Having lost $33m of crypto assets at the height of FTX bloodbath, Digital Surge plots remarkable comeback
Deeply affected by the collapse of FTX, Brisbane-based crypto exchange Digital Surge endured a horror end to 2022. Its CEO, Dan Rutter, tells Stockhead how it’s managed to stay alive and kicking.
First, some context.
One of the thousands of businesses left reeling in the wake of the imploded global FTX crypto exchange, Digital Surge, which had financial exposure to FTX, lost $33 million dollars worth of client assets in 24 hours at the height of the crypto bloodbath in November last year.
Six months on, the company is looking to simplify managed custody for its clients through a combo of regulatory advocacy, a new approach to digital currencies and the development of a five-year customer payback rescue package with a $1.25 million personal investment from the exchange’s founders.
In February, Digital Surge reopened its platform for trading, deposits, and withdrawals…
Hi, Dan. Thanks for responding. What do you think are the main reasons Digital Surge has been able to survive as a business amid and since the FTX collapse?
Digital Surge CEO Dan Rutter: Digital Surge’s ability to survive and resume operations following the collapse of FTX can be attributed to several factors. Firstly, the company demonstrated a proactive approach by swiftly suspending deposits and withdrawals when it became evident that FTX was facing significant troubles. This precautionary measure aimed to safeguard customer funds and prevent potential disruptions.
And in the face of the FTX collapse, we made the difficult decision to enter voluntary administration in order to restructure the company and develop a comprehensive rescue plan. Appointing KordaMentha as the administrator meant we were provided with professional guidance throughout the process, ensuring a thorough evaluation of available options.
Can you tell us a bit more the voluntary administration stage?
During the administration period, Digital Surge’s directors, along with other involved parties, submitted a Deed of Company Arrangement (DOCA) proposal. This outlined a structured repayment plan for customers, offering an initial repayment of 43% followed by quarterly payments over a five-year period.
To demonstrate their commitment, Digital Surge’s directors also contributed $1.25 million of their own funds. The DOCA proposal was deemed the most favourable option by [business management consultancy] KordaMentha, and creditors subsequently voted in favour of its adoption.
Following the successful implementation of the DOCA, control of the company was returned to us. We executed cost reduction measures while fulfilling repayment commitments to creditors. And creditors with claims up to $250 were paid in full, while those with claims exceeding $250 received 57% of their claim.
Where does the exchange go from here, and can you elaborate on the commitment to your users?
We’re committed to rebuilding the platform and fulfilling its obligations to users who have experienced losses. The company’s primary objective is to repay customers in full for what they are owed. While this will not be an easy task, the company understands the urgency and significance of repaying customers who’ve suffered losses, and is fully dedicated to regaining trust and credibility.
Can you tell us a bit more about the rescue package?
Yes, reiterating, the plan offers an initial repayment of 43% to customers, followed by quarterly payments over a period of five years – and that’s utilising the company’s profits until customers are paid 100% of the AUD value they held. That’s in addition to the $1.25 million Digital Surge directors have contributed towards the repayment.
Additionally, Digital Surge’s claim against FTX is being managed by KordaMentha, and once the funds are retrieved, they will be distributed to creditors. The company will continue to use its profits to facilitate ongoing payments, ensuring a swift recovery with the ultimate goal of achieving 100% recovery for all creditors.
What other measures is the exchange undertaking?
By proactively addressing security, transparency, risk management, compliance, and customer support [see section directly below this one for details], Digital Surge aims to rebuild trust and provide a reliable and secure platform for cryptocurrency trading.
Additionally, the company is forming a customer advisory board to provide a platform for sharing information and seeking input from customers. This initiative will ensure that customers’ priorities and concerns are taken into account in decision-making processes.
What are the main lessons you/Digital Surge have learned from the FTX fallout and the subsequent impact on your exchange?
Several, and I’ll outline them here, including concrete measures Digital Surge has taken to prevent a similar situation from occurring for our business in the future…
• Limiting funds on third-party liquidity providers: Digital Surge now maintains a limit on the amount of funds stored with third-party liquidity providers. This helps to diversify risk and reduce dependence on a single provider.
