse information directly from the respective blockchains. This mitigates the risk of factious assets and proves the existence of the assets as well as ownership of a specific account, referred to as public key addresses, which holds the cryptocurrencies.

The evolution of digital assets such as cryptocurrencies brings phenomenal potential to change the financial industry, but with this comes certain challenges to adapt and overcome. Fortunately, regulations are there to aid us in this journey by protecting consumers and developing the industry to better allow an alternative financial system.

You will find it difficult to find a virtual asset service provider operating in this industry that is not pro-regulations, because these service providers understand what the benefits are of a regulated industry and, ultimately, the positive impact this could potentially have on a country’s economy.

MTI’s fraud: a case study

Looking from a financial audit and Companies Act perspective there are various ways that MTI’s fraud could have been prevented or limited with the use of a financial audit and regulations. According to the CIPC (Companies and Intellectual Property Commission), MTI was registered as a South African company on April 30, 2019, by the sole director, Johannes Steynberg, to commence business on the very same day.

The Companies Act required MTI to be audited as a result of it holding customers’ bitcoin and fiat currency in a fiduciary capacity where that value was in excess R5 million.

Based on the application of relevant accounting frameworks each rand or bitcoin invested into MTI would have resulted in a corresponding customer liability on the balance sheet.

This massive liability would have resulted in a significant public interest score (as calculated by the Companies Act) that would have also required the company to be audited and to have a social and ethics committee.

Properly constituted, this would have further reduced the possibility of fraud as a result of a single director denominated company.

MTI also has a February year-end and in terms of the Companies Act was required to have audited financial statements by no later than August 31, 2020, which is six months after its financial year-end. Had MTI been regulated by the FSCA, this period may have decreased to three months.

If one looks at the rate at which funds were flowing into MTI (but also out the back door), these losses could have been limited to August or even May of 2020.

Read: MTI liquidators recover R1.1bn in bitcoin

The sole director, Steynberg, had failed to appoint an auditor and there was no regulating body overseeing or requesting MTI to provide audited financial statements.

Several red flags on its extremely complex multiple level marketing business plan would have been raised by both regulators and auditors.

If a company such as MTI made it past the acceptance procedures of an audit firm, the challenge would be to identify the fictitious assets that a Ponzi scheme relies on in addition to a certain level of pseudo-anonymity that bitcoin provides.

Wiehann Olivier is a partner and digital asset lead at Mazars.

COMMENTS   14

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The minute crypto is regulated, the main argument for its use disappears. Evading the authorities, the law and especially taxes is exactly why the fanatics are so keen on crypto. Regulation will remove this possibility, and will kill the entire scam.

Inferring that we are all criminals is quite a stretch and frankly quite insulting.

You don’t need to get so annoyed at the fact that simple tech like Bitcoin is enjoying such success. Instead of getting so annoyed, you might start questioning why Bitcoin is enjoying such success. Is it because people are criminals and want to evade tax? Or maybe because inept politicians and central banks are inflating our wealth away? Or maybe because they are dictating what we can / can’t do with our own money?

Maybe you should do a thought experiment on Zimbabwe 20 years ago and envisage whether something like Bitcoin may have been able to assist in preserving the wealth of people affected by political madness. There is nothing wrong in having an alternative to the funny money controlled by politicians and governments.

Anyway, this is just more confirmation that these university qualifications do no necessarily make us smart or equip us with common sense.

Why does crypto enjoy such success? And by “success” you obviously mean why is its price rising in dollar or rand terms, because you still can’t buy bread of petrol with these so-called currencies, so as a currency it’s been an epic failure.

Same reason tulip bulbs enjoyed huge success in the 1600s and subprime mortgages enjoyed “success.” Because they were bubbles. Because of speculation.

Yes, a rise in price is definitely one indicator of success, but this simply means that demand is outpacing supply at this stage of the cycle.

There are obviously others indicators which we may reference to point out Bitcoin’s continuing success such as increased developer contributions, increasing mining hash rate, increasing value transacted per day, corporate adoption, network uptime, etc. I won’t bore you with them all – You have been reading the news and it is your own choice to remain in denial.