• Instant fund ejection: The platform has implemented a streamlined process that allows for the instantaneous ejection of all funds from a liquidity provider in cases where substantial risk is perceived. This quick-response mechanism ensures prompt action can be taken to safeguard customer assets.
• Asset storage ratio: Digital Surge has introduced a cap on the ratio of assets stored in hot wallets (online) versus cold wallets (offline). This ensures that the majority of assets are held in cold storage, which provides enhanced security while maintaining sufficient trading liquidity.
• Enhanced due diligence: The platform has revised its due diligence process for onboarding new liquidity providers. This includes implementing additional risk assessments, conducting thorough evaluations, and adding extra safeguards to ensure the integrity and reliability of the providers.
• Managed custody solution: Digital Surge is actively developing a managed custody solution for its customers. This solution aims to ensure that customers’ assets remain under their custody, regardless of external events or circumstances. This measure reduces the risk of asset loss and enhances customer protection.
How has this experience altered your view of the crypto industry more broadly?
The FTX collapse and its effects have served as a reminder that while cryptocurrencies offer exciting opportunities, they also come with inherent risks. As the industry continues to evolve and gain mainstream attention, it’s crucial to establish a robust regulatory framework that protects investors and ensures the stability and integrity of the market.
What do you think needs to happen so that a future FTX debacle never happens again?
First and foremost, governments and regulators must acknowledge the permanence of cryptocurrencies and blockchain technology.
And that means, instead of resisting or fighting against their existence, it is essential to embrace the potential benefits and work towards developing comprehensive laws, regulations, and frameworks specific to the crypto industry.
Implementing strict standards for security, transparency, and operational practices within cryptocurrency exchanges is crucial. Regular audits and third-party evaluations can help ensure that exchanges are operating in a responsible and trustworthy manner.
The need for creating a true self-custody solution within the crypto industry is also crucial to protect customer assets in the event of a third-party collapse.
Furthermore, enhancing investor protection mechanisms, such as mandatory insurance for user funds and implementing rigorous KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures, can help safeguard the interests of users and prevent fraudulent activities.
There’s also a growing recognition of the importance of having crypto domiciled locally. Examples such as FTX Japan, which was required to domicile its customers’ assets locally and successfully recovered all customer funds, and the recent court battle won by Binance US against the SEC, which allowed them to continue operating by domiciling customer assets locally, highlight the potential benefits of such a requirement.
This approach provides an additional layer of protection and oversight, enhancing the security and resilience of the crypto ecosystem.
Collaboration between industry participants, regulators, and experts is also vital for the development of best practices and standards that promote responsible innovation.
Where do you think the industry is headed from a regulatory standpoint? There have been concerning signs in the US, and here in Australia, too – with banks pulling back from sections of the industry, for instance.
The regulatory landscape for the crypto industry is evolving rapidly, and it can vary significantly from country to country. While there have been concerning signs in the US and Australia, it’s important to note that regulatory approaches can change over time as governments and regulators gain a deeper understanding of the industry’s potential and risks.
In the United States, regulatory actions and statements from various agencies have raised concerns among industry participants. However, it’s worth mentioning that there are ongoing discussions and proposals for clearer regulations and regulatory frameworks to provide more certainty and clarity for market participants.
Similarly, in Australia, banks pulling back from the crypto industry might be a response to regulatory uncertainties and risk management considerations. The Australian Securities and Investments Commission (ASIC) has been actively monitoring the crypto space and has issued guidance to clarify regulatory obligations for market participants.
However, the regulatory environment is still developing, and it’s possible that clearer regulations and guidelines will be established to address concerns and foster a more supportive environment for the industry.
Overall, it is expected that regulatory scrutiny will continue to increase as the crypto industry gains more mainstream adoption. Regulators are working towards striking a balance between protecting investors and fostering innovation.
While regulatory developments may introduce challenges, they also present an opportunity for the industry to mature and gain broader acceptance.
Has your belief in crypto as an asset class changed or waned at all? Or is it as strong as ever?
Our belief in cryptocurrencies as an asset class has remained strong over the past year. Despite the volatility and occasional setbacks, cryptocurrencies have continued to attract significant attention and investment from individuals, institutional investors, and even governments.
Cryptocurrecies’ potential for innovation and disruption across various industries is huge. Blockchain technology offers the potential for more efficient and secure transactions, decentralised applications, and improved transparency.
Furthermore, major financial institutions and companies are increasingly exploring ways to incorporate cryptocurrencies into their operations, whether through accepting payments in cryptocurrencies or investing in digital assets.
Additionally, the increasing recognition of cryptocurrencies as a hedge against inflation and economic uncertainties has attracted investors seeking alternative stores of value.
Do you believe the crypto industry and market will survive and thrive in the coming few years? What positives are you seeing at the moment and ahead?
There are several positive factors indicating that the crypto industry has the potential to survive and thrive in the coming years.
• Market recovery: The market’s ability to rebound after a bearish period in 2022 indicates resilience and investor confidence. The significant price increases witnessed in cryptocurrencies like Bitcoin and Ethereum in 2023 suggest ongoing interest and support.
• Altcoin success: The success stories of various altcoins, driven by emerging narratives and market trends, demonstrate that there is room for innovation and growth beyond the major cryptocurrencies. This diversification of projects and ideas can contribute to the industry’s overall strength.
• Increased adoption: The integration of AI technology and the broader acceptance of cryptocurrencies by governments, such as Hong Kong’s plans to legalize crypto trading, indicate growing adoption and mainstream recognition. These factors can lead to increased participation from institutions and the general public, further driving the industry’s growth.
• NFT market boom: The surge in popularity and trading volume of NFTs signifies the emergence of new use cases and opportunities within the crypto space. This trend brings in a broader user base and expands the scope of blockchain technology beyond traditional finance.
• Ethereum Layer 2 solutions: The adoption of Ethereum’s layer 2 scaling solutions addresses the network’s scalability challenges and improves user experience by reducing fees and increasing efficiency. These advancements can attract more developers and users to the Ethereum ecosystem, fostering innovation and growth.
• Upgrades and innovations: The Ethereum Shapella upgrade and the continuous development of new technologies and protocols demonstrate ongoing progress and improvements within the crypto industry. These upgrades can enhance functionality, security, and scalability, providing a solid foundation for future growth.
If it were possible, what’s the number one thing you would you go back and change regarding Digital Surge over the past year?
If we could go back, in addition to strengthening risk management, we would prioritise promoting self-custody options at Digital Surge.
Encouraging customers to take control of their own cryptocurrency holdings would add an extra layer of security and reduce reliance on third-party custodians. By educating and empowering users about self-custody practices, we would contribute to a more decentralised and resilient crypto ecosystem while enhancing the privacy and control of our customers’ assets.
What’s next for the company? How do you think Digital Surge can regain a decent foothold again in the crowded crypto exchange market in Australia?
A prioritisation of transparency and open communication. The company is addressing the FTX incident head-on, providing clear explanations of the events and outlining the measures taken to prevent similar incidents in the future. We are actively engaging with customers and the public to rebuild trust and confidence.
As mentioned, security and risk management are also key focuses and Digital Surge is placing a strong emphasis on customer support and education, as well as staying ahead of market trends and customer demands.
Are you relying on the next big bull run in the crypto market to help turn things around?
While the potential for a future bull run in the cryptocurrency market is an optimistic prospect, our focus is not solely relying on it to turn things around, no. Our primary objective is to prioritise our customers and ensure that they are repaid 100% of what they are owed.
While market conditions can influence the overall performance of the industry, we are dedicated to taking control of our own destiny. We believe the success of Digital Surge lies in our ability to deliver exceptional services, provide outstanding customer support, and continually adapt to the evolving needs of our users.
This Q&A was edited lightly for clarity.
All information presented in this article should not be construed as investment advice. Cryptocurrency investments carry risks, and individuals should conduct thorough research and seek professional advice before making any investment decisions. The responsibility for investment decisions rests solely with the individual.