I will concede, I have not been buying bread with Bitcoin, however, I have been buying Vodacom airtime every month for the last couple of years with it. Epic failure? Not so much…

Almost every market which exists today has some form of ongoing speculation, but this does not mean we should just ignore said markets. If Bitcoin were to be compared to the tulip bubble, subprime mortgage bubble, south sea bubble, etc. the only similarity is that Bitcoin is a bubble which keeps recurring ad infinitum.

And before 2008, there was a huge demand for “investing” in subprime mortgages, just as there was a huge demand for “investments” in Krion.

Regulation is crucial. In SA unfortunately anything “regulated” by the anc government will be a disaster as with anything else they touch.

Where some might think the main argument for the use of crypto is to avoid taxes or the “authorities” it is not always the case.

When you “educate” yourself a bit you will soon find that there is evidence (calculated and back tested) that an inclusion of crypto as an asset class into a properly constructed and balanced portfolio has great advantages. Surprisingly the volatility is not as bad as ones gutfeel would want you to believe.

Depending on your personal risk appetite etc. but maybe around 5% seems to give good results. Search the internet a bit and you will soon find numerous masters and PHD thesis’s on this very subject.

It goes without saying that with proper regulation there would be more managers making use of crypto in the construction of portfolios.

Should SA get the regulation wrong (and they probably will) crypto investments will become and Offshore investment like many other investment classes in SA has. So no real problem for the investor but good old SA will as usual be shucking the hind ……! and money will flow to where things work.

Surprisingly the volatility is not as bad as ones gutfeel would want you to believe.

LOL! Really?

One only has to be educated enough to be able to interpret a graph, say for bitcoin from December 2017 to December 2018, or from January 2020 to January 2021, to see how utterly laughable this little jewel is.

Why the hell is ” mass adoption” of crypto currencies a desired or necessary outcome in the first place? As if that’s really a financial priority in the Republic of South Africa in 2021.

For goodness sake let’s get real in this country and not waste time on fads like this. This whole crypto story – all of it actually including Bitcoin and Coinbase – smells to high heaven of operators (yes even the supposed ‘legit’ ones) hyping the thing as far as they can to make a buck.

I’m getting tired of hearing from visionaries who have this incredible deeper understanding of fiat currency and transactional systems. And of course we’re all going to miss out on the next big thing if we don’t get involved right now…what rubbish. A perfect opportunity for the like of MTI and thousands of other con artists.

Why does crypto have to have a use? Very simple: because if you’re investing in something, you’d better hope that it has a real-world economic use, else you’re merely gambling or a member of a pyramid scheme.

Crypto was designed to remove the middlemen (that take their excessive cut from the system).

To impose regulation… its like going back to being a bank…. and we dont want that.

If you have issues with Crypto, Simple Solution, Stay OUT.
Its for the brave and those who have guts.
Its important to do your homework and research.
For those who are clueless about technology and you loss your cash… tough luck. Do your homework.

Yes. It was developed to avoid (read “evade”) laws and the authorities.

Authorities, Who are they???

Have a look at dysfunctional SARS? Takes cash from people and gives supposedly back to the people…. The Politicians in this country, South Africa, have destroyed almost R1 trillion of Tax payers money. ZUMA and the Guptas have looted South africa, yet they still on the run, and we wasting money on a dysfunctional commission.

I have very little respect for the ANC, SARS, POLITICIANS, POLICE or whoever you consider Authorities in this country.

I am happy to pay for taxes and support a country, but when its wasted like the way the ANC is doing it, I am not prepared to invest in SOuth africa.

Good luck to you and you can happily waste your money on the ANC

And the Fed and the Bank of England and the German tax authorities?

Big mistake

Regulating crypto’s is like trying to get slightly pregnant.

No such thing.
Its cryptography and block chain technology -that’s suppose to prevent fraud
Its decentralized – hence no government involvement

but maybe regulating the players maybe there’s something there
international agreed upon standards may be needed

End of comments.

